In an important consultation paper, the DWP has reversed its previous decision not to legislate to force pension scheme trustees to “go green”.

Rather than rely on the Pension Regulator’s guidance, the Government now intends to require the trustees of pension schemes to take account of financially material risks of the Environmental, Social and Governance kind in their investment strategy.100

If this sounds a little wishy-washy, the DWP makes it clear that for  schemes with more than 100 members, Trustees will be required to have a stated policy on stewardship (the exercise of voting rights and influence on the management of investments). What’s more DC Trusts (where the member’s are taking the risk) will need to publish their Statement of Investment Principles (SIP), alongside their statement on the costs and charges of a scheme, on a website. The SIP will need to be accompanied by an implementation report that tells members how the trustees got on with doing what they said on the packet.

Why?

The Law Commission recommended in its 2014 report that pension schemes adopt ESG but the Pension Regulator’s guidance has led to “confusion and misapprehension” among trustees. It would seem that – left to their own devices, trustees ended  up doing nothing at all.

So the stick is now being brought to bear, rather than the carrot. The Law Commission had established two principles

1. That trustees should be prompted to action by concerns of members
2. That their actions implementing ESG should not cause financial detriment to members

The “confusion and misapprehension” was around both principles. Trustees didn’t know what members thought and did nothing. Trustees did not understand the consequences of intervening on ESG, so  did nothing.

In discussing why the Government thinks these new measures will help in solving this confusion, the consultation points to considerable research (including the recent DCIF research from Ignite published on this blog)  that points to considerable public awareness of the importance of ESG (or responsible investing as I’d prefer to call it).

Infact 61% of the people interviewed by Ignite assumed that responsible investment was part and parcel of what a pension scheme did.

It would appear that most members are clearer about what they think the trustees should be doing, than the trustees!

Which is why the Government are effectively telling trustees to get on with it. I agree with the Government, I just wish we’d taken this stance four years ago (most of these measures will not be up and running until the next decade, but relative to the implementation of the new AE regs, this is lightening quick!

Does this go far enough?

Much of the paper discusses the balance to be achieved between driving “ethical” behaviour and financially responsible behaviour. The DWP conclude that they do not have the right to decide what is ethically right and impose this on trustees. For instance the new rules would short of requiring trustees to have a policy on positive social impact,  this leading to confusion and disputes that could get – well – political!

However, where there is clear evidence that poor environment, anti-social or weak governance is causing financial loss to members, the trustees will – in future – be required not just to state they will reduce the risk of loss  but also to report on how they got on in implementation reports.

Much as I would like to impose my ethics on everyone else, I recognise that this is not my job nor the Government’s job for that matter. I think that the Government has got this right and though I’d like to see trustees responding to pressure from members to push boundaries on things like social impact, I don’t think that ethical policies can be delivered top down. Not without some fair criticism of trustees for paddling their own canoes.

What is the financial justification for introducing ESG?

The paper is clear that there are occasions where there will not be an onus on trustees to implement an ESG approach

1. Where the scheme is smaller than 100 members and can’t find resources or the clout to make a difference
2. Where a scheme is winding up, and the short time horizons mean that the cost of implementing change can’t be justified by the positive impact of ESG over time

But for the majority of Pension Schemes – especially DC schemes, the new rules can be justified because they reduce the wrong kinds of  financial risks being taken by members.

Here we come to the philosophical heart of the paper and that part that I find most interesting. If trustees are exercising their duty to protect members (one of the Pensions Regulator’s Statutory Objectives for them, then they should be protecting them from the financial risks surrounding ESG.

This begs the question -what risks? There is an increasing body of  evidence that shows that pension schemes can reduce volatility and increase returns for DC members by adopting ESG principles.

However, trustees can choose to ignore this research and decide that ESG factors are not for them. To do so, they are going to have to say why in their statement of investment principles and revisit those principles year on year to prove they are still right.

This will be very difficult for trustees to do. They will have to justify this stance not just to the member, but to the Pensions Regulator and finally to themselves.

Ultimately , the risk of not implementing an ESG policy and stating what it is to members in a public way, will outweigh the risk of doing it.

This is what this consultation is saying and I would be very surprised if many trustees contested it.

What is the political justification for this intervention?

Government has signed up to the Paris Accord. Britain is committed to lower emissions and the prevention of harmful climate change. Like governments should, it is interested in good governance and of course it encourages positive societal change.

Pension funds are long-term investors in the assets and organisations that influence our capacity to improve behaviours. It would be great if our trustees were able to adopt and encourage these behaviours themselves, but attempts so far have ended in “confusion and misapprehension”.

This consultation is about resolving confusion and making it clear what trustees should be doing. It could go further, but I suspect it would not take trustees with it. As it is, I think it is what is needed, when it’s needed and I’m very glad it has been published.

I hope that the FCA read it properly – and indeed their IGCs.

Good article on this in this morning’s Guardian (no paywall)