What are the risks of flouting ESG statement rules?

Pension scheme policies on environmental, social and governance risks such as climate change are “vague and non-committal”, the UK Sustainable Investment and Finance Association found in a report published last Thursday.

Few schemes had published their revised SIPs by mid-November last year, despite a legal requirement to do so by October. If the results of the UKSIF sample were replicated across the industry, two-thirds of schemes would be in breach of a legal duty.

Compliance deteriorated significantly with size, the report found. While each of the very large schemes assessed published its updated statement, half of the large schemes flouted the rule and 80 per cent of medium-sized schemes were non-compliant.

It goes without saying that trustees who fail to comply with the law expose themselves to legal challenge

Jo Etherton, ClientEarth

Among those trustee boards that did publish a SIP, the majority expected their investment managers to consider and integrate ESG risks into their decision-making.

However, UKSIF said that “word-for-word” replicas in most statements afforded managers full discretion over whether, or to what extent, they act on these issues. Just two schemes explicitly required their manager to take ESG into account.

More than half of the trustees surveyed said ESG issues would not factor into their decisions around hiring and firing managers, suggesting the asset management will be able to pay lip service to sustainability issues without any risk of pushback.

Regulator to publish guidance before enforcing

The views the report reveals stand in clear contrast to those set out by both the Department for Work and Pensions and the Pensions Regulator. However, it is unclear what consequences schemes will face for taking a different stance.

Neglecting to publish a statement will attract regulatory enforcement, although the timetable for doing so is unconfirmed.

A TPR spokesperson said: “The issue of climate change is systemic and cross-cutting. It affects not only environmental risks and opportunities, but also social and governance considerations. 

“As part of our new supervision approach, we are talking to trustees of major schemes to make sure they are aware of their responsibilities to comply with the new investment regulations that came into force in October 2019.”

The regulator plans to issue guidance on climate risk, building on the framework provided by the Taskforce on Climate-related Financial Disclosures, at the Pensions and Lifetime Savings Association’s Edinburgh investment conference in May.

However, while plans to enforce the SIP regulation are under way, trustees appear to have got away with it for now. 

“We will be developing a strategy to set out the improvements we expect over a specific time period. This is likely to include steps to identify non-compliance and plans for when we will routinely enforce against the requirements,” the spokesperson said.

“We may take action ahead of this against schemes where a failure to engage with climate risk and other ESG requirements appears to be part of a pattern of wider governance failings.”

One key challenge will be collecting information on compliance, according to Ben Nelmes, head of public policy at UKSIF and author of the report. 

“[SIPs] need to be sent into a kind of centrally hosted database,” he said, noting that this has enabled the regulator to take robust action on chairs’ statements. “That would actually give TPR a way of monitoring compliance.”

Mr Nelmes said many trustees were clearly lagging in their awareness of the new regulations.

“It seems to me that a lot of trustees just hadn’t noticed this,” he said. “Some of them wrote back [to requests for information] and said ‘who are you and why are you asking?’”

Members could take legal action

While the regulator does have the power to take action against trustees who fail in their legal requirements to publish SIPs referencing ESG risk, it does not appear to have any power to police the content of the statements.

This state of affairs looks unlikely to change, with the government facing significant difficulties in attempting to force trustees to pick or divest from specific investments.

"The government has been very vocal about what it expects from trustees but the requirements placed on trustees by the ESG regulations at this stage are quite limited," said John Sheppard, partner at Linklaters. "Trustees must say what their policy is on ESG issues but aren’t yet required to go beyond this. It will be difficult for TPR to show that trustees are in breach of the legal requirements because the policy in the SIP is only a high level statement."

He also said that as a large portion of non-compliance is due to logistical considerations, such as schemes not having their own website, and have now been rectified, taking regulatory enforcement action would seem excessive.

One potential threat to sluggish trustees, however, is that of litigation brought by members. Pension schemes have been hit with lawsuits in both the US and Australia over their ESG stance, although none has yet been successful.

Joanne Etherton, climate finance lawyer at ClientEarth, said the report was “enlightening”, and that “those who have fallen behind with their obligations need to take urgent action”.

“It goes without saying that trustees who fail to comply with the law expose themselves to legal challenge,” she said.

“Members should be aware that there are legal avenues they can explore if they are unhappy with how their scheme is managing climate-related financial risk.”