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'No legal barrier' for UK funds on ESG investments: Law Commission

Defined contribution (DC) pension schemes in the UK have invested much less than peers abroad in socially and environmentally beneficial investments because trustees seem unsure whether they are allowed to, according to a new report.

The Law Commission, a non-political body that recommends legal reform where needed, has confirmed in a government-prompted report that there are no legal or regulatory barriers to pension schemes making socially responsible investments.

Law commissioner Stephen Lewis said: “Defined contribution pension schemes will be investing billions of pounds over the next decade, and it’s only right that they seek to get the best returns for their clients.”

However, it was possible to ‘do well and do good’ at the same time, he said, adding that large amounts had been invested in Australia and other countries in infrastructure, which had benefited savers and society.

“In the UK there seem to be some misconceptions as to whether this is allowed for these pension schemes,” he said. “We’re clear, legally, there’s nothing to stop them doing the same.”

The government asked the commission late last year to assess to what extent pension schemes should consider issues of social impact when making investment decisions, and to identify any legal barriers.

Since auto-enrolment was introduced in the UK five years ago, total DC investments have rocketed and are expected to reach around £1.7trn by 2030, the commission said. This had raised questions about how the new pension assets were to be invested and whether at least a proportion could be invested for the wider social good.

“Investment in property and infrastructure has the potential to provide financial returns and address social concerns at the same time,” it said.

However, DC schemes in the UK lag behind the rest of the world in investment in property and infrastructure.

“Less than 5% of funds are invested in property and the Law Commission has not found any examples of infrastructure investment by UK defined contribution pension schemes,” the commission said.

Defined benefit (DB) schemes, on the other hand, were already investing in social impact projects like infrastructure. This included £370m for the Thames Tideway Tunnel to upgrade London’s sewerage system, raised through the Pensions Infrastructure Platform.

Large Australian funds invested around 8% of assets on average in infrastructure in their default arrangements, it said.

UK law lets pension trustees make investment decisions based on non-financial factors – such as environmental and social concerns – provided that they have good reason to think scheme members shared the concern, and that there is no risk of significant financial detriment to the fund. 

Sustainable and responsible investment lobby group UKSIF welcomed the report, which it said echoed things for which its members had been asking for some years.

“The government should change the investment regulations and the FCA should reflect ESG in its regulations with respect to [independent governance committees] and pension providers,” said Simon Howard, chief executive of UKSIF.

Meanwhile ShareAction, an organisation promoting responsible investment, urged the government to accept the commission’s recommendation to change pensions investment regulations to clarify that trustees can take ESG concerns into account.

“A change in the investment regulations would prevent trustees from using this uncertainty as an excuse for inaction,” said Bethan Livesey, head of policy and research at ShareAction.

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