UK pension schemes are subject to new stewardship rules that push ESG to the top of their agendas.
Stewardship is widely considered one of the most effective tools in an asset owner’s toolbox to ensure companies are prioritising ESG-related issues, such as mitigating the effects of climate change.
“It is through good stewardship that corporate engagement can drive high carbon emitting companies to develop and implement a net zero transition plan, which will ultimately help to decarbonise the global economy,” says Stephanie Pfeifer, CEO at the Institutional Investors Group on Climate Change (IIGCC).
Following a consultation, last month the UK’s Department for Work and Pensions (DWP) published new guidance to improve pension trustees’ reporting on ESG-related stewardship priorities and progress.
It included non-statutory guidance on Statement of Investment Principles (SIPs) disclosures and statutory guidance for Implementation Statements (ISs).
Through SIPs, trustees with 100 or more members are now expected to publicly state their – or their external managers’ – engagement policy and priorities, and explain in detail how they steward their sustainable investments. They are also required to report how, and to what extent, schemes have utilised that engagement policy, publicly disclosing significant votes as evidence in their ISs.
Trustees must comply with statutory guidance from 1 October, but non-statutory requirements apply from the publication of the paper. The DWP will assess whether further guidance is needed in H2 2023.
The DWP simultaneously published a response following its consultation on proposals to amend the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021. It emphasised the importance of trustees raising their climate stewardship ambitions by using Paris-alignment metrics to inform their engagement efforts to ensure they are truly contributing to the goals of the Paris Agreement.
“The initial consequence of all of this is a lot of extra work for pension trustees and the professional service providers,” John Wilson, Head of Technical, Research and Policy at independent professional pension trustee consultancy firm Dalriada Trustees, tells ESG Investor.
“Nonetheless, trustees need to make sure [stewardship] is higher up their agenda and that requires some hard work, so we appreciate what the DWP is trying to do.”
Speaking to the manager
A core part of the DWP’s stewardship guidance was the requirement that trustees exercise more oversight over external asset managers, including on voting.
It is “incumbent” on trustees to closely scrutinise their managers’ stewardship policies and engage if they are not aligned with their objectives, according to Olivia Mooney, Responsible Investment Consultant at Hymans Robertson.
“This requires both skills and resource to do properly,” she notes.
Currently only 35% of UK occupational pension funds conduct an annual stewardship assessment of their investment managers, according to a recent Mercer study. This week, Hymans Robertson called for pension schemes to raise expectations of managers on stewardship when publishing a guide for trustees.
The DWP said trustees must publish their own voting policy or “acknowledge responsibility for the voting policies that asset managers implement on their behalf”. Simply reporting that they have delegated stewardship to their asset managers is not satisfactory.
If schemes hold assets directly, trustees must set out their stewardship policy on engaging with issuers in their SIPs. If dependent on their asset managers, trustees are encouraged to engage with managers “at least annually” to discuss their voting and engagement policies to inform reporting.
Trustees must outline in their ISs whether the investment manager has agreed to follow their voting policy and, if not, their reasoning for why.
“Some of the disclosures required on voting are basic statements of fact – for example, whether the scheme has used a proxy voting service provider – but aspects like requesting voting data from managers and providing narrative on the most significant votes will require more time to prepare,” says Mooney.
Trustees can consult the UK Stewardship Code to monitor investment managers’ stewardship progress, as well as the Pensions and Lifetime Savings Association’s (PLSA) Vote Reporting Template and the Association of Member Nominated Trustees’ (AMNT) Red Lines Voting Initiative, the DWP said.
The updated Stewardship Code came into effect from 1 January, 2020, and reflects the increasing importance of ESG factors for investors, as well as expectations for higher standards by regulators.
Other initiatives have been working to improve stewardship alignment between asset owners and managers.
In January 2021, a new steering group was launched to improve and align stewardship by asset owners and managers, spearheaded by the PLSA and the Investment Association. The group recently published new recommendations, including introducing a ‘governing charter’ setting out mutual expectations on the promotion of long-term sustainable value.
Experts speaking to ESG Investor point out that pension trustees investing in pooled assets have less say over external managers’ voting priorities and level of engagement.
This is because the asset owner doesn’t directly own the shares and has to accept the manager’s voting policies “by default” says Nikesh Patel, Head of Client Solutions UK at Dutch investment manager Van Lanschot Kempen.
The DWP noted in the stewardship guidance that trustees can publish an ‘expression of wish’ outlining the stewardship criteria they would like external managers to follow, but asset managers aren’t required to take this into account.
Trustees are expected to indicate in their ISs whether their expression of wish has been followed.
Patel argues that the expression of wish is “a complete waste of effort and time”, as asset managers “don’t have the time or capacity to consider every individual expression of wish from all trustees”.
