The impact of ESG investing on pensions


The impact of ESG investing on pensions has been phenomenal and will accelerate with the arrival of a UK taxonomy and mandatory disclosures on climate-related financial risks.

In this podcast episode hosted by Cornwall Insight, Sasha Butterworth, head of pensions at TLT, and Tegolin Harding, director at Independent Trustee Services, discuss:

  • Key drivers, including the growing realisation that climate risks and the risk of stranded assets need to be managed
  • How boards looks at ESG strategy and measurement, and the danger of letting the perfect be the enemy of the good when it comes to metrics
  • Why the UK taxonomy and mandatory disclosures will trigger a step-change in ESG governance
  • How to distinguish between greenwashing and a true ESG fund
  • How to progress quickly and the debate between divestment vs engagement
  • Future risks and opportunities, including the role of pensions in funding infrastructure and clean energy projects, and a rise in legal claims, pressure and action

This is the first in a series of podcast episodes by Cornwall Insight and TLT on green finance.

Transcription

Dan Atzori:

Hello everyone. Welcome to Cornwall Insight’s latest podcast. Today, we're going to talk about the impact of ESG investing on pensions in particular. According to PWC, ESG fund assets under management will reach over 50% of total European mutual fund assets by 2025, with European ESG assets totalling between €5.5 trillion and €7.6 trillion by 2025.

And the UK is clearly determined to secure leadership in everything related to ESG investment and green finance, with upcoming initiatives such as the issuance of the first green gilt; mandatory disclosures by 2025; and the publication of a UK taxonomy.

Today, we will focus on the market participants such as pensions, of course. I am Dan Atzori, research partner at Cornwall Insight, and I am delighted to be here today with our guests, Tegs and Sasha. You're welcome to introduce yourself.

Sasha Butterworth:

Okay, hello. I'm Sasha Butterworth, national head of pensions at TLT, and I advise pension boards and employers on ESG governance and compliance. I'll hand over to Tegs.

Tegs Harding:

Hi everyone. I'm Tegs Harding. I'm a director at ITS. So I'm an independent trustee on a range of different pension schemes, mostly in the defined benefit space, but I also do a bit in defined contribution and master trust as well. With my other hat on, I chair the APPT (that's the Association of Professional Pension Trustees) committee on ESG and climate change. So this is a topic very close to my heart.

Dan Atzori:

Brilliant, thanks both. We are really glad to have you here, and I have a first question for Tegs. So just to get started, how quickly are things moving in the UK in terms of the growth of ESG investing? And as we're coming out, hopefully, of the pandemic, what will be the key drivers for ESG investment?

Tegs Harding:

Yeah, I mean, the pace of change in this area has been absolutely phenomenal. Going back a few years, it would only be the very niche managers in this space that would be talking about this topic, and now it's absolutely everyone. Investment managers will all claim that they have this at the heart of the way they invest. Similarly with pension scheme agendas, it might have got mentioned at five minutes at the back end of an investment meeting a few years ago, but roll forward to today and you're having whole meetings dedicated to this topic.

So it's definitely accelerating. And I think that's coming from regulatory change, but also from just wider public awareness. You're getting pressure from members, but just more and more in the press about it. Things like COP26 are definitely raising everybody's interest in this topic.

Dan Atzori:

And a question people usually ask: is there a tension between investing in ESG compliance investment and delivering the same returns, or do you see a trade-off between the two?

Tegs Harding:

I think this is definitely one area where the conversation's moved on a little bit. I think now most people that I talk to, particularly in the pensions industry, are aware that climate change is one of the many financial risks that is going to be faced by their asset portfolio. And that risk is obviously going to impact returns, and that's coming through things like policy change as we move towards a net zero target by 2050, particularly in the UK; by things like stranded assets; and then even more than that, by things like extreme weather. So I think it's very much seen as one of the risks that pension trustees now have to manage.

