Trustees of pension schemes have a fiduciary duty to act in the best interests of the scheme’s beneficiaries. This includes making investment decisions that will provide adequate returns to fund the pension promises made to scheme members. However, as the world becomes more conscious of environmental, social, and governance (ESG) issues, there is increasing pressure on trustees to consider the impact of their investments on society and the planet.

What is ESG Investing?

ESG investing is an investment approach that considers environmental, social, and governance factors in addition to financial factors when selecting investment. Environmental factors assess a company’s impact on the environment, such as its carbon footprint, pollution levels, and resource usage. Social factors assess how a company impacts society, including labour practices, diversity and inclusion, community relations, and human rights. Governance factors focus on how a company is managed, such as its board diversity, executive compensation, and transparency. By considering these factors, ESG investing aims to create positive societal outcomes while also generating financial returns.

ESG and UK Pension Law

Pensions law in the UK has evolved over the years to reflect the increased importance of ESG factors.

The Occupational Pension Schemes (Investment) Regulations 2005 first required pension scheme trustees to consider financially material factors, including ESG issues, in investment decisions. The Occupational Pension Schemes (Investment and Disclosure) (Amendment) Regulations 2018 later built on this requirement by also mandating that trustees disclose how they have considered ESG factors in investment decisions.

More recently, the Pension Schemes Act 2021 introduced provisions relating to ESG for large occupational schemes. This includes a requirement for pension schemes to maintain oversight and assess the risk of relevant climate-related risks and opportunities, undertake scenario analysis, select climate metrics, and publish a report on their compliance.

The UK government has now also published its Green Finance Strategy 2023. This aims to mobilise private investment, including from pension funds, to meet climate objectives. The strategy includes a regulatory review with The Pensions Regulator, an examination of stewardship guidance compliance by the DWP, and a working group on fiduciary duties for pension trustees. Following from this, the government has also released a consultation on a potential regulatory regime for ESG ratings providers, which is open until 30 June 2023.

Benefits of ESG Investing

Beyond compliance with the law, ESG investing in pension schemes offers several benefits for trustees. Firstly, it aligns pension schemes with social responsibility, allowing trustees to invest in companies that are committed to sustainable practices and ethical values which can have a positive impact on the reputation of the pension scheme.

Secondly, ESG investing can help mitigate investment risks by identifying potential financial risks associated with companies that engage in unsustainable practices, such as environmental damage or poor governance. By incorporating ESG factors into their investment decisions, trustees can potentially reduce the exposure of their pension scheme to such risks.

Thirdly, ESG investing can lead to long-term sustainable returns, as companies that focus on sustainable practices and ethical values are more likely to be successful in the long run.

Challenges of ESG Investing

ESG investing in pension schemes can present some challenges for trustees. First and foremost, there may be limited options available for ESG investments, especially in certain sectors or asset classes. This can make it difficult for trustees to create a diversified portfolio that meets their investment goals.

Another challenge is the lack of standardisation in ESG reporting and metrics, which can make it difficult for trustees to evaluate the ESG performance of potential investments. This can also make it challenging for trustees to compare the performance of different investments and hinder their ability to make informed investment decisions.

Finally, there is also the challenge of balancing ESG considerations with the fiduciary duty to act in the best financial interests of the pension scheme’s beneficiaries. While ESG investing can potentially provide long-term financial benefits, trustees must ensure that they are not sacrificing returns, including short-term returns, in pursuit of ESG goals.

Conclusion

In summary, ethical investing is becoming increasingly important for pension schemes in the UK. In light of legal changes, trustees have an increasing responsibility to consider ESG factors when making investment decisions. While there are challenges to ESG investing, it is likely the benefits and compliance with the law outweighs these challenges. Overall, by incorporating ESG investing principles into their investment strategies, pension trustees can potentially contribute to a better world while fulfilling their fiduciary duties to their beneficiaries.

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