Why trustees must embrace ESG sooner rather than later

The most recent announcement from the pensions minister, Guy Opperman, in late January, made clear the UK is set to become the first major economy to require climate risks to be specifically considered and reported on by pension schemes. This is a positive step and a strong commitment to tackling the climate issue, the greatest challenge facing mankind today.

As we move towards the COP26 Climate Conference in Glasgow in November 2021, we expect to see more focus on the climate emergency and on the actions pension funds must take to manage the risks and seize the opportunities posed by our changing climate. We have been working with our clients who are leaders in this area for many years now and many pension funds have started that long journey towards sustainable investing.

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.

Where to start?

The pathway to responsible investment starts with beliefs. Trustees need to agree where they are travelling to in this journey. Often that direction will come from their members, for defined contribution schemes, and from their sponsors, for defined benefit schemes. Once the beliefs underpinning the strategic journey plan have been established, setting policies, establishing processes and informing the portfolio all fall readily into place.

The explosion of data available to trustees has been a major feature of the integration of ESG. Schemes need to know what the carbon footprint of their current portfolio looks like, in order to set meaningful carbon reduction targets. Trustees cannot monitor improvements in voting and engagement or in diversity from their managers, unless they know what the starting position is.

The duties being asked of pension trustees are very different to those of previous years. Much closer relationships with investment managers are being sought. The regulator is expecting trustees to become active asset owners, in a way some trustees will find new and potentially challenging.

The message from Opperman in January was stark. All occupational pension schemes with less than £100m in assets must either prove they are offering value for members or consolidate. The largest pension schemes are being given short-dated targets to demonstrate how they have aligned their portfolios with the Taskforce on Climate-Related Financial Disclosures (TCFD) recommendations. Many of them were also asked in February by the pensions minister to detail their stewardship and voting policies. The Department for Work and Pensions has made it clear that this level of pressure will only increase. A call for evidence in relation to social factors and a future consultation on stewardship have already been flagged.

Some leading asset owners in this area have been flag-bearers in integration of ESG. Some of them have seen stellar fund performance in recent years as a result. They have successfully shifted their dialogue with their investment managers over the years to ensure the managers are aware of their beliefs and priorities, and report on them accordingly. They have also put time, effort and resource into understanding, measuring and monitoring their carbon position. I think the pension funds that will prove most resilient in this area will be those who embrace this new direction of travel and aim to be leaders.

The climate and sustainability agendas will be in sharp focus this year in the lead-up to COP26. We are already seeing increased attention on ESG as companies aim to build back better after the Covid-19 shutdowns. Positive signs include schemes looking to sign up to the revised UK Stewardship Code by the end of April 2021, to demonstrate good practice; investment consultancies agreeing through the Investment Consultants' Sustainability Working Group (ICSWG) to sign up to a code of climate competency, and increased use of the UN's sustainable development goals as a reporting framework. We know that some clients have found this journey helpful in aligning their interests more closely with their sponsoring employer.

In summary, the pressure from the regulator will intensify. It makes sense for pension trustees who want to take the route of proving that they do add value for members to embrace this direction of travel sooner rather than later. There are numerous collaborative initiatives, which ones suit you will depend on which issues you have prioritised as a trustee board in your beliefs session. There are also numerous parties who can help you on your journey. Embrace the direction of travel and jump on board.

Lucy Tusa is UK head of responsible investment at Mercer

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.