Sasha Butterworth:

Okay. So Tegs, just talking about returns, and we hear lots about greemiums. There's a lot of jargon quite often around this topic. Can you tell us a bit more about greemiums: what they are and what they could be used for?

Tegs Harding:

Yeah. So greemiums is a term usually applied to the green bond market. That has been established for some time in Europe – so it's about a trillion dollars worldwide – but it's obviously much newer to the UK, with the UK launching its first green gilts just this year. And a greemium refers to the fact that investors would be prepared to pay a little bit more if they knew that the proceeds of those bonds were going to be invested in something that is responsible. So renewable infrastructure would just be one example of that.

Typically at the moment, it isn't very much. It's between one and three basis points, I would say. And what I've heard from the investment management community is they're very much open to putting these bonds in portfolios. And they will just do the assessment like they would with any other bond, as to what's best to put in the portfolio considering the risk and return needs, and then also the investors' other objectives, so responsible investment and climate being two of those.

Sasha Butterworth:

So I suppose just to say that it's literally that, isn't it? It's green premium, so then it's greemium.

Tegs Harding:

Yeah.

Sasha Butterworth:

Okay. So moving on, just looking at the pension sector, how's it going to be impacted by the taxonomy and mandatory disclosures that are coming down the track?

Tegs Harding:

Yeah, so I think the mandatory disclosures are definitely a good thing. They're getting ESG and climate change on pension scheme agendas, which is brilliant. I think you can't get away from the fact, though, that it is going to require a step change in the level of investment governance for the majority of schemes. The very largest, with their in-house teams, are obviously all over this kind of thing already, not least because they have to go first with the climate reporting.

Sasha Butterworth:

Yeah.

Tegs Harding:

But it's definitely going to be a lot of work and looking at things in a slightly different way for the majority of everybody else.

Sasha Butterworth:

So, yeah, there's plenty for people to have to get up to speed with on this. So just based on that, how does a trustee board look at their ESG investment strategy? And I suppose just thinking about the core criteria and how do you measure this? I think this measurement's a real issue for people to think about.

Tegs Harding:

Yeah. I mean, data is a real issue at the moment, particularly around things on carbon emissions. Everybody discloses slightly different metrics and that makes monitoring it hard from a trustee perspective.

I think it's one of those areas where you definitely can't let the perfect be the enemy of the good. There is data out there that we can start taking action based on. So let's just get going and just accept the fact that our metrics and measurement systems are going to evolve over the next few years.

I think the consistent taxonomy is really going to help, particularly in the investment management industry where at the moment, every investment manager out there will tell you that they do a great job in this space. Having some consistent frameworks and benchmarks to measure them against is really going to help from a trustee perspective.

Sasha Butterworth:

Yes, because obviously they've got something they can look to, and also look at the progression as how they improve, I suppose, over time. I suppose one question, then, you hear people use this phrase a lot, so how do you tell the difference between greenwashing and then a true ESG fund? And I suppose here I'm thinking about what happens if you invest in the wrong fund as a trustee board, which claims to have ESG credentials, and I suppose I'm thinking here about the trustees' fiduciary duty to act in members' best interest. There's a lot of questions there, but shall we unpick it?

Tegs Harding:

Yeah, so greenwashing is a really hard topic for trustees, and it's where most trustees are going to be really leaning on the advisors to help them tell apart those who are talking a good game and those who are actually genuinely investing in this way. Generally, though, in my experience, when you start to interrogate managers a little bit on what they're doing under the bonnet, it's quite easy to tell apart those who are talking a good game.

One of the things I did on a big scheme that I work on that has a net zero target by 2035 is simply get a list together, working with the company's head of UK sustainability, on the things that they'd rather not see in the portfolio. Just to get a snapshot today of where we are relative to our carbon emissions and things like that. Giving that wishlist to the investment managers and then simply asking them to portion their portfolio up against that list, it was really telling who could do that easily and who pushed back to say actually that they don't look at things in that way. And that's a great way of telling who's telling you the truth.

