Pension scheme trustees: Time to think about the “S” in ESG?

Already at the vanguard of climate risk governance and reporting, trustees of occupational pension schemes may soon need to turn their attention to the risks and opportunities posed by social factors.

But, in contrast to the detailed statutory requirements on climate risk, the Government’s recent response to a March 2021 call for evidence suggests a “softly, softly” approach, aiming to nudge trustees into action by reminding them of their legal duty to take account of financially material ESG considerations when making investment decisions. Whether this approach is adopted in the wider economy remains to be seen.

The response reveals few concrete proposals, leaving it up to trustees to choose how they comply with their legal duties i.e. whether to include consideration of social factors within an integrated approach to ESG as a whole or instead create standalone “social factor” policies.  There is, as yet, no suggestion that there will be any legislative requirement to disclose these policies (although the Government believes they should be communicated to members in some way). 

The Government does, however, propose to establish a cross-departmental, Minister-led, working group (which will include financial regulators).  Within its remit will be identification of data sources and other resources (with a suggestion that these will feed into guidance for trustees), and monitoring developments with the International Sustainability Standards Board and other international standards.

We expect the work of this group to feed more widely into the financial services industry.

The recognition that reliable data sources are, except in relation to modern slavery, currently scarce, is welcome, reflecting the difficulties trustees have had in relation to climate risk, as first movers in having to report in line with TCFD requirements.

It is something of a relief that there is no suggestion from Government that trustees should take account of anything other than financially material social factors.  Again this reflects a softening of its previous stance on the extent to which trustees should take account of non-financial matters in their investment decisions. Trustees’ fiduciary duties do not allow them to invest in a way otherwise than for the financial benefit of the scheme: while this does require them to take account of the risk-adjusted return over the appropriate time horizon, it does not allow for other factors, such as showing disapproval of certain industries. For this reason, we recommend that any investment decision is supported by advice that evidences the financial benefit to the scheme.

As with climate risk, trustees of defined benefit schemes (that rely on the strength of the sponsoring employer) will need to take account of the potential impact of the employer’s own exposure to social risk. Again, information on this is unlikely to be publicly available, but trustees are able to ask for information direct from the employer in the same way as for any other factors that may affect employer strength. We are expecting guidance from the Pensions Regulator on assessing the impact of climate risk on employer strength shortly: the same principles will apply to social risk factors. 

As with climate risk disclosure, pension scheme trustees are leading the way here. We welcome the Government’s laissez faire approach to trustees’ duties to take account of social factors, and its acknowledgment that more work needs to be done to achieve reliable data sources before anything more prescriptive is required. In the short term, trustees can demonstrate engagement on social factors by asking investment managers about their policies as part of the selection/appointment process.