Theresa May’s legacy as prime minster will sit in each of her successor’s in-trays for the next 30 years. In 2019, she enshrined in law that the UK must be carbon neutral by 2050. Just over a year later, the Labour Party sitting on the opposition benches in parliament called for the law to be widened to include pension schemes.
“The climate emergency demands urgent action,” said Jonathan Reynolds, the then shadow secretary of state for work and pensions. A Labour amendment to the Pension Schemes Bill – which was ultimately unsuccessful – would have required retirement funds to align with the Paris Accord on climate change by 2050 “or sooner”.
The amendment caused a debate across the industry. The Pensions & Lifetime Savings Association (PLSA) was quick to respond and offer clarity. “With many pension schemes leading the charge on responsible investment and already committed to net-zero strategies, these blanket proposals are unnecessary,” a statement from the association said at the time. “More importantly, [the proposals] break the principle that trustees should apply their fiduciary duties, and their responsibility to invest in their members’ best interests.”
It is on this last point that the nub of the matter rests. Is pushing for ESG investments part of the fiduciary duty of trustees or a breaking of it? The Labour Party had joined a debate that had been simmering for a while. It centres around ESG commitments, particularly climate change, and where they sit with fiduciary duty.
Should the focus be on getting the best returns for asset owners and members, as the original precept for fiduciary duty declared, or fulfilling wider objectives on ESG? Fiduciary managers have enjoyed a certain amount of wriggle room in their discretion as to how they invest, and this can be pretty wide with many occupational pension funds, but the central principle was always getting the best returns for members.
Fiduciary evolution
Following the ruckus caused by Labour, it was inevitable that the issue would rear its head at the PLSA’s Annual Conference in October. Here ShareAction chief executive Catherine Howarth asserted her view that there needs to be something of an “evolution” of fiduciary duty to enable a wider and braver investment mindset from trustees which takes into account many aspects of ESG.
“Pensions certainly want to get a good return on investment, but if the investments made over the lifetime of a pension fund accumulation journey have contributed to things that destabilise quality of life and wellbeing, and even raise costs in the future, then that member’s best interests have not been optimally served,” she said.
“We do need an evolution of fiduciary obligations, so that we retain that old historic focus on best interest but updated for the context we operate in where we have a climate crisis and give trustees more latitude to shift away from what could be pro table investments in the short term, but which actually exacerbate the climate crisis,” Howarth added.
This seems a fair and reasonable approach to shifting the dial on the fiduciary role towards an ESG methodology while ticking the important box of getting the best return for members. But for some pension funds this does not necessarily tally. For Nest chief executive Helen Dean there is no conflict between undertaking ESG investment and the principle of fiduciary duty. “We see complete congruence between it and the point is we are long-term investors.
“We want to invest sustainably over the long term because we believe that will provide our members with better assets,” Dean says. “Therefore, in our view, investing sustainably will achieve that. So, what we are doing is in the best long-term financial interests of our members.”
The message here is simple: leave us be and we, as pension funds, will get the returns needed while abiding by ESG principles.
Avoid overreach
However, a warning has been offered by Morten Nilsson, chief executive of the BT Pension Scheme. “We need to be careful that pension schemes do not overreach in trying to do everything and be everything for every key topic we have going, because that will be difficult to defend,” he adds.
This is a fair concern. In the earnest pursuit of doing the right thing, pension funds could follow ESG or another investment trend but end up chasing rainbows. In other words, the principles of investment must be built on solid ground.
The United Nations Environment Programme Finance Initiative (UNEP FI) attempts to do just that. But it is also an indication of how the fiduciary duty function has shifted, as the organisation clearly sets out what is a different and new definition of fiduciary.
“Investors that fail to incorporate ESG issues are failing their fiduciary duties and are increasingly likely to be subject to legal challenge,” warns Fiduciary duty in the 21st Century published by UNEP FI, the opposite of the principles fiduciary management has built its reputation on.
According to UNEP FI, there are three main reasons why the fiduciary should be required to incorporate ESG issues. One, ESG incorporation is an investment norm. Two, ESG issues are financially material. Three, policy and regulatory frameworks are changing to require ESG incorporation.
The shift in the relationship between the fiduciary and ESG probably rests on the second point. “The assumption that ESG issues were not financially material, and so, therefore, inconsistent with fiduciary duties, is no longer supported,” UNEP FI says.
We need to be careful that pension schemes do not overreach in trying to do everything and be everything for every key topic we have going, because that will be difficult to defend.