Sasha Butterworth:

I think so. I mean, I thought from an investment manager's perspective, it helps them, because they can position themselves for that trustee board. So I think that's a good tip there. So I suppose, just picking up on some tips, then, what makes a real difference in terms of making progress, and I suppose also thinking about the key bottlenecks. So we don't want ESG compliance to become a tick-box exercise, but what are the key bottlenecks that you're seeing at the moment?

Tegs Harding:

So my top tip, not a bottleneck, but the way to get progress most quickly in my experience, is actually engaging with the sponsor on this. More and more, I am seeing pressure from the sponsor to align the pension scheme with how they're running their business in terms of their own net zero targets.

And I think that is coming from…a lot of companies now are seeing a reduction in the cost of their own debt if they can show that they're meeting certain ESG or responsible investment targets themselves. So this is a really common thing to be discussing in boardrooms now. So as a trustee, starting to have that conversation with the sponsor really gets things moving quite quickly.

Sasha Butterworth:

And I think that's good, because that's something that you need both the trustee board and the employer, the sponsor, working together to deliver on this so that it's something that really is delivering an outcome together. Okay. Well, that's really helpful. I think, Dan, I was going to pass back to you now.

Dan Atzori:

Yeah. Thanks. Thanks, Sasha. So of course, green finance is about both greening finance and financing green. So on the latter in particular, how should funds position themselves to attract ESG investment from pension schemes?

Tegs Harding:

I think it's a really good question, and it depends on the asset class that you're talking about. Some are going to naturally lend themselves to this, and you'll have those large schemes that want to make an impact with their investments approaching them almost. Renewable infrastructure would be a really good example of that.

But then, with the more common asset classes – equities, buyer-maintained bonds, that sort of thing – it's about making sure that you communicate your ESG and green credentials really clearly, that that can be evidenced to your investment advisors and ultimately to members as well, so that you can show that the way that you're investing is making a difference.

Dan Atzori:

And more broadly, how do you see the future role of pension funds in funding infrastructure as well as sustainable energy projects?

Tegs Harding:

I mean, it's definitely the mood music from the DWP, and actually government more broadly, that they want to use pension fund assets to help finance some of these initiatives, which I think is a really good one. We've obviously got some barriers to overcome in terms of just the way things are done from an operational perspective at the moment, particularly in the defined contribution space, where investing in long-term illiquid assets is a challenge. But I think we're getting there on overcoming some of those challenges.

And there's definitely going to be an increase in pressure from members who ultimately are going to have their savings invested for 20, 30, even 40 years, but they're going to increasingly want their money invested in this way. So it's definitely going to be an area that grows in the future.

Dan Atzori:

And I have a question for Sasha. I'm a bit curious to understand better what's happening elsewhere, outside the UK, from a regulatory point of view.

Sasha Butterworth:

That's a really interesting question, Dan. I suppose, from a pensions regulatory perspective, we tend to look to the US and to Australia to basically see what's coming down the track for the UK. And I think an interesting recent case that happened in Australia in 2018 was brought by a member, Mr. McVeigh, against the trustee board of the Retail Employees Superannuation Trust, and he basically alleged that the board had breached its fiduciary duties and they'd not really thought about the risk that climate change posed to the fund’s investments.

So that's a really interesting case. From a legal perspective, it's interesting because it didn't create a legal precedent, because they actually settled on the first day of the court hearing. But after that, the trustee board did release a statement acknowledging climate risks in its portfolio, and then they agreed to a long-term 2050 net zero target. So I think this is an example where we can see which way the wind is blowing, and the standards that trustee boards are probably going to have to meet over time.

Tegs Harding:

I think this is a really interesting topic, because a lot of the public pressure that you're getting is actually around divestment, so not investing in things like fossil fuels in the portfolio at all. Whereas I think most trustee boards, particularly those that are investing for the longer term, want to find ways of using their collective voice to influence what companies are doing. So much more on the engagement over divestment. And I think there's a little bit of tension there when you get a lot of pressure coming from members.

