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UK, European Pension Plans More Proactive on ESG Risks

Asset owners expected to increase focus on social-related issues, says Mercer.

UK and European pension plans are increasingly motivated to proactively address ESG risks beyond compliance drivers, according to a report by investment consultants Mercer.

‘European Asset Allocation Insights 2021 – Sustainable Investment’ surveyed 850 institutional investors, managing €1 trillion in assets, across 12 countries on their commitment to and progress in managing ESG risks within their investment strategies.

Although the majority (67%) of surveyed asset owners still view regulatory drivers as the main catalyst for accounting for ESG risks within pension plans, this is down from 85% last year. Asset owners are increasingly driven by other factors, including an awareness of the financial materiality of risks (40%), reputational risk (35%) and demands of individuals on the trustee board (14%).

“Beyond complying with regulation, we are expecting to see asset owners engaging with sponsors, beneficiaries and trustees on how they are accounting for ESG risks within their investment strategies more and more over the next few years,” Vanessa Hodge, Mercer’s UK ESG Integration Lead told ESG Investor.

A number of larger pension schemes across the region have displayed a more proactive approach to ESG risks by going beyond regulatory requirements, notably in setting ambitious timelines for decarbonising portfolios to reduce exposure to climate change. Earlier this week, the UK-based Border to Coast Pension Partnership, responsible for £55 billion AUM, committed to net-zero portfolio emissions by 2050 or sooner.

Compliance and beyond

Nonetheless, with the number of measures expected to be enforced next year, it is unsurprising that regulation continued to be the main driver, she added.

In the UK, this includes mandated Task Force on Climate-related Financial Disclosures-aligned (TCFD) reporting. UK pension schemes with over £5 billion in assets under management must begin finalising their first reports from 1 October, for publication in 2022.

In Europe, although potentially subject to further delays, the Taxonomy Regulation is expected to come into force from January 2022 via its first Delegated Act for two of its six environmental pillars: climate change adaptation and mitigation. The taxonomy establishes a list of environmentally sustainable economic activities, with the aim of limiting the risk of greenwashing and outlining the behaviours companies need to adopt to be considered sustainable.

“Regulation can sometimes distract investors from taking action,” Hodge said. “The focus has been on what needs to be done to comply, rather than what these measures are showing asset owners in terms of their ESG-related performance and exposure to risks and opportunities.”

Once compliant, asset owners will have more time to focus on the next steps that need to be taken in order to manage their exposure to systemic ESG-related risks, she said.

The survey also found that the large majority of UK and European pension plans are now integrating ESG into all aspects of their business operations, such as investment manager selection (83%), reporting (79%) and asset allocation (64%).

Social stewardship

Asset owners have also been increasing their ESG-based stewardship activities this year, questioning their asset managers on how they are factoring ESG risks into their engagements with investee companies, Hodge added. Over a third of respondents said they plan to increase their voting and engagement in 2022.

Efforts are largely focused on their equity portfolios (87%), but nearly half are now applying their stewardship strategies across alternatives (46%) and bonds (55%).

With 27% of respondents saying that they aim to focus more on social factors, such as human capital and labour rights issues, over the course of 2022, Hodge noted that social will likely feature more prominently in pension plan stewardship strategies.

“In particular, we’re advising asset owners to ask their asset managers to take account of social-related risks in corporate supply chains,” said Hodge.

Social has taken something of a backseat to environmental concerns over the past few years, she acknowledged, noting that the pandemic has forced many industries to reconsider how they account for social-related risks.

As with environmental, this shift in focus has also been prompted by regulatory measures.

The European Commission’s Platform on Sustainable Finance published a draft social taxonomy, to complement the existing environmental taxonomy. Earlier this year, the UK’s Department for Work and Pensions (DWP) also consulted on whether, and to what extent, trustees understand the role of social factors in pension scheme ESG policies.

However, there are continued issues surrounding social-related data which will make it more challenging for asset owners to measure and mitigate such risks.

“Ultimately, any progress comes down to what asset owners choose to focus on. They will then bake those ambitions into their investment strategies and expect asset managers to vote and engage in line with their beliefs,” said Hodge.

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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