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Our views 20 October 2020

ESG and pensions: the evolving landscape

By Ashley Hamilton Claxton, Head of Responsible Investment

5 min read

RLAM's Head of Responsible Investment reflects on a year since the DWP implemented ESG requirements in pension schemes.

This article was originally published on ESG Clarity on 20 October 2020.

In October 2019, the Department of Work and Pensions (DWP) implemented changes requiring pension schemes to outline how they are considering financially material ESG factors, including climate change, as well as their approach to voting and company engagement.

It was a pretty significant moment for the responsible investment (RI) industry, which had been campaigning for more regulation to incentivise and further embed responsible investing into the mainstream. This drive for greater transparency has taken on even more urgency, spurred by the ‘Make my Money Matter’ campaign, which seeks to shine a light on where and how our pensions are invested.

So, one year on – what has happened?

Quite a lot actually. It was only a few years ago where many of us spent an inordinate amount of our work (and personal) time trying to convince clients, colleagues, bosses and even spouses that responsible investing really mattered, that it was our fiduciary duty to consider ESG issues when making investment decisions, and that voting could change behaviour.

Now many of us spend our time fielding complex RFP (request for proposal) queries, preparing fund managers for client interrogations, and presenting our plans and strategies to our senior colleagues who have become RI champions and allies. This is all being driven by client demand. RI is now both the right thing to do, and a commercial imperative, which is a great recipe for change.

So what is changing?

Nearly all RFPs or client due diligence questionnaires include questions about responsible investing. This is forcing asset managers to think more clearly about how they articulate their approach to ESG in commercial discussions with clients. Equally, the client queries are getting more sophisticated, which is helping move the industry past ‘greenwashing’ and allowing us to have more detailed and nuanced discussions with clients. If we are to do ESG well, then the details matter, so this is a welcome trend. Finally, demand for funds with a sustainability or ESG focus has never been higher and clients are now willing to put money behind their good intentions. As money flows towards RI and away from other areas, we will inevitably see more scrutiny – from clients, regulators and of course, pension savers, which will help drive up standards.

So what’s not going very well?

Despite good intentions, greenwashing still exists. It is somewhat inevitable during any period of innovation and rapid growth, but anyone allocating capital to this space needs to be mindful of this so they don’t get caught out. Likewise, investment managers need to be honest and realistic about where and how ESG can add value, and clients need to make stretching but reasonable demands of their investment managers, recognising that our ultimate end goal is to provide a safe and secure retirement income for our clients.

As RI goes mainstream, we may need to remind ourselves that not all investment decisions have a legitimate ESG input and not all ESG inputs have a legitimate investment outcome. Finally, there is still a lot of box-ticking, both from pension clients and from investment managers. People will always seek out the easiest, most convenient and cost effective way to comply with regulation, particularly in the early days. It’s important that trustees don’t treat this as a compliance exercise, but rather build it into the ongoing relationship with investment managers by asking the right open-ended questions and seeking continuous improvement.

Where do we go from here?

Trustees are now preparing their first ‘implementation statements’ to explain to members how they’ve considered ESG issues and how they are monitoring their asset managers on RI issues. This first round of regulatory compliance will be fraught with challenges. From where I sit, it is clear that many of our clients are not as prepared for this as they could have been, and have left it to the last minute. Many don’t understand the nuances of ESG in fixed income, nor have they looked at an engagement or proxy voting report before, so we are spending a lot of time educating and coaching our clients.

However, these are welcome new challenges, and a testament to how far we’ve come as an industry in the last few years. It’s an opportunity to really start the discussion with our pension clients, to better understand the needs of our end customers – pension savers.

Ashley Hamilton Claxton is Head of Responsible Investment and editorial panellist for ESG Clarity.