Five ESG questions pension trustees should be asking

With so much for trustees to grapple with at the current time, what are the most important questions they should be asking about ESG?

1. Take a step back to review progress and policies

Pension trustees should first turn their attention to implementation reporting and check if their investment policies and stewardship arrangements are delivering against their investment principles, according to Barnett Waddingham policy and strategy lead Amanda Latham.

She says: "They need to be thinking about how they have developed their policies, the actions they have taken over the year and also the actions taken by managers on their behalf, and then report this to members. This is a developing area for trustees as well as for asset managers adapting to new reporting requirements."

Professional Pensions' parent company Incisive Media will host its inaugural Sustainable Investment Festival this summer to help schemes, trustees and advisers navigate this rapidly-evolving area of the market. Click here for more information.

2. Are trustees considering the environmental impact of their portfolios and factoring in climate risk?

Pension schemes are exerting pressure on investment managers to be transparent, disclose ESG risks and clearly demonstrate how they manage them.

Impax Asset Management managing director for client services and business development Scott Thompson says: "Pension trustees need to understand the ESG approach investment managers are taking during their stock picking and as well as understand the process for considering the different climate risks across sectors in the portfolio construction."

Investment managers' impact reporting allows trustees to ensure their own investment statements and objectives correlate with their investments, clarifies Thompson.

Barnett Waddingham's Latham says the government's roadmap for disclosures across the investment chain aligned with the Taskforce for Climate-related Financial Disclosures (TCFD), published in November 2020, "begins to give clarity and certainty on the flow of information".

She suggests trustees use the Pensions Climate Risk Industry Group's (PCRIG) guide on adopting the TCFD recommendations, to put them in a "better position to understand and manage climate change issues".

"The challenge now is in embedding these considerations into scheme governance, strategy and risk management," she adds.

Trustees should also ask fund managers the following questions on engagement and stewardship, according to 2020 Trustees managing director Naomi L'Estrange.

"What have been the tangible outcomes of stewardship activity in the last year, and can the ESG team/other team members veto a stock/bond choice on ESG grounds? If not why not?" she says.

"Ask investment consultants and fund managers what steps have they taken in the past year to improve the ESG characteristics/reduce the carbon intensity of their portfolios? What are they doing this year? What measurable impact has that had/will it have?'"

Trustees could also ask investment consultants if they will sell rate a fund on ESG grounds, Latham suggests. If not, why not and when will they start?

3. How should trustees use the DWP's ESG monitoring requirements to genuinely manage risk?

New reporting requirements requiring schemes to assess and report on the financial risks of climate change within their portfolios will include scenario testing and calculation of carbon footprints. While these disclosures will only initially be mandatory for the largest schemes, there are no hard and fast rules for how trustees should act on this information, according to Independent Trustee Services (ITS) director Tegs Harding.

Barnett Waddingham's Latham says those running smaller schemes also need to be aware of these changes and consider their response: "The recent consultation on taking action on climate risk indicates climate governance and disclosure requirements should be rolled out for all schemes in 2024."

All trustees should be asking how they go beyond just disclosure into actually managing the risks inherent within those disclosures, says Harding.

"Part of that is about considering how we engage with managers, and how the information we've gathered steers investment decisions, as well as how we square this information with the metrics we use to manage risk in the scheme today," she explains. "But at the heart of it is thinking what questions do I need to ask to genuinely understand the capital at risk from climate change, and does my adviser have the capability to answer them?"

4. What are the investment opportunities arising from ESG and climate change?

Pension funds could improve returns by investing in companies and funds that will be a part of the transition economy.

"Renewable energy is perhaps the most obvious example of an area that both offers good returns to the scheme and serves a useful purpose in the wider economy. There is also talk of the future role that things like green bonds and natural capital could play in portfolios," says ITS's Harding.

"How soon these opportunities will be available to institutional investors and does that fit with the journey plan the scheme is following? Will there be a first mover advantage? Does my adviser have the capability to advise on these new areas?" she adds.

5. Are trustees preparing for net-zero targets?

As we approach COP26 in Glasgow, net-zero emission commitments are coming from countries, companies, investors and pensions schemes alike.

Barnett Waddingham's Latham says: "Achieving net-zero by 2050 is already law in the UK, so right now is an opportunity for those running pension schemes to get a head start managing the risks stemming from climate change, as well as taking advantage of the opportunities coming from the transition to a low carbon economy. 

"This is by no means an easy task; net-zero is much easier to say than do and the industry as a whole has a hill to climb to make this happen," she adds. "We've got a clearer idea of the path now, but the hard slog still lies ahead."

Sustainable Investment Festival, 22-25 June

Professional Pensions' parent company Incisive Media will host its inaugural Sustainable Investment Festival this summer, featuring keynote speakers, innovative breakout events and sessions to help schemes, trustees and advisers navigate this rapidly-evolving area of the market. Click here for more information.