UK Trustees Must Close Gap on ESG Compliance
The Pensions Regulator is being encouraged to take its focus beyond disclosure, and issue more guidance that incentivises action.
A recent report from The Pensions Regulator (TPR) has revealed a gap between UK pension trustees’ ESG disclosures and their actual processes, with industry pundits calling for new guidance to push ambition.
TPR reviewed trustees’ statement of investment principles (SIPs) and implementation statements (ISs) in three ways to assess ESG compliance: a quantitative review of around 3,500 defined benefit (DB), defined contribution (DC) and hybrid pension schemes to check how many trustees provided a weblink to their SIP and IS disclosures; machine-reading to identify ESG-related content from a representative sample of SIPs and ISs; and a deeper assessment of SIPs and ISs provided by 50 schemes.
Around 99% of schemes provided TPR with access to their ESG disclosures, but most smaller schemes only opted for minimum compliance within their reporting.
“Many [trustees] are merely ticking boxes rather than demonstrating a genuine commitment to environmental, social and governance factors,” Karen Shackleton, Founder and Director of pension fund advisor Pensions for Purpose, told ESG Investor.
Generally, trustees identify climate change factors as financially material to their investments, but they should now go beyond climate reporting and focus on other sustainability-related themes, such as social factors, TPR argued.
The regulator also found that pension trustees often failed to demonstrate ownership of their ESG policies and activities.
“Despite the importance of these [ESG] issues, many trustees appear to delegate responsibility to third parties, such as asset managers, without sufficient oversight,” said Shackleton. Taking such a hands-off approach increases the risk of missed opportunities and inadequate management of ESG-related risks, she warned.
In many instances where trustees delegated activities to asset managers or other in-house employees, SIPs and ISs often did not sufficiently explain or demonstrate trustee oversight of asset managers’ activities, TPR said.
“It is not enough for trustees to report that they have delegated these matters to asset managers,” the report noted. “Where the management of financially material risks and engagement and voting [are] delegated to the scheme’s asset managers, we would still expect to see evidence of oversight by trustees.”
In addition, only a minority of schemes invested in pooled funds said they were reviewing and monitoring manager policies on ESG-related areas.
“We found that even where trustees referred to reviewing and monitoring managers, there was often little detail provided on what this entailed,” the report mentioned. “ISs were often lacking in clear, scheme-specific examples of what ESG-related voting and engagement activities had been undertaken during the reporting year.”
There are several options trustees can use to show that they are actively monitoring and engaging with managers of pooled funds, according to TPR. These include using existing resources like the UK’s Stewardship Code signatory list and reports, and the Pensions and Lifetime Savings Association stewardship and voting guidelines.
“Trustees should try to better understand how their investment managers are measuring, monitoring and mitigating ESG risks and taking advantage of ESG opportunities,” said James Moore, Partner at investment consultancy LCP. “Trustees do not need to be experts on ESG factors, they just need to ask their managers questions, challenge them and push for improvements.”
Small schemes need big ambition
TPR’s qualitative review of pension schemes SIPs and ISs showed that larger schemes were typically more actively and broadly engaged on ESG issues and provided meaningful details that went beyond compliance.
Some smaller schemes with assets up to £20 million (US$25.4 million) also produced some “very high-quality disclosures”, TPR said, but most struggled to expand their disclosures with more detail.
There are a variety of reasons for this, according to Moore.
“ESG risks are complicated and interconnected, and therefore require significant knowledge and resources to understand and mitigate them,” he said. “The resources challenge is also not helped by the complexity of the pensions landscape and the number of rules, regulations and guidance that trustees are expected to follow.”
TPR could better support trustees of smaller pensions by highlighting what it sees as best practice under a range of different scheme circumstances, Moore suggested.
“This should include specific examples of actions that trustees could take within the practical constraints that many schemes have,” he added.
Other challenges for many DB pension schemes include a shortened investment horizon, and a misperception that ESG risks are largely long-term.
“We believe that a re-interpretation of pension trustees’ fiduciary duty to enable them to have a longer-term horizon could help with this,” said Moore.
If pension trustees believe they lack the expertise or governance to manage financially material ESG risks effectively, they should consider whether consolidating their schemes could improve this, TPR suggested.
“Although we have seen many trustees do more to manage ESG risks since regulations started requiring disclosures, it would be much more effective for regulations to focus on action,” said Moore. “Taking climate risks as an example, substantial investment is required in climate solutions such as renewable energy to successfully transition to a net-zero economy. Many of these investments are illiquid growth assets, posing challenges for UK pension schemes, both DB and DC, to invest in them.”
Regulatory changes could help overcome these barriers, Moore said, which would then increase the funding available from pension schemes for climate solutions.
“We are optimistic that there is appetite from the new government to address these barriers, given its focus on increasing productive investment in the economy,” said Moore.
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