As the market for green pensions evolves, some employers have been accused of adopting more of a “tilt” than a genuine commitment to greening their pension plans for employees.
The issue for employers is that the market is at an embryonic stage. As such, it can be difficult to know if they’re doing enough to live up to their own environmental, social and governance (ESG) standards.
How can employers respond to pressure from the government and society to go green? What are the challenges, and how should they respond?
The government is encouraging pension schemes to invest in green technologies and renewables, as recently set out in the Prime Minister’s 10-point green plan.
Other “nudges” have come from the Chancellor, who recently announced the UK’s first sovereign green bond aimed at long-term investors, including pension schemes. The proceeds raised from this will fund projects to help tackle climate change, finance infrastructure and investment, and create green jobs.
Meanwhile, the Pension Schemes Bill is also currently going through parliament. When this becomes law, it will require trustee boards to consider climate change as part of ESG factors, when considering risk in a scheme’s portfolio.
The direction of travel is clear from what we have been hearing from pension schemes in recent times.
In the Australian case Mark McVeigh v Retail Employees Superannuation Pty Ltd (Rest), a member alleged that the climate change information provided by the scheme was insufficient to discharge its statutory duty to disclose such information.
In a public statement, the AU$57bn superfund said: “climate change is a material, direct and current financial risk to the superannuation fund,” and “Rest, as a superannuation trustee, considers that it is important to actively identify and manage these issues.”
It agreed to “align its portfolio to net zero by 2050 and report against the Task Force on Climate-related Financial Disclosures (TCFD). The fund will conduct scenario analysis to inform its investment strategy and strategic asset allocation, disclose its entire portfolio holdings, and advocate investee companies to comply with the goals of the Paris Agreement.”
In the UK, the DWP has also recently responded to a consultation requiring mandatory TCFD climate governance and reporting for large pension schemes with more than £1bn assets.
Employers will have to follow suit. As well as political and regulatory pressure, employees will only become more vocal about the need to “green” pension plans.
According to a recent Marsh & McLennan report, 72% of the workforce will be millennials and generation Z by 2029, up from 52% in 2019. These employees are more likely to be concerned about the environment and society than baby boomers.
There is also a reputational risk if ESG is an integral part of an employer’s ethos and business plan but its pension plan fails to live up to these standards. The Church of England experienced this when it discovered it had assets invested in Wonga, yet the Archbishop of Westminster had previously vowed to replace payday lenders with credit unions.
A new approach is needed to engage and retain employees, and to align corporate beliefs with pension provision. Longer term, this could help decrease risk, improve corporate and pension returns, reduce employee turnover and save recruitment and training costs.
As employers look to improve the green credentials in their pension plans, there are a few challenges to consider:
Trustees have to meet their fiduciary obligation to act in members’ best interests. This has traditionally been considered to mean financial interests, and a green fund may not deliver that over the short term.
However, there is a growing view that trustees should factor in risk when considering ESG, and the long-term sustainability of a business or fund.
For example, a fund including companies whose business is based on fossil fuels may decrease in value due to government legislation and societal pressure over time, possibly reducing returns in the long term. For a corporate that sponsors a defined benefit pension scheme, ultimately this could affect the funding that it has to pay into the scheme to ensure benefits can be met.
A report from Bain Consulting in February 2020 also found an emerging view that “ESG investing may enhance performance, not detract from it. Over the past 16 years, a STOXX index of global ESG leaders has outperformed the STOXX Global 1800 Index by 37%.”
There is a lack of consistency in the terminology and indices that are used to describe green funds, making them harder to compare.
This needs to be addressed urgently, so that employers and trustees can cross-reference the criteria and consider whether a fund is sustainable enough.
Although a sponsoring employer of a pension scheme is required to be consulted about the scheme’s statement of investment principles, the trustees do not require its consent about how to invest the scheme’s assets.
Many employers are using master trusts for auto-enrolment or to transfer legacy defined benefit changes to ensure good governance of ESG issues. The time for employers to ask questions about the green pension funds available is before adhering to the master trust. In particular, they should quiz the trustees about the master trust’s default fund used for auto-enrolment and the self-select funds available to their employees.
Now is the time for employers to act and review the pension funds offered to their employees.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at December 2020. Specific advice should be sought for specific cases. For more information see our terms & conditions.