Morten Nilsson, BT Pension Fund
Sustainable returns
Another issue, and the source of much historical disdain towards ESG, is that at one time ESG investment was seen as a good, ethical approach, but one that did not sit easily as part of an effective portfolio. This was because ESG returns were not top notch, creating a clear conflict with the fiduciary aim of pension funds investing in their members’ best interests for the best return.
But the volume of research has changed that. A paper published in 2014, The Impact of Corporate Sustainability on Organisational Processes and Performance by Robert Eccles et al, investigated the long-term effect of corporate sustainability on organisational processes and performance.
Using a matched sample of 180 companies in the US, the paper found that corporations which had voluntarily adopted sustainability policies signi cantly outperformed those which had not – termed ‘low sustainability’ companies.
The paper also suggested that highly sustainability firms generated significantly higher stock returns, signifying that indeed the integration of such issues into a company’s business model and strategy may be a source of competitive advantage in the long run.
In another ESG investment bonus, companies with higher ESG scores saw their shares perform better in a crisis, a point highlighted during the pandemic. George Serafeim, a professor at Harvard Business School, analysed the share price performance of more than 3,000 companies globally as Covid-19 spread.
He found that companies with strong ESG credentials suffered less severe shocks to their valuation while the market collapsed. Even more strikingly, there was a more pronounced effect in industries that were badly hit by the pandemic, such as retail, restaurants and airlines. So, on this showing, pension funds using some form of ESG investment approach may have bene ted nicely during the pandemic.
ESG factors
A push back also has come from asset owners demanding that asset managers pay attention to ESG issues – shifting the fiduciary issue further on its head. In a 2019 Principles for Responsible Investment (PRI) Reporting and Assessment framework, 69% of asset owners stated that they consider ESG factors when appointing asset managers, and 62% consider ESG-related factors in all stages of asset manager selection, appointment and monitoring.
As part of that annual reporting and assessment framework, the PRI asked signatories to discuss how they interpret their duciary, or equivalent, duties. More than 90% acknowledged the consideration of ESG issues in their investment processes as a component of their duciary duties.
The vast majority of these regarded the consideration of ESG factors as a necessary and important part of fulfilling their fiduciary duty towards their clients or beneficiaries – a conclusion that the UNEP FI would no doubt be pleased with. A smaller number noted that this duty “allowed” or “permitted” them to take account of ESG issues where relevant, and a minority – a measly 3% – perceived fiduciary duty as a constraint to the consideration of ESG in some circumstances.
For most, the analysis of ESG issues was seen as enabling better risk management or the avoidance of downside risk, less than half highlighted the investment opportunities, or upside, associated with such an analysis. Stewardship activities such as engagement and voting were identified by close to 40% of respondents as an important way of enhancing value and delivering on their fiduciary duty.
Changing dynamic
In addition, professional trustees told a study by Charles Stanley Fiduciary Management that they wanted greater use of ESG metrics.
All this means that fiduciary managers must be alert to the changing dynamic ESG presents to the industry. Being a pragmatic bunch, fiduciary managers are consulting more on ESG issues to deal with this demand, even if many originally had a different definition about their work. Some have even suggested they wish to get rid of ESG as a label as it will be central to their role, making the ESG turnaround complete within the fiduciary role.
Giving a legal perspective, Susannah Young, partner in the pensions team at law firm Burgess Salmon, offers funds advice on how to deal with the changing fiduciary picture. “Given the severity of issues, such as climate change, there has been an increased push within government and the pensions sector more generally to support investment in entities which mitigate and adapt to climate change in particular.
“In light of this, pension schemes need to update their Statements of Investment Principles, set out policies on non-financial considerations and stewardship matters, implement those policies and understand disclosure requirements,” she adds. “ESG factors are particularly prominent when considering pension scheme investment. Due to the rise of issues such as climate change, regulatory bodies have increased the need for transparency, disclosure, planning and consideration among those managing pension schemes. Trustees now have further duties, and this is only likely to increase.” The last point is vitally important for trustees to keep in mind.
Given its importance in defining the fiduciary position and ESG, the final words must go to the UNEP FI. “Fiduciary duty itself is not a static concept,” it says. “It evolves and adjusts in response to changes in knowledge, market practices and conventions, regulations and policies, and social norms.”
It then adds what it believes to be closure on the matter: “The conceptual debate around whether ESG issues are a requirement of investor duties and obligations is now over.”
It appears that Her Majesty’s opposition may have been right to raise the issue.