Sasha Butterworth:

Yeah. And there's also that issue around, do you stay invested and so you try and change from the inside, or do you divest and try and put the pressure from externally. So it's an interesting conundrum, that, I think.

Tegs Harding:

Yeah, it is. And I think certainly I agree with the clear message on this that's coming out of bodies like the DWP, in that it has to be staying invested and trying to influence, because there will always be other investors that don't hold themselves to these same standards. So if you want to make an impact in the real world, it has to be through using your collective voice to influence change.

Dan Atzori:

It's a very interesting dynamic. And looking a bit ahead – because of course COP26 is taking place in a few months – Sasha, on the legal side, are there any specific regulatory and legal updates people should be monitoring, and any requirements in particular coming up in the next few months?

Sasha Butterworth:

Sure. So I think a good starting point for people to be aware of is these new requirements for the TCFD disclosures – so that's the Task Force on Climate-Related Financial Disclosures – and that comes into force on 1 October 2021. So just in broad terms, that will apply to schemes with assets of more than 5 billion. So really the very, very large schemes which Tegs has talked about earlier, saying that the big schemes are already all over this. But it also will apply to all authorised master trusts. There's no relevant asset limit there. And then looking ahead, from 1 October 2022, that will apply to schemes with assets of more than 1 billion.

Now, it'll be interesting to see... I think this will start accelerating and come down to the smaller schemes probably faster than we might initially have anticipated. What trustees must do is they've got to produce a TCFD report within seven months of the end of the scheme year, and that's got to be on a publicly available website and be free of charge, so anyone can go and look at that. So that will be quite interesting to see what starts coming out there.

And then I'd say just a wider point to make is just, as Tegs has said already, the speed of compliance and the new legislation, the regulatory requirements on climate change that are coming down the track here are just coming out so quickly. Just keep an eye on DWP, TPR, to the pensions regulation and FCA consultations, lots of acronyms there, and look at their responses to these. We're going to be doing a summary on the TLT website around these, so just to really make people aware of what they have to do and when. So yeah, lots to focus on, plenty to read over the summer!

Dan Atzori:

Excellent. Thank you. And again, looking forward, what do you think will be the key developments for pension schemes in particular over the next 12 to 18 months?

Sasha Butterworth:

I'll kick off first, shall I. And from my perspective, I think there's just going to be more and more pressure from scheme members, especially millennials, who want to ensure that as Tegs was talking about before, that their money is being invested sustainably rather than just for a quick return, which could be quite volatile.

And I think the other issue I would say is more around, I think there will be more legal challenges on how pension schemes are invested, as has happened in the McVeigh case that I mentioned.

So I just think that trustee boards have to be much more aware of their positioning and be aware that they may suddenly need some PR support as well, which again means that alignment, perhaps. Working together with the employer is really important.

Those are my probably key ones that I'm thinking about at the moment.

Tegs Harding:

Yeah. Just to add to that, I think everybody at the moment is focused on the climate change disclosures in particular, and that's just because that deadline of October is looming. I think as we move into next year, what you're going to see is people start to use that data in anger and you'll start to see actual changes in the way that pension schemes are invested as a result of just being more aware of some of the risks that are embedded in that portfolio at the moment.

Sasha Butterworth:

And I think particularly, Tegs, as I was just saying before, the fact that a lot of this information is going to be publicly available is going to be interesting to see how that comes through.

Tegs Harding:

Yeah. And when you look at things like the TPR consultation that's out at the moment around the take-up and the use of TCFD reporting, it's clear that they expect people to actually use it. So I think more and more people will start making changes as a result of this.

Sasha Butterworth:

Yeah.

Dan Atzori:

Brilliant. Thanks a lot, Sasha and Tegs. It was great to have you with us today and to hear about the key drivers and developments in ESG investing and their impact on the pensions sector. Of course, we will keep monitoring this sector very closely as COP26 approaches. Thanks a lot for your attention, and have a great day.

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