The Pensions Regulator (TPR) has warned UK pension fund trustees that ignoring ESG factors is no longer an option.

In a blog on the Regulator’s website, Louise Davey, director of regulatory policy, analysis and advice, wrote: “Just a few years ago it would have been rare for pension trustees to consider climate, environmental, social and governance (ESG) factors and wider sustainability issues in significant detail.

That has changed – driven by developments in government policy, increased regulations, industry initiatives and greater awareness of the potentially profound implications for life as we know it if action is not taken on global climate change and biodiversity loss.”

She noted that one challenge raised by trustees is addressing the climate and biodiversity crisis as a matter for government and policymakers, not for trustees and how they invest and manage their assets.

Michael Bushnell, managing director at Cardano Advisory, said: “It’s good to see the acknowledgment in today’s TPR blog that trustees’ focus should also include biodiversity risk alongside climate risk when embedding ESG factors into their decision-making processes. This step is essential in our view.”

He said, however, ultimately an even broader perspective will be needed, especially given the unique relationship between scheme and sponsor. “For example, taking into account the ESG risks to covenant provides trustees with the opportunity to maximise member outcomes while influencing real change,” he added.

Concerns over greenwashing and ‘green hushing’

There have been concerns around availability and quality of data, effective modelling of outcomes and impacts, the “implementation risks of greenwashing and the potential for ‘green hushing’ – where firms keep quiet about their emissions reduction targets to avoid scrutiny”, TPR’s Davey said.

“These are legitimate concerns, but they shouldn’t be a barrier to trustees meeting their legal duties or an excuse to put things in the too-difficult-to-do box,” she said.

Around 3,900 pension schemes must produce and publish a statement of investment principles (SIP), with trustees also required to publish an implementation statement (IS), which shows how certain principles in the SIP have been implemented.

TPR will be carrying out a regulatory initiative in relation to SIPs and ISs, as it stated back in April 2021 when it launched its climate change strategy.

Louise Davey at TPR

Louise Davey at TPR

The regulatory initiative will have two phases. The first involves checking all trustees have published their SIPs and ISs (where they need to). These documents should be publicly available. Where schemes have not published correctly, TPR will contact the trustees to ensure they do.

The second phase involves a review of a cross-section of SIPs and ISs. This will be a qualitative review and only in relation to the climate, ESG and wider sustainability related provisions included in these documents.

The Regulator plans to start the review in the autumn, as the ISs prepared and published for scheme years ending on or after 1 October 2022 should reflect the guidance published by Department for Work and Pensions (DWP) in June 2022.

This guidance was intended to address weakness in existing SIPs and ISs in relation to stewardship and to a lesser extent, consideration of financially material ESG factors and non-financial factors, Davey wrote in the blog.

“Over the coming months, we will finalise the details for this second phase and the schemes we intend to include in our analysis. The outcome of this review will be shared with industry to highlight good practice,” she continued.

Vague and generic

While the content of SIPs and ISs will vary from scheme to scheme, depending on investment strategy and implementation, TPR is aware some schemes produce disclosures where the wording is relatively vague and generic.

Davey said she wants to see a change to that practice. “When we carry out our review, we expect to focus on the extent to which the DWP guidance has been adopted by the trustees.”

TPR will also look to identify and publish examples of good practice to help other schemes to improve their future disclosures.

Risks and opportunities

“Science indicates the climate consequences of global warming are not linear. Some scientists believe we need to limit the increase to 1.5°C above pre-industrial levels. Some suggest every fraction of a degree above 1.5°C increases the risk of a tipping point – a critical threshold once crossed could lead to potentially irreversible, catastrophic impacts, including more warming,” Davey noted.

However, while there are significant risks, there is the potential for significant opportunities, she said, as the global economy transitions and local economy policymakers align behind a ‘carrot’ approach to incentivise decarbonisation, emissions reductions and transition.

As the DWP guidance highlights, stakeholder engagement can be a key stewardship tool and trustees need to understand and consider financially material ESG factors (including, but not limited to climate change), and stewardship in their investment decision making.

Trustees need to improve their understanding of climate, ESG and wider sustainability issues, Davey continued, adding that trustees also need to improve the quality of their policies and disclosure, move away from “boilerplate wording” and ensure action follows intent.

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