Break down the Barriers

Despite pressure from members, UK DC pension schemes face structural obstacles to sustainable investments, says Jessie Wilson, a Professional Trustee at Dalriada Trustees.

ESG investing continues to sit on the fringes of many UK defined contribution (DC) pension schemes’ investment strategies, despite clear indications from membership that they would like to see their retirement savings having some positive impact.

An October survey from the Department for Work and Pensions (DWP) of the UK’s auto-enrolled DC schemes finds a reluctance from employers to offer ESG as part of the default offering, fearful of “imposing their beliefs on the employees”.

When asked if they would make ESG an option or a default, the majority of employers said they would not offer ESG investing as an option and most indicated that they did not consider ESG when choosing their pension schemes.

Respondents also argued ESG options were riskier and were likely to offer lower returns.

The DWP stated: “While smaller employers tended to be concerned with taking on the responsibility of picking an ESG option that may give low investment returns, some employers shared an underlying concern with the investment returns of ESG options, believing them to be more risky than traditional schemes.”

These attitudes contradict the findings of research from the DC Investment Forum which has repeatedly found evidence that members want exposure to responsible investment strategies.

Its most recent study, conducted in 2020, finds two thirds of members would have more trust in their pension if they knew that their money was used for responsible investment. This is up from 56% who felt the same in 2018.

Freedom from the fee cap

Jessie Wilson, a Professional Trustee at Dalriada Trustees – a company which “strongly [believes] that companies addressing and managing ESG factors impacting their business will provide better outcomes for their shareholders, and other stakeholders, over the long term” – says the current system needs to change.

“There are steps being taken to get the mechanisms in place that will allow members to ensure their money can ‘do good’. But there is a clear understanding that in DC this is the members’ money, and we have to consider cost,” she says.

Wilson argues that the mandatory fee cap of 0.75% for auto-enrolled default funds’ scheme and investment administration charges, which was introduced to keep costs down for members, leaves scant room for including ESG options.

“The fee cap puts pressure on trustees to choose more basic solutions for default funds. This means it is more difficult to have higher levels of ESG integration.”

This October the UK government announced a consultation into “broadening the investment opportunities of defined contribution pension schemes” which includes relaxing the rules around the fee cap.

The proposed measure would enable trustees to exempt performance-based fees from their charge cap calculations where they feel it is in their members’ best interests.

This, Wilson says, has the potential to allow DC scheme trustees to include more ESG strategies in default funds, especially those that want to invest in illiquid asset classes.

“If you wanted to invest in more illiquid assets such as infrastructure that can have a real ESG impact, this potential regulatory change will enable it,” she says.

The ability of DC pension schemes to invest in illiquid assets is likely to get a boost from the work of the Productive Finance Working Group, which this week published guidance to DC pension fund trustees, their sponsoring employers and their investment consultants on investing in assets such as venture capital, private equity, private credit, real estate, and infrastructure.


Competitive imperative

The DWP survey found that some employers “would be more likely” to consider ESG in default funds if they were to switch schemes in future; a factor Wilson says is driving the asset managers and insurance companies that provide DC pensions to understand the competitive importance of offering sustainable strategies.

“If you look at what the DC providers are doing, ESG is becoming a marketing point. They know that some employers will want their company DC scheme to have fantastic ESG credentials. Some of the bigger providers like Aviva have 2040 as their net carbon neutral target rather than 2050 and they are including carbon offsetting in their funds. If providers are not being as precise with ESG as the competition are, it’d be quite hard for employers to pick them going forward.”

In the defined benefit (DB) world there are also signs that providers with demonstrable ESG credentials have the edge over those without.

A September report from consultant Hymans Robertson shows that insurers involved in the buyout market – where DB plans pass their liabilities to a third party – are also keen to prove there are taking responsible investment seriously.

Paul Hewitson, Head of ESG for Risk Transfer at Hymans and author of the report, said: “There are opportunities for insurers to gain a competitive advantage by having strong ESG credentials. Trustees are increasingly assessing insurers on their ESG capabilities. In our view, it is important to assess insurers’ approach to ESG.”

Recent examples of insurer forays into ESG include Aviva investing £7.6 billion in green assets as at 31 December 2021 while, also last year, Phoenix Group invested £1.3 billion in sustainable assets.

The role of insurers in picking up the ESG mantle once they have taken control of DB liabilities is critical, Wilson says, because typically the schemes they take on are not invested in assets where they have a huge amount of influence, due to their weighting toward gilts close to maturity.

“I’m a huge ESG advocate but I’m also huge long-term investing advocate; they come hand in hand. But if you’re planning to go to buyout in the next couple of years, the trustees’ focus is on matching liabilities, meeting the insurer’s buyout price, and locking in any surplus. That does not give trustees scope to do much on the ESG front. However, when the scheme gets to the insurer, they can do a bit more because they have a longer investment time horizon.”

Reporting frustration

While acknowledging the notable progress made in supporting UK pension funds to meet their ESG responsibilities, Wilson is frustrated by the lack of standardised reporting from asset managers.

Wilson says: “We need more standardisation across asset managers so ESG decision making can be made on a on a fair and consistent basis. I keep hearing asset managers tell me how their ESG approach is the best, but I want them to report in the same way as everyone else. All we want is for them to agree on a standardised reporting mechanism.”

Wilson notes the progress made by the Investment Consultants Sustainability Working Group (ICSWG) which last November published a set of ESG-related metrics for all public equity and public credit asset managers. These are based on metrics that ICSWG’s institutional clients “are increasingly seeking to collect from asset managers”.

Standardised metrics would make life easier for trustees to meet their obligations under the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021.

These include taking proper account of the risks and opportunities from climate change when making decisions about the scheme, and reporting in line with the Task Force on Climate-Related Financial Disclosures (TCFD).

Wilson would also like to see more progress from asset managers in supporting pension schemes’ social investment considerations.

She welcomes the creation this July of a taskforce to support pension scheme engagement with social factors in ESG investing.

The DWP says the minister-led taskforce will “help identify reliable data sources and useful resources for pension schemes to assess and manage financially material social risks and opportunities. This work will contribute towards the development of wider principles, standards, and metrics”.

As part of a greater consideration of these issues, Wilson says she spends an increasing proportion of time looking at asset managers’ shareholder voting reports to assess whether and how they engaged with investee companies on social resolutions at AGMs.

“I would like to see managers are engaging on specific social issues. As an asset manager earlier in my career, I know that they can make a real difference when they engage with companies. I am frustrated when I get a shareholder engagement report that doesn’t have a single issue raised beyond basic corporate governance.”

Despite looking for innovation and engagement from asset managers on ESG, Wilson says it is more important that providers continue to get the basics right, such as helping trustees compile their annual implementation statement which much include detail of their stewardship activities.

“Asset managers are not always aligned with what trustees need. It is all well and good them talking about the latest evolution in ESG but if schemes are not getting things like their implementation statements right, then they need to focus on that. Asset managers should be constantly checking not just what’s good for them and business development but also how they are serving their asset owners.”


The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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