Trustee investment duties: the environmental, social and governance impact

The Department for Work and Pensions’ consultation on clarifying and strengthening trustees’ investment duties closed on 16 July. The findings of the consultation will be of interest to trustees for DB, DC and Hybrid Dual-Section Schemes alike.

In response to a review of social investment by pensions funds carried out by the Law Commission in 2017, the Government has noted that there is confusion and misapprehension regarding trustee responsibilities, with evidence of trustees incorrectly believing that environmental, social and governance risks are irrelevant or run counter to financially material concerns in pension investments. On 18 June, it opened a consultation on clarifying and strengthening trustees’ investment duties.

What is the Government proposing?

In a nutshell, the aim is to revise regulations to reassure trustees that they can and should do the following:

• Take account of, and have a policy on the evaluation of, financially material considerations. This includes but is not limited to environmental, social and governance (ESG) considerations, including climate change, in the selection, retention and realisation of investments;
• Fulfil the responsibilities associated with holding the investments in members’ best interests, through a full range of stewardship activities including monitoring, engagement and sponsoring shareholder resolutions;
• Have an agreed approach on the extent, if at all, to which they will take account of members’ concerns about ESG factors and the scheme’s investment strategy as a whole; and
• Where trustees are required to produce a SIP, use the SIP as a real effective and regularly reviewed guide to investment strategy.

These changes are currently proposed to take effect from October 2019, some of which would be introduced on a transitional basis.

What are ESG considerations?

ESG considerations are used by investors to evaluate corporate behaviour and determine companies’ future financial performance. Environmental considerations include resource depletion, pollution and deforestation. Social considerations include working conditions such as slavery and child labour, health and safety, employee relations and diversity and social unrest. Governance considerations include executive pay, bribery and corruption.

What does this mean for trustees if the proposals go ahead?

For DB schemes (including DB schemes with AVCs) with less than 100 members there are no new requirements proposed under this legislation. However, given that 16 of the largest investment consultants have agreed to recognise the importance of addressing risks around long term sustainability, including ESG considerations, and to draw this to the attention of pension scheme trustees, it is still something to bear in mind.

For DB schemes (including DB schemes with AVCs) with more than 100 members, the trustees will need to update their SIP to take account of financially-material considerations (including ESG), stewardship and to state how members’ views are taken into account.

For DC schemes (and hybrid dual-section schemes), the trustees will need to update their default strategy to take account of financially-material considerations. Such schemes with more than 100 members will also have to update their SIP in the same way as for DB schemes, and also produce and publish both a SIP implementation report and a statement as to how members’ views are taken into account.

In light of these proposed changes, trustees will still retain control of investment decisions and their prime focus remains delivery of a return to members over an appropriate investment period. Trustees are required to come to their own conclusions about materiality of risks, taking into account the advice they receive from their consultants. However, these proposals aim to clarify trustee responsibilities, and make trustees more relaxed in their decision-making.

For further information please see the guidance on the government website here.