The amount of legislation at hand and the pace at which different directives and guidelines are coming out could be seen as daunting for some

Responsible investing is rapidly climbing the trustee board meeting agenda. This is due in part to increased interest and understanding around the importance of taking environment, social and governance (ESG) considerations into account.

Momentum is also being driven by new investment-related legislation and guidance which is forcing these issues to the fore.

While increased focus on ESG and wider responsible investment themes is a good thing, the amount of legislation at hand and the pace at which different directives and guidelines are coming out could be seen as daunting for some.

The most pressing regulation in focus for asset owners is the Europe-wide IORP II Directive, which was launched last year and is coming into force across Europe on a staggered timeline.

Amongst other measures, the directive requires improved disclosure from large schemes on responsible investment and stewardship, for example around how they apply responsible investment across the management of their assets, be that internally or via third-party managers.

The focus on transparency is a common theme across the new regulations and represents a broad cultural shift toward asking institutions and investors to explain what they are doing, and how.

The aim is to improve clarity and ensure that risks are taken seriously by all investment stakeholders.

Other areas of legislation will impact both asset managers and pension schemes alike. For example, the revised UK Stewardship Code, introduced in late 2019 has a framework which subjects all asset classes to a responsible investing lens.

Institutions and managers are expected to demonstrate strong management and governance on responsible investment issues.

Within Europe, EU regulations are emerging or being built around sustainable finance objectives. For example, the new green taxonomy – which seeks to classify what environmental activity looks like – as well as new disclosure regulation, the introduction of green bond standards, and also the development of green benchmarks.

Most recently, market regulators have announced a new consultation around non-statutory guidance on climate change and how to assess, manage and report on climate-related risks.

While taken altogether this might appear to be a lot to digest (and the regulations mentioned in this article are by no means comprehensive), most of the legislation seen so far focuses at a high level.

This means that while regulators are looking for greater transparency from investors with regards to their activities and approach to ESG subjects, they are not yet applying prescriptive guidelines.

Regulators are seeking information from schemes on how they’re managing the issue but not mandating action such as demands to divest from oil and gas companies.

It’s hoped that a trend toward greater transparency will usher in improved accountability, and that accountability will in turn lead to more ‘action’ on dealing with climate-related investment risks.

Given the explorative nature of most new ESG regulation, at this stage schemes are focusing on being able to evidence and explain their activities in managing responsible investment themes.

This covers areas such as how the scheme board expects to engage with fund managers; what they believe to be the most important issues, including anticipated time-frames; how well money managers’ investment processes are aligned to manage these risks, including suitable incentives or performance metrics; and how best to disclose these activities in a clear and concise manner.

Josh Kendall at Insight Investment

Josh Kendall, Insight Investment

There are still challenges and questions to address, for instance the standardisation of reporting.

Eventually we expect that the industry will shift to more standardised approaches to reporting, with certain models and formats emerging as the new normal for standard practice.

This will allow managers to become even more efficient in their reporting and also give institutions greater clarity when comparing ESG performance.

The new regulations present trustees with reason to engage with fund managers. In doing so they can deepen their understanding of the different approaches to ESG issues and stewardship currently underway across the industry.

Techniques vary according to asset class and responsible investment has as much relevance to LDI and fixed income as it does to equities.

We would like to encourage pension schemes to use their discussions and research to develop responsible investment policies that state clearly how a positive non-financial impact should be understood within their wider investment strategies. 

Josh Kendall is a senior ESG analyst at Insight Investment. He joined the firm’s fixed income group in 2015.