Direct contribution: Are pension reforms driving better ESG?

ESG investments were attracting particular attention pre-pandemic, as they were generally assessed to be outperforming the market and to have lower levels of volatility in the long term. 

While ESG obligations apply to almost every sector of the UK economy, pension schemes are directly in the firing line — as far as the government is concerned — for trying to ensure society takes greater responsibility for ESG matters.

October 2019 saw the first set of deadlines for pension trustees to document their approaches to ESG in their statements of investment principles. 

While ESG reforms to pension investments are a welcome step towards improving corporate ethics and sustainability, further action is needed to ensure companies set and actually meet meaningful ESG objectives

By October 1 2020, trustees will need to include further detail in their SIPs on their stewardship policy and arrangements with asset managers.

Trustees who are required to produce a SIP — for defined contribution/hybrid and defined benefit schemes with more than 100 members — will also need to produce an implementation statement when they publish their scheme’s annual report, setting out how they have followed and acted upon the investment principles and policies in their SIP during the scheme year.

The Pensions Regulator intends that this will help to ensure action follows words, and the obligation to publish both the SIP and an implementation statement should mean trustees will lean on asset managers and consultants to produce evidence of compliance.

Non-compliance with the legislative requirements is subject to discretionary penalties under s10 of the Pensions Act 1995 and Regulation 5 of the Occupational and Personal Pension Schemes (Disclosure of Information) Regulations 2013.

Is it working?

While pension funds are being targeted by the UK government as the principal vehicles for driving higher ESG standards in business, there is evidence to suggest that many funds have been slow to change course. 

A report by the UK Sustainable Investment and Finance Association, published in January 2020, found that most trust-based DC schemes had ESG investment policies that were “vague and non-committal”.

It also found that two-thirds of schemes had failed to comply with the minimum legal requirement to publish their SIPs. 

Such non-compliance places trustees in breach of their fiduciary and regulatory duties, although to date there has been little or no meaningful enforcement of pension funds’ obligations.

Moreover, provided a pension fund publishes a detailed SIP and implementation statement, there is at present no penalty if it fails to meet the ESG targets it sets out to achieve. 

The approach the government is taking is not to use a big stick to beat pension funds to comply, but to use public opinion to force scheme trustees to publish and implement their policies and/or investment strategies.

It is envisaged that this will give activist bodies the information they need to put pressure on schemes to engage more rigorously with ESG issues.

Problems with public opinion approach

One of the potential pitfalls of relying on public opinion to encourage pension funds and their investee companies to adopt ‘good’ ESG is that the public is several steps removed from the businesses whose job it is to implement ESG practices.

Some pension trustees have been concerned whether the changes to investment regulations mean they should be consulting members’ views on ESG. However, there is no strict requirement to consult members, but rather for trustees to continue to act in the best financial interests of beneficiaries and generally to disregard personal preferences or ethical views of members — or indeed of the trustees themselves. 

While ESG reforms to pension investments are a welcome step towards improving corporate ethics and sustainability, further action is needed to ensure companies set and actually meet meaningful ESG objectives.

In time, there will need to be mandatory targets coupled with legally enforceable penalties for failing to achieve them.

While many stakeholders currently look at company ESG ratings compiled by respected agencies, rather than evidence of legal compliance, such ratings may become less relevant as the volume and coherence of legislation increases, and if/when penalties for non-compliance become a greater deterrent.

Michael Calvert and Jeremy Harris are specialist pensions lawyers at European law firm Fieldfisher