Barry Parr, an independent trustee of Salvus master trust
Most trustees are aware of the new obligations under the Occupational Pensions Scheme Investment Principles Regulations regarding ESG issues. Related policies must now be published in the Statement of Investment Principles (SIP) from 1st October and progress reported in 2020.
Lesser known requirements fall under the Shareholders Rights Directive II (SRDII) and run to a similar pattern next year. These put focus on stewardship duties and trustee incentivisation mechanisms, arguably presenting relationship management challenges between schemes and their investment managers.
Though financially material factors must be considered, there’s no obligation under the investment principles to consider non-financial factors unless there are strong expectations that they represent specific views of the membership.
Trustees are not generally equipped to judge the materiality of the multiple ESG factors across asset classes and territories. And even if they are, for all but the largest schemes, directing the implementation of that policy is challenging at best and unrealistic at worst. The key reasons for this are that most defined contribution (DC) schemes are:
- Investing via platforms and not directly holding end investments; rather they are holding promises under an insurance structure.
- Investing through omnibus registration accounts alongside hundreds or thousands of other investors, making the representation of an individual scheme’s interests impractical.
- Investing in pooled funds. Even with the best desires of all parties, it often isn’t economically practical to execute individual scheme positions. In some jurisdictions the consequential split voting may even be illegal.
- Investing in collective global passive funds for the majority of investment. These align with the market indices and, arguably, to the extent that markets are efficient, then all risks including ESG factors are already priced in at any point in time.
Limitations can apply even if some members show strong views. Diverse memberships overall – characteristic of master trusts – may typically mirror the views of the general population; though some schemes may seek the reputation appeal that addressing specific ESG factors or single issues might present.
So other than when trustees identify a risk of real material impact, they must take care that their decisions truly represent the membership.
Of course, where impact is clear and material then trustees may fully integrate their ESG principles within a scheme default, whilst others may prefer initially to adopt a filter or tilt. Others scheme may offer specific ESG structured funds as self-select options, meaning members with strong views can take responsibility for their own judgements, beyond the more holistic perspective required of the trustee.
The limitations mentioned earlier are a clear barrier to the effective stewardship envisaged in SRDII. It’s just not realistic to expect that schemes can or should exert their individual policies on investment managers.
Schemes will certainly now select managers having ESG policies and stewardship track records which are most aligned with their own. And at last investment managers have now woken up to ESG and some even preach it as a Damascene revelation and business differentiator.
Clarity around the standards with proven financial impact however remains weak. It’s illogical that views should differ markedly between schemes and managers. And as an industry we need to align in addressing specific horrors – of which climate change must be the front runner!
Let’s look towards a collective set of accepted standards. We have seen seeds in the form of the UN Global Compact and so many others, but if we are not careful these simply become meaningless labels, or worse – marketing levies!
Our approach requires a dynamic governance cross-industry structure as new issues emerge and need incorporating.
