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The clock is ticking . . . especially for larger DC schemes.
With deadlines (thanks at least in part to Brexit) almost permanently in the headlines these days, a reminder of another one may not be all that popular. Be that as it may, there are now only just over six months to go before the new regulations on environmental, social and governance (ESG) disclosure come into effect for pension schemes.
If scheme trustees have yet to address this looming development, time is beginning to run out. This matter is also relevant to UK charities, whether or not they sponsor pension schemes for their employees. That’s because it is usually the case that regulatory change or best practice in the pensions arena is sooner or later mirrored in the charity sector.
Firstly, a reminder of the Department for Work and Pensions (DWP) regulations and the key dates for the introduction of the new rules. In terms of what does not have to change:
- For schemes with less than 100 members which are wholly non-money purchase (“pure DB”) or non-money purchase apart from AVCs (“almost pure DB”) there are no new requirements.
- If such schemes have more than 100 members, however, then by 1 October 2019 they must have updated their policies on “financially-material considerations, stewardship and non-financial matters.”
Turning to schemes which are either (a) a mix of non-money purchase and money purchase from sources other than Additional Voluntary Contributions (AVCs) (“dual section”) or (b) schemes where all benefits are money purchase (“pure DC”), again the distinction between smaller (less than 100 members) and larger (more than 100 members) schemes is crucial.
- Smaller schemes: by 1 October 2019, must have updated their default investment strategy to take account of financially-material considerations and any policy on non-financial matters.
- Larger schemes: these face potentially the most onerous list of requirements. By 1 October 2019 they must have (i) updated their policies on financially-material considerations, stewardship and non-financial matters; (ii) updated their default investment strategy to take account of financially-material considerations and any policy on non-financial matters; (iii) updated the default investment strategy to take account of their policy on stewardship, and published their Statement of Investment Principles; (iv) by 1 October 2020, produce and publish an implementation statement as part of their annual report, setting out how they have implemented their investment policies and explaining any changes made as a result.
The final DWP paper published in September 2018 included the following table as a guide to the effect of the regulations on the different scheme types.
Illustration of the effect of these regulations on different types of schemes
It is important to be clear on “ESG” and, in particular, to distinguish it from socially responsible or ethical investing. We define ESG investing as the consideration of environmental, social and governance factors alongside financial factors in the investment decision-making process. The integration of ESG into an investment philosophy does not change the investment universe.
ESG investing enhances the framework for assessing companies, but does not make judgements on the activities of the companies themselves. Decisions are still based on the financial performance of a company and the ability of that investment to make money; the ESG approach simply helps to identify risks and opportunities that exist due to extra-financial factors (the E, S and G).
There may be an overlap between ESG investing and other investment styles (such as ethical investment or impact investing) but the crucial difference is the rationale for making the investment. With ESG, one makes the investment believing it will lead to financial and risk management benefits (either in the form of higher returns or lower risk). One is not investing purely based on ethical beliefs or a desire to positively impact society or the environment.
To illustrate the distinction, it may help to highlight a case which is currently before the Attorney-General and the Charity Commission and which may have ramifications for the way in which charity trustees invest their portfolios.
A group of 20 charities, including the Sainsbury Family Charitable Trusts, NCVO, the Quakers, RSPB and Joseph Rowntree Charitable Trust, has asked the Attorney-General and the Commission to seek a ruling from the First-tier Tribunal on whether the public benefit of charities means they should be required to align their investment policies with their own objectives and commitments to wider society. The campaigners’ move reflects an increasing emphasis on ethical investment and whether charities should maximise returns to donate to their chosen causes, or divest from activities which are felt to undermine those activities.
The group claims that existing guidance is outdated, vague and potentially misleading since it pre-dates rising concern over climate change and subsequent legislation governing trustees and charities. There is no set date by when the Attorney-General and Commission need to respond, so further updates on this interesting development will be issued as and when available.
"New regulations are often viewed with foreboding by trustees, already faced with administrative burdens. Yet in our view the DWP initiative is good news for investors of every kind. ESG factors are key drivers for the long-term sustainability of companies. "
Companies with good ESG ratings will, common sense suggests, usually be better at mitigating financial risks related to ESG factors such as climate change, labour disputes, cyber security and bribery. In addition, the outcome of the DWP consultation tilts the emphasis of the ESG policy towards risk management rather than ethical considerations, and as such should reinforce governance best practice. These benefits, though, are not a free lunch. It will no longer be possible to pay lip service to ESG factors with a brief comment in the Statement of Investment Principles; trustees will be expected to give a more detailed account of their policies in this area.
To sum up, within the next six months for relevant schemes:
- Trustee boards must decide to what extent they believe ESG factors are financially material.
- A policy should then be put in place, reflecting the board’s view in a manner proportionate to other aspects of risk management within the investment strategy.
- The policy should be clearly stated in the Statement of Investment Principles.
- ESG investing should become a standing agenda item for all future board/investment committee meetings.
ESG is already a very topical issue for investors of all kinds, and there is no doubt that the DWP regulations will strengthen the trend towards greater deliberation on, and disclosure of, the extent to which it is embedded in investment policies. There will inevitably be ramifications for charities as well as pension schemes, and we strongly recommend that charity trustees should be addressing these if they are not already doing so. We would naturally be only too happy to assist trustees in navigating what can be a complex area.
 The Occupational Pension Schemes (Investment and Disclosure) (Amendments) Regulations 2018 (now the Pension Protection Fund (Pensionable Service) and Occupational Pension Schemes (Investment and Disclosure) (Amendment and Modification) Regulations 2018).
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