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ESG and sustainable finance – issues for pension schemes and their sponsors

ESG and sustainable finance – issues for pension schemes and their sponsors

Overview

Sustainability is rising rapidly up the pensions agenda because of a mix of changing law, regulatory guidance, and growing demand from pension scheme members and other stakeholders.

As understanding develops, pension schemes are being prompted to consider how ESG and wider sustainability factors may affect the financial performance of their investments, as well as their relationship with sponsoring employers.  In some cases, stakeholders are starting to enquire about levels of activism from their pension schemes in this area, often highlighting the wider economic and social role of pension funds as major asset owners.  Diversity and governance considerations are also attracting increasing focus.

 

Overview of relevant law and regulation

The starting point is pension schemes' core legal duties in relation to governance and investment (including consideration of their proper purposes and scheme members' best interests). In recent years there has been extensive legal debate, following a Law Commission report, about how these duties apply in the ESG and responsible investment context: for example, see our article in Trust Law International.

The interface with sponsoring employers is essential here because the obligations will broaden and deepen in the near-term and, in defined benefit schemes, may interact with sponsors' scheme funding obligations. 

The core duties are now also supplemented by an increasing amount of specific law and regulation. As a result, many pension schemes are now legally required to disclose (and therefore to develop) investment policies covering asset manager arrangements, climate change, other financially material considerations and the extent to which non-financial matters such as member views are taken into account in the investment strategy. 

In respect of governance, the Pension Schemes Act 2021 will require many schemes to develop effective governance systems in relation to climate change risks, and to make mandatory disclosures aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). Under current proposals, this will apply initially to schemes with assets with assets in excess of £1billion (and to authorised master trusts and collective defined contribution schemes), with a further review expected in 2024 to consider whether the regime should be extended to smaller schemes. As well as statutory guidance, there is also non-statutory guidance developed by the Pensions Climate Risk Industry Group about how pension funds can align themselves with TCFD recommendations. Travers Smith presented a client roundtable on the original DWP proposals and contributed a response to its 2020 consultation. We have also produced a Bitesize Guide explaining the key aspects of the requirements. 

Alongside this, regulators are increasingly focussed upon pension scheme governance and board diversity (see, by way of example, this consultation response from the Pensions Regulator, and our PLSA article). The Pensions Regulator has now published a new code of practice on own-risk assessments and effective scheme governance

The Association of Pension Lawyers (the APL) has issued a paper seeking to clarify when trustees of occupational pension schemes can take into account non-financial factors when investing. The paper was launched following a September 2020 webinar co-presented by Travers Smith, the slides from which are available in the link to the paper (the webinar slides also provide some notes on the limitations of the recent Supreme Court case of R (on the application of Palestine Solidarity Campaign Ltd and another) v Secretary of State for Communities and Local Government).

Travers Smith co-authored the Impact Investing Institute's October 2020 paper Impact investing by pension funds: Fiduciary duty – the legal context. This paper examines the compatibility of impact investing and the fiduciary duties of pension scheme trustees when trustees are making investment decisions.

This article published in the International Comparative Legal Guides, written by Travers Smith Partners Jonathan Gilmour and Andy Lewis, discusses the ways in which ESG is emerging in pensions law and specific considerations in this respect for pension scheme sponsors and managers.

More recently, Jonathan Gilmour and Andy Lewis, contributed a new chapter, in the International Comparative Legal Guide on Environmental, Social & Governance Law 2022. The new chapter outlines the key aspects of ESG law for occupational pension schemes and argue that ESG should be approached as a governance matter as well as an investment matter.

Risks and opportunities

Risks

A key issue is the extent to which sustainability considerations may negatively affect performance of businesses and, thus, influence the long-term risk or financial performance of scheme investments and/or employer covenant.  Examples of risk factors here could include enterprises with relatively lower resilience to climate change or the transition to a low carbon economy, or those where poor governance or negative social impacts (such as around working conditions) have led to particular threats to value.  Increasingly sophisticated tools are available for assessing these matters, but this should always be discussed with professional pension scheme investment advisers.

More widely, as institutional investors, pension schemes may be coming under direct or indirect pressure from their members and NGOs to address sustainability considerations more proactively through investment, stewardship and scheme management.  This is also a clear focus of government and regulators at present – with associated reputational and regulatory risks in the event of non-compliance with emerging legal requirements. The new climate change disclosure duties being introduced under the Pension Schemes Act 2021 are likely to further increase this scrutiny and accountability for schemes that are in scope.

Key considerations for pensions strategy

A central challenge is how to develop overall pension strategies which incorporate sustainability in an appropriate way. Although we can expect to see increased focus on climate-related risks and opportunities in the coming years as a result of COP26 and the Pension Schemes Act 2021, sustainability covers a much wider spectrum of issues, not all of which are purely legal.  In our experience, an effective strategy requires a collaborative approach between businesses, pension schemes and their advisers and we are seeing the boards and investment committees of some larger pension schemes increasing their focus on these matters.  Specific legal points on this journey include:

  • building knowledge and understanding of sustainability and ESG issues (including climate-related risks and opportunities), and the legal requirements
  • reviewing existing pensions governance and adviser arrangements from climate, ESG and sustainability perspectives
  • assessing board effectiveness and identifying diversity challenges and opportunities
  • pension scheme compliance with ESG-related disclosure requirements (including TCFD-related reporting for certain schemes), which will continue to increase in the future
  • where ESG and related services are included in a portfolio, ensuring these services and service standards are covered by appropriate legal agreements
  • managing stakeholder and other enquiries, and potentially complaints, about pension scheme sustainability issues
  • for defined benefit schemes, assessing possible interactions between sustainability, scheme funding, employer covenant and "endgame" planning


Back to ESG and sustainable finance

Our work

Effective management of sustainability issues requires a multidisciplinary approach.  Our well-established pensions sector group brings together lawyers from across legal specialisms, who understand how pensions clients operate and work seamlessly to help you plan and make decisions.  We are known for our high quality legal support in pension investment, de-risking, funding and governance: of which are affected by sustainability considerations. We are also thought leaders in diversity & inclusion for pensions. For more information, please visit our Pensions Diversity & Inclusion page

Engagement with external organisations

Our lawyers contribute to key industry bodies developing best practice and thought leadership in this area, including the PLSA's Diversity External Advisory Board, the SPP Council sub-committee on Diversity and Inclusion, the Association of Pension Lawyers Legislation and Parliamentary and Investment and DC Committees, and the Impact Investing Institute.

Recent work

Recent examples of our work in this area include

Contacts and further reading
Read Susie Daykin Profile
Susie Daykin
Read Alexander Economides Profile
Alexander Economides
Read Daniel Gerring Profile
Daniel Gerring
Read Jonathan Gilmour Profile
Jonathan Gilmour
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