Pension Supervisors’ Principles-based Approach
IOPS Head Dariusz Stańko talks about the importance of integrating sustainability factors into pension funds’ investment and risk management processes.
The amount of assets in pension plans in Organisation for Economic Co-operation and Development (OECD) member countries grew by over 8% to US$53.1 trillion in 2023, equal to 82.4% of their total GDP.
With such huge financial firepower, pension funds have been encouraged by their supervisory authorities to consider ESG and wider sustainability factors in their investment decisions, as part of their fiduciary duty to secure the long-term wellbeing of beneficiaries.
This step change dates back to 2019, when the International Organisation of Pension Supervisors (IOPS) – an international standard-setting body for private-pension supervision with more than 90 members from both OECD and non-OECD countries – published its seminal guidelines.
Of the 10 guidelines it laid out, six were focused on the integration of ESG factors in investment and risk management process, three on disclosure, and one on scenario-testing of investment strategies.
Currently, the IOPS is working on an ESG guidelines implementation note, which is scheduled for publication later this year. The note is due to compile examples of how pension supervisory authorities from Australia to Colombia have interpreted and applied the guidelines in their national context.
Long-term sustainability
The idea behind the 2019 guidelines was to help pension supervisor members react to ESG developments, according to Dariusz Stańko, Senior Private Pensions Expert in the OECD’s Financial Affairs Division, who also heads up the IOPS Secretariat.
“We had already thought about starting a discussion three or four years beforehand, but there was not much appetite because at that time regulators didn’t think ESG was part of their mandate,” he said, speaking in a personal capacity to ESG Investor. “Of course, that changed and supervisors are now involved in many initiatives.”
Illustrative of the positive impact made by the publication of the guidelines, many countries – even those that weren’t IOPS members – began incorporating the suggestions into their national processes and regulations. “Many were inspired by the guidelines,” Stańko said.
In his opinion, the guidelines’ main achievement was to signal to pension funds that integrating ESG criteria into their investment and risk management decision-making processes aligns with trustees’ fiduciary responsibility and members’ best interests.
“Looking at investments through an ESG lens reveals risks and opportunities that could impact financial results,” he added. “A pension fund’s role is to take care of its members, which means looking at what will impact return. Considering ESG factors is part of the modern job.”
Stańko believes this approach can help avoid an ideological discussion. The highly politicised debate taking place in the US, with some states enacting anti-ESG investing rules, is a case in point.
“If the investment decision is motivated by saving the world, then it is possible to end up with something that doesn’t work, as investments can deliver returns or losses,” he explained. “Instead, integrating ESG factors in investment decisions should be synonymous with proper use of funds.”
In other countries, there is growing pressure on pension funds to be more ambitious and proactive in incorporating ESG factors in their investment strategy – even to the point of advocating a greater focus on saving the planet, and less on return.
While the IOPS guidelines encouraged disclosure around stewardship (guideline 9), Stańko said they stopped short of suggesting that pension supervisors should adopt such a stance – though he doesn’t rule it out for the future.
“The guidelines’ point is that investment decisions can be motivated by financial or non-financial factors based upon a set of values,” he added. “Either could result in financial return or loss. Therefore, the risk-return profile should be decided by the pension funds and their members.”
Some funds, for example, base their investment decisions on religious beliefs.
“This is acceptable as long as the members are properly informed and understand that this approach might result in some return sacrifice,” Stańko continued. “It should be an active decision.”
Concrete examples
Importantly, the IOPS guidelines are not an “iron law” that must be followed, but should be viewed as desirable advice for all types of investments, he argued.
The implementation note does not set new guidelines either – but rather aims to support pension supervisors by providing a variety of existing practices and rules in different countries.
“The note is a review of developments across the world and includes examples from outside the pension sector, such as banking and insurance,” Stańko explained. “We also provide several examples from the Network for Greening the Financial System (NGFS).”
Some examples might appear to contradict others, he said, but that is because they are tailored to national environments. As such, it is up to each jurisdiction to choose its own approach.
“We think it is inspiring to see how a central bank is structuring its supervisory expectations on integrating ESG in investment and risk management processes, for example, because it can also be applied to the pensions world,” he added.
The implementation note highlights the standards developed by the International Sustainability Standards Board, including the IFRS S1 and IFRS S2 – which fully incorporate the recommendations of the Task Force on Climate-related Financial Disclosures. It also refers to the European Sustainability Reporting standards and the Global Reporting Initiative standards.
“It is for the members to choose – we do not endorse a specific standard as yet,” said Stańko. According to him, IOPS’s role is to share experiences and facilitate discussions around what is working, and what should be avoided.
He shared his disappointment that in preparing the implementation note, he couldn’t find more inspiring examples of how to treat the ‘S’ – the social aspect of ESG – outside diversity and inclusion.
“Perhaps it is not visible because the social concept is hard to quantify,” he added. “While NGFS and others have done good work around stress-testing environmental issues, not much attention has been given to social matters.”
Measured approach
Over recent years, Stańko has noticed a shift in supervisors’ attitude when giving guidance to pension funds. Instead of providing a detailed list of expectations, supervisors are now taking a principles-based approach and creating high-level frameworks, giving the pension industry room to research and develop new solutions.
“At this stage, it would be difficult to provide detailed, prescriptive rules for the integration of ESG factors because things are evolving so quickly,” he added. However, he believes that a principles-based approach could prove to be a burden on pension funds as it requires technical skills, people and proper funding.
Stańko also expressed concerns that the increasing regulatory pressure, expectations and amount of information may have an impeding impact on small pension funds.
“Hopefully, there will be some proportionality applied, but it still puts a lot of expectations on smaller funds and increases their costs,” he said. “As with all good ideas, some might lack the capacity to implement them. Collective knowledge will be helpful, but small pension funds may feel the pinch – which is why they are asking supervisors and policymakers for guidance.”
Pension supervision is best done by the entities themselves, with the supervisor simply ensuring that the risk management process is appropriate, Stańko argued.
“This is the concept of risk-based supervision,” he added. “The pension supervisor should create a suitable framework at pension-fund level.”
Next steps
Like in many other areas, one of the biggest challenges still facing the pension industry is lack of data. Given pension funds’ ever-increasing demand for the resource, Stańko is hopeful that a market solution will soon be found – but supervisors and policymakers will need to assess the data’s accuracy
“The ‘black box’ around ESG ratings, for example, is concerning, as there isn’t much consistency between the different rating providers,” he said. “While there can be some deviation, a lot of questions are raised if the results are widely divergent.”
As pension funds require new types of data to facilitate the integration of ESG factors into investments, the next iteration of the IOPS ESG guidelines should aim to heighten its focus on the issue, he added.
Reflecting on the 2019 iteration of the guidelines, which Stańko deemed “quite general”, he said:
“Perhaps we could have provided more detailed examples, but it wasn’t really possible as the whole area was still developing. In addition, each jurisdiction has particular nuances that can be added on top of a general structure.”
A wider context should be considered in future revisions of the guidelines, Stańko further suggested.
“We should look not only at investments, but also at the role of pension supervisors and funds in reacting to climate change in the long run,” he said.
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