June 27, 2018

Pension Scheme Investment: trustees to consider environmental, social and governance risks

The Department for Work & Pensions has laid out plans to change the Occupational Pension Schemes (Investment Regulations) to clarify trustee duties to consider Environmental, Social and Governance (ESG) risks when investing.


The Department for Work & Pensions has laid out plans to change the Occupational Pension Schemes (Investment Regulations) to clarify trustee duties to consider Environmental, Social and Governance (ESG) risks when investing.


Concerns were first identified by the Kay Review of UK Equity Markets and Long-Term Decision Making in 2012 as to how fiduciary duties were interpreted in the context of investment.  The Kay Review recommended a Law Commission report, which was duly published in July 2014.  The Law Commission concluded that trustees should take into account financially material factors when investing – and this could include ESG factors.  Pension trustees could also make investment decisions based on members' views, subject to a two-step test being satisfied: first, that the trustees should have a good reason to think the scheme members hold the concern, and, second, the decision should not involve a significant financial detriment.

However, in January 2015, the Government consulted on several of these proposals and found no compelling reasons for legislative action; rather, they thought sufficient guidance was provided by the Pensions Regulator (PR).

In 2017, the Law Commission carried out a review of social investment by pension funds which considered the extent to which the barriers to social investment could be improved as to reduce their impact. These recommendations were broadly similar to those identified in the report.

The Government, in response to the 2017 report, indicated that it was now "minded" to make the changes proposed by the Law Commission. It was recognised by the Government that the PR's guidance had not relieved the confusion and misapprehension surrounding trustees' responsibilities. Moreover, they also found evidence to suggest some trustees were still incorrectly interpreting ESG risks as irrelevant or running counter to; financially material concerns. Therefore, these proposals are being introduced to help clarify trustees' investment duties.


The Government, in response to the recommendations put forward, are to implement the following:

Trustees will be required to update or prepare their Statement of Investment Principles (SIP) to:

  • outline how they will take account of financially material considerations, including (but not limited) to those arising from ESG considerations; including climate change. This will replace the current requirement to state "the extent (if at all) to which social, environmental or ethical considerations are taken into account" in investment decision making. The words "if at all" are regarded as misleading as they suggest that trustees could take no account of such considerations even if the risk are financially material. The reference to "ethical" is also dropped as it conflates purely ethical consideration (which trustees may consider) and social / environmental consideration (which trustees should consider if financially material). (By 1 October 2019)
  • their policies on the stewardship of investments including engagement with investee firms and voting rights.It is envisaged that even relatively small scheme should be able to have some impact through the consideration of stewardship; for example, in the selection of asset managers andfunds (by October 2019)
  • include a statement which explains the how the views of members on financial and non-financial matters will be considered in the preparation or revision of the SIP. It is not intended that Trustees have to survey scheme members, nor that they are required to act on any particular concerns members hold (from 1 October 2019)

Trustees of "relevant schemes" (broadly, occupational money purchase schemes subject to a few exceptions) will also be required to:

  • publish their SIP on a website so that it can be found by scheme members and the public. The aim behind this is to encourage trustees to reflect on their SIP and actually reflect the strategic decisions if the trustees. There is a broad consensus that SIPs too often contain generic text which meets the legal requirements but does not reflect the trustees' investment beliefs (by October 2019)
  • prepare or update their default strategy to set out how they take account of financially material considerations, including ESG risks (by October 2019)
  • produce an implementation report setting out how they acted on the principles set out in the SIP and how they acted on their statement about taking account of member views.Again this will need to be published on a website (from 1 October 2020). The Government's intention to set a later coming into force date for the latter proposal is timed to prevent trustees having to report on the implementation of the SIP produced under the old requirements.

Clyde & Co Comment:

The Bank of England has been emphasising over the last few years the impact that climate change will have on the economy.  So it would appear that is should be a relevant consideration for trustees' when investing.  Yet the House of Commons Environmental Audit Committee recently asked the largest 25 schemes about their attitude to climate change risk and whether it taken into account in investment decision making.  The response led the Committee to conclude that there was a "more engaged group" that say they are taking steps to assess and minimise their exposure to the physical and transition risks from climate change and an "engaged" group that are making some progress; but also a "less engaged" group that has not formally considered climate change as a strategic risk.

Climate change is of course only one ESG factor.  These regulations are intended to encourage trustees to give ESG more consideration then perhaps they do.

The requirement for money purchase scheme to publicise their SIPs is also an interesting development.   It will be easier for the larger schemes – and the Government and the Pensions Regulator are keen for money purchase schemes to be consolidated.  But it also it fits in with the Pensions Institute's recent report "Bringing Black Box Thinking to the Pensions Industry" which suggests that more sharing of ideas between schemes will bring benefits.

The Consultation documents are available here and the consultation closes on 16th July 2018.