Better ESG integration is a marathon, not a sprint

Mark Carney’s ‘Breaking the tragedy of the horizon’ speech in 2015 helped push ESG into the spotlight, but more recently, measures have been put in place to drive tangible change.

Department for Work and Pensions rules, made effective on October 1 2019, require trustees of both defined benefit and defined contribution schemes to include, in their statements of investment principles an explanation of how they have taken into account ESG factors. This includes a specific reference to climate change, with emphasis on financially material factors.

While the momentum built in recent years must not be lost, we remain at the beginning of a journey

We welcome these rules and acknowledge the long-term benefits they will deliver. Clearly the UK pensions sector, one of the world’s largest investor groups, representing £1.6tn of assets, should be at the forefront of change. 

Yet, in the short term at least, this is placing new demands on trustees and those involved in making this vision a reality. While asset owners can be the drivers of ESG integration, we should acknowledge that this is not something that can happen overnight, and should be viewed as a journey towards a better, more sustainable future.

Product choice is insufficient

We believe there are three important questions to address at this early stage. First, how can trustees best engage with fund managers on this issue?

The UK pensions sector has the collective power to push the fund management industry for solutions that will allow their assets to be invested responsibly. Yet trustees who invest in pooled or commingled funds especially struggle to meet their ESG requirements because of many roadblocks.

Trustees are often told by fund managers that they are unable to offer bespoke voting policies or direct shareholder votes, fund-specific reporting, or convey trustee expectations through fund terms and investment restrictions.

There is also the issue that fund managers, depending on their domicile, are subject to differing regulations and interpretations of fiduciary duty.

Second, how can the industry guarantee a sufficient breadth of products? Currently, ‘ESG-labelled’ products tend to exclude such a range of activities that it limits the investment universe materially, which ultimately could affect the expected return profile or overall characteristics of the fund.

Trustees therefore often find themselves having to compromise between selecting a catch-all ESG-labelled product, which may avoid investments in a range of activities they are not opposed to investing in, or continuing to invest in a mainstream fund where they will need to accept that their ESG expectations cannot be met.

At what cost?

Finally, resource and budget constraints resulting from the new requirements are a significant issue to navigate for trustees.

At present, the level of fund-specific ESG reporting provided by managers is sparse; often asset owners are told that ESG reporting is only available on their ESG-labelled funds. Therefore, if trustees wish to have a thorough oversight of non-ESG-labelled portfolios in relation to ESG risks and opportunities they end up having to monitor these portfolios themselves.

This requires extensive resources in terms of time, experience and costs, which many schemes are not set up to do.

These challenges are by no means insurmountable, but serve as an important reminder: while the momentum built in recent years must not be lost, we remain at the beginning of a journey, and all partners must work together to make our shared vision of a sustainable future a reality.

Claire Curtin is head of ESG at the Pension Protection Fund, and a member of the Pensions Climate Risk Industry Group