In July, the UK’s DWP (Department of Work and Pensions) formed and charged a new taskforce with ‘supporting pension scheme engagement with social factors in environmental, social and governance (ESG) investing.

While there has been substantial progress made in climate-related and governance issues, and social factors, the ‘S’ within ESG investing has not always received as much attention.  

The new taskforce, led by the minister of pensions, Guy Opperman, will have a remit to help pension scheme trustees and other industry participants identify risks and opportunities as a result of social factors, including the identification of reliable data sources and other resources to allow trustees to centre on social principles.

With this aspect of ESG covering a plethora of issues, such as corruption and bribery, the impact of supply chains, relations between employers and their employees and communications - and human rights more broadly - any institutional support in navigating this is surely welcome. Aside from providing practical help, this also signals the high level of seriousness with which the UK financial establishment is taking the integration of ESG into the pensions industry. 

Understanding the current ESG regime

The formation of this taskforce follows the Pension Schemes Act, passed in February 2021 which requires certain pension schemes to provide reporting on their climate change governance.

Regulators have made it clear that, by October of this year, occupational pension schemes of £1bn or more will fall under the TCFD (Taskforce on Climate-related Disclosure) reporting standards already required by schemes of £5bn or more.

Further legislation that not only strengthens regulation of this type but introduces huge financial consequences of non-participation with ESG ideals is inevitable.

One example of the form this could take is apparent in the US Inflation Reduction Act, a 755-page bill that passed the Senate at the start of August. Within its five sections, four directly concern environmental issues, with almost $250bn earmarked for various grants, tax credits, and investment programmes for the development and procurement of clean technologies and integration of new infrastructure and industry practices. The downsides and upsides for pension schemes that stem from this bill are worth extensive study.

To continue with the US theme, in March this year, the Securities and Exchange Commission proposed rule changes that would require registrants to produce periodic climate-related reports and statements. Similarly, all UK registered companies and LLPs (limited liability partnerships) with over 500 employees and annual revenue of more than £500m must abide by two laws that cover various climate disclosures.

Governments of the biggest economies are displaying serious and long-lasting commitment to ESG principles. Clearly, ESG needs to be a primary aspect of every pension scheme’s investment strategy. 

Making ESG integration a success

Integrating ESG principles into a scheme is a continuous process that starts at the top level.

Managers will need to identify how their scheme’s own values align with desired ESG principles. They’ll also need to consider whether there will be a focus on everything ESG encompasses or specific values within it – and from there start a review process.

That review will involve analysing what data trustees have access to, what data is missing and how to obtain the latter. At the same time, a review of current regulations and likely future regulations will be necessary.

Strategies regarding further investing and possible disinvestment in firms and funds that don’t fit with the new ESG criteria will need to be developed, along with a review of how such actions may impact the scheme’s stated aims and strategy.

Coming out in the wash

But as more schemes start the ESG journey, the pensions world must be wary of the threat posed by ‘greenwashing’. This describes, particularly in the world of investing, where investment funds or products are marketed as ‘green’ or ‘sustainable’ when the underlying investments are not obviously different from a standard fund or product. 

There have already been cases where regulators have been involved in investigations on asset managers who make claims about the amount of assets which are deemed ‘ESG’ assets, as well as fashion businesses that make claims about their clothing range using descriptions such as ‘sustainable’ or ‘responsible’. In the UK, the Financial Conduct Authority has made clear that tackling greenwashing will be one of their key areas of focus. 

With numerous authorities making promises to tackle greenwashing, this can only mean one thing – improved transparency. It means companies selling anything from sophisticated financial products to everyday household products will have to adhere to a higher level of standard when they make any ESG claims. By bringing this issue to light, it will also mean that trustees will be more cautious about not only looking at the surface of an investment fund. And because it is so easy to be led astray by clever marketing and other tricks, a hard-headed approach to analysing data and other disclosures is essential. Trustees must be able to act as an ‘independent, intelligent interrogator’ of facts and question the information provided to them – they must interrogate the data gathering process itself when possible - and seek third-party verification where feasible.

Thankfully, as more companies and governments throw their weight behind ESG principles, the more effective the tools used to evaluate credentials become. This is a new and fertile field, and innovation is ripe.

Worldwide, the growth of ESG investing is likely to become exponential. And so will the financial and non-financial risks and opportunities this presents to pension schemes. All trustees must take action now.