Perhaps recognising the practical difficulties of case-by-case monitoring, the DWP noted that proactively conducting due diligence prior to asset manager selection is vital to make sure that the asset manager’s stewardship priorities are already closely aligned with the trustee’s objectives.
Patel further notes that introducing split voting – meaning that asset owners have a share of the vote according to their percentage of ownership – “could really move the dial”, as this would give trustees and members the option to highlight their voting and engagement preferences to the asset manager.
Investor engagement fintech Tumelo has been working on technological solutions in this area, most recently partnering with Fidelity International to launch a Stewardship Hub for pension funds, trustees and advisors. Tumelo has also worked with Aviva Investors to help pension clients access member voting data and with Legal and General Investment Management on a similar project in 2020.
In 2020, Pensions Minister Guy Opperman announced the launch of the Taskforce on Pension Scheme Voting Implementation which, independently from the DWP, has been investigating barriers preventing trustees’ voting policies from being implemented and ways to increase the number of asset managers prepared to engage with their client preferences.
In its new guidance, the DWP acknowledges that trustees’ stewardship priorities vary, but says this should be reflected in their SIPs and ISs.
Stewardship priorities depend on the trustees’ investment beliefs, risk assessments, members’ and beneficiaries’ best interests, assets currently invested in, and investment horizons, the DWP said.
Although pension trustees have a variety of different priorities, IIGCC’s Pfeifer counters that the net zero transition is “increasingly accepted as a priority for all investors”.
Other ESG-related themes such as biodiversity, executive remuneration and modern slavery are also expected to become increasingly relevant to pension scheme members and should therefore be reflected in trustees’ stewardship priorities, the guidance noted.
The DWP’s acknowledgement of pension schemes’ different investment time horizons is an important one, says Patel, noting that stewardship priorities need to be “feasibly ambitious”.
“Trustees with a five-year time horizon are unlikely to be able to fulfil a net zero stewardship priority, but they can commit to more realistic emissions reduction priorities aligned with that timescale,” he says.
Once priorities are identified, trustees must disclose why they have chosen to focus on those areas in their SIPs.
Fergus Moffatt, Head of UK Policy at NGO ShareAction, notes that the DWP has softened its stance on requiring trustees to explain how they are acting in the ‘best interests’ of scheme members, which he notes “would have been a helpful way for trustees to outline to members what they considered their best interests to be”.
Nonetheless, he welcomes the retention of guidance around how schemes can “consider the views of members”.
Plotting a path to Paris
As outlined in the DWP’s updated requirements under the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021, Paris-alignment metrics should be used to direct trustees’ climate-related stewardship efforts.
“Effective stewardship, informed at least in part by portfolio alignment assessments, will help trustees drive real-world decarbonisation outcomes whilst delivering long-term value to savers,” the DWP said.
The government body outlined that a “binary calculation for listed equities” can be used to identify the number of portfolio companies with science-based targets or poor climate records. Trustees can then use this information to prioritise specific companies for engagement.
“We agree that portfolio alignment metrics can help schemes to determine where stewardship is most critical within their portfolio – for example, targeted engagement or voting escalation strategies with laggard companies – but trustees will need to look through the headline metric into more granular detail to enable this activity,” says Mooney.
The DWP pointed to the IIGCC’s Net Zero Stewardship Toolkit as a useful resource. Developed in partnership with UK pension scheme Railpen, it includes guidance on setting net zero alignment criteria and developing engagement strategies for priority companies.
Pfeifer tells ESG Investor it’s important to ensure that increasing focus on portfolio alignment metrics doesn’t “incentivise the wrong behaviours – for example, lowering of portfolio temperature scores through divestment rather than engagement”.
Van Lanschot Kempen’s Patel says that some assets (listed equities) are easier to engage with and decarbonise than others (debt and real assets). Pension trustees would have benefitted more from both sets of guidance if the DWP had more specifically considered how a bond or property investor can assess the degree of Paris-alignment of their assets and how engagement then applies.
“The DWP seems to be a decade out of date, thinking that equities make up the majority of pension portfolios, which simply isn’t the case,” he says.
The IIGCC’s Net Zero Investment Framework (NZIF) provides investors with guidance on measuring the decarbonisation of a growing number of asset classes: listed equities, corporate fixed income, sovereign bonds, real estate, infrastructure and private equity. It can be used to identify laggard holdings for engagement across each of these classes.
Despite the increasing availability of tools and frameworks, Paris-aligned stewardship is likely to remain a work in progress for some time.
“The recognition of the relationship between portfolio alignment metrics and stewardship is welcome, but with continuing challenges around Paris-alignment data, linking the two is probably years away from being implementable,” says Patel.