On 1 October 2021, new regulations came into force requiring larger pension schemes (starting with occupational schemes that have £5 billion or more of assets, plus authorised master trusts) to put in place appropriate governance, reporting and publication arrangements in connection with climate-related risks and opportunities. It is unusual for statute to direct trustees as to the extent of their fiduciary duties although when the legislation was going through Parliament, the government of course denied it was directing trustees how to invest their members’ money. These new requirements reflect the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). This is a big change, which will apply to schemes with assets of £1 billion or more from 1 October 2022.  The government is keeping this under review and it is likely that the majority of schemes will be caught by the new requirements over the next few years, as the government continues to review the detail of the requirements. More information on the TCFD requirements is set out in our #How2DoPensions quick guide on TCFD Reporting.

Meanwhile, The Pensions Regulator (TPR) has adopted various climate change initiatives, including publishing its climate change strategy in April of this year, incorporating a section on climate change in its draft single code of practice, and consulting on draft guidance to help trustees comply with their TCFD governance, reporting and publication obligations – emphasizing that all trustees might wish to consider elements of the guidance, even if they are not in scope for the legal requirements. This follows on from TPR’s annual defined benefit survey, which revealed that only 19% of the smallest schemes had allocated time or resources to assessing financial risks or opportunities associated with climate change and even fewer had taken specific actions or implemented appropriate processes.

In addition, Make My Money Matter has launched its Green Charter encouraging the pensions industry to agree net-zero targets for all investments by COP26, and of course, there is COP26 itself, being held in Glasgow at the end of this month.

Finally, the UK government issued its first green gilt in September, raising £10 billion, so it would seem that there is definitely an appetite amongst investors to be part of the movement against climate change. There’s no doubt that climate change is one of the biggest challenges of our time and it is a financially material consideration that trustees must take into account when setting their investment policies. It’s not a ‘nice to have’. It is not, however, the only financially material consideration that trustees must consider.

Other environmental, social and governance considerations must not be overlooked. When setting their policies on investment choices, trustees must take account of all financially material considerations. While this is an obvious trust law duty, it is also set out in legislation, with “financially material considerations” being defined as including environmental, social, and governance factors, including climate change. For most trustees, this will mean thinking about what their investment beliefs are and setting a responsible investment strategy, which is shared and considered with their investment managers. It’s no good having a strategy that their investment managers can’t/won’t implement. It will also be important to consider the ESG strategy and beliefs of the employer. Having a strategy that clashes with that of the employer may cause relationship issues, even if the employer has no formal right in law to dictate how trustees should invest.

Part of the difficulty in taking account of ESG factors when setting a policy is that there is so much focus on climate change, that the other factors, particularly those that make up social factors, are often overlooked. While it is easier to assess the likely financial impact of environmental and governance factors (for example, poor governance and inadequate risk management policies in a company is likely to lead to loss of profit and a reduction in the value of any investment in that company), the financial impacts of some social factors can involve greater subjectivity in measurement.

Last year, various large companies came under pressure to investigate their supply chain when a report by the Australian Strategic Policy Institute estimated that more than 80,000 Uyghurs were transferred to work in factories across China under forced conditions. This posed problems for those trustees whose pension funds were invested in those companies. This was a social factor that would need to be taken into account, but how? What happens if a report commissioned by the investment manager concludes that all is fine, despite the press reports? Might the potential reputational damage alone reduce the long-term value of the investment and mean that the pension fund should no longer invest in such a company? Might there be a consequential reputational issue for the pension trustees and the sponsoring employer, or is that an issue that should not be taken into account when considering social factors?

It is also easy to confuse social impact investment (a positive, conscious opportunity that is designed to achieve social change at the same time as delivering a financial return) with those social factors that are financially material to an investment’s return.

But getting to grips with what does constitute social factors is important for pension trustees. This is why, in March 2021, the government launched a call for evidence-seeking views on the effectiveness of occupational pension scheme trustees’ current policies and practices in relation to social factors.  In its June 2021 response to that consultation, the Pensions Policy Institute noted that “nearly two thirds (64%) of Principles for Responsible Investment (PRI) signatories surveyed in 2020 said that COVID-19 had highlighted some social issues that were not already a priority, including areas such as: occupational health and safety; social safety nets; worker protection; responsible purchasing practices and supply chain issues; diversity; and digital rights, including privacy“. It went on to note that “Social risk factors can have a substantial impact on the sustainability of supply chains and the value of shares held by investors, and so present a material financial risk to schemes that do not appropriately take account of these risks“.

There is clearly still work to be done to increase awareness and knowledge amongst the trustee community so that they feel well equipped to take account of all ESG factors when setting their investment strategy, and not just the risks and opportunities around climate change. In the meantime, there will no doubt be much in the press around COP26, climate change and pressure on pension trustees to use their £2.6 trillion in assets to drive forward the Government’s green agenda.  Just don’t forget the “S” and “G”!