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Speaker
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Transcript
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Chris Brown, Director, Burges Salmon
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Hello everyone I'm Chris Brown, a Director in the Pensions team here at Burges Salmon, and welcome to episode three of season two of the Burges Salmon Pensions Pod. Now when she doesn't come in in just a minute, regular listeners will note that Helen's not with us today. She's unavailable this afternoon as she's tasting the menu for the wedding breakfast for her upcoming wedding, so while she's no doubt having a feast we are here to feast on the latest updates and news on a very hot topic in the pensions industry, that of ESG.
So this is very much a developing and blooming area. On the 10th of June we had a blog from David Fares at the Regulator, who was noting that the Regulator expect around 100 schemes to publish the first reports in line with the climate change governance and reporting regulations and it's good that the Regulator has said it will provide high level observations and feedback for the next wave of schemes in scope on their reporting.
So here to discuss ESG and the latest updates with me, are George Fowler who's a Partner at ISIO, also a qualified actuary, and George's primary role is providing investment advice to large institutional clients including db and dc schemes ranging in size from 100 million to 50 billion. Hi George, nice to have you on the podcast.
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George Fowler, Partner, ISIO
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Hi Chris.
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Chris
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Hi there, and also Tegs Harding who's a Director at Independent Trustee Services, having joined there in March 2020. Tegs is also a qualified actuary and an investment specialist with over 15 years’ experience in the finance industry, hi Tegs.
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Tegs Harding, Director, Independent Trustee Services
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Hi Chris.
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Chris
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Hi, and lastly, but by no means least, Kate Granville Smith, who's a Senior Associate in the Burges Salmon Pensions team and who advises both trustee and employer clients and is our go-to expert on ESG legal matters, hi Kate.
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Kate Granville Smith, Senior Associate, Burges Salmon
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Hi Chris.
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Chris
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Hi. So without further ado, first question I think for all of you but George maybe you could pick this one up in the first instance, what's ESG all about and why is it important for pension schemes?
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George
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Thanks Chris. So dealing with the first half, well what's ESG all about? That's both an easy and a difficult question, I guess the easiest side is ESG stands for Environmental, Social and Governance factors, so what's that about?
Well as an investment advisor it means taking into account ESG when building an investment strategy, selecting managers or monitoring those managers over time. But it's broader than just investment, your actuaries should be thinking about it from a funding perspective and your current advisor also should be taking into account ESG and advising on covenant, so that's the easy bit.
I guess the harder bit is well actually how do you take into account ESG? There's many, many different ways you do it and almost trying to do it in an effective way is almost the more important decision to do it in the first place, so that probably leads quite nicely into the second part of your question which is well why should we take into account ESG? And I think that's for two main reasons, the first I think is the most important one, in that my view is if you properly take into account ESG it will lead to a better investment outcome, whether that be a higher level of return or a better management of risk over the long term, or potentially both.
I guess the second reason is much more of a regulatory, you can't ignore what you have to do from an ESG perspective whether it's implementation statement, vfm on the dc side or tcfd, it's everywhere and so as a trustee, even ones that are more cynical around ESG, you can't ignore the regulatory driver to take more account of it.
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Chris
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Yes absolutely, and there is a regulatory driver but I think as you were suggesting, and as the Regulator has said in that David Fares blog on the 10th of June, the regulator believes that the disclosure requirements, the reporting you were talking about, should be seen not as an exercise in compliance but this is all part of an exercise in risk and opportunity management so all of this will lead to improved outcomes for scheme members and I guess that's a key driver behind it all, rather than the compliance and reporting.
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George
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Yes I agree, I think the difficulty is it's sometimes hard to ignore the regulatory burden, and I've got a lot of schemes going through tcfd at the moment and it is challenging and there is a lot to do and it is eating up governance time, but I think even in my darkest moments with the volume of ESG that needs to be considered I think it's stepping back and saying well why is the regulator trying to get schemes to do that and not just nudging them but forcing them to consider it, and it goes back to the point you're making Chris, that fundamentally I think if you do take it into account, whether it's a better outcome for your dc members or better management of risk on the db side, I think there is a genuine positive outcome that you can gain by actually giving due care and attention to how you think about ESG.
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Chris
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Yes absolutely.
Okay well, I think next question then would be how you're seeing issues as clients approach it, and Tegs I might bring you in on this in a moment as well from what you're seeing from the trustee side. George, I don't know if you could tell us what you're seeing?
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George
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Well I think one of the fun things about talking about ESG is there isn't a right way of doing it and I think every scheme comes at it from a slightly different perspective. I think from my side there are two main ways you can do it and I actually think blending both of these together is the best way to do it.
I think the first is at the strategic or the top down level, so getting everyone around the table and saying well what are our beliefs from an ESG perspective? Not just at the trustee level but at the company level and getting all of the views out there. I think ESG can be quite an emotional topic where people have strong opinions, and so I think you can get the most value where you get it all out there and say well what are we actually trying to achieve here by taking into account the ESG? And I think that's a positive exercise.
Now I think the negative of doing that is it can be quite abstract, so when you're talking about well I want to achieve a carbon reduction or net zero by this state, it's very difficult to think about that without getting down into the detail. And so what I would always encourage schemes to do is not just do the strategic side but actually do it at the more micro level, so talk to your investment managers, understand what they're doing, understanding what is actually achievable at mandate by mandate level if you take greater account of ESG, and I think in doing that it leads to a much richer discussion at the top down level when you're trying to set overall targets.
So I've seen schemes come at it from both ways, but to my mind the way you get the best result is that combination of the top-down strategic discussion, with really working out what the art of the possible is with your investment managers.
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Chris
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Yes, that's really helpful and you can see that blending the macro and the micro is the way to go. Tegs, ESG is moving to business as usual for some schemes and some are yet to get started, from the trustee side who are you seeing in which camp and what would be your top tips for getting started?
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Tegs
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Sure. I mean those that are going first in my book are doing so for a couple of reasons, they're multi-billion and tcfd is landing so they've got that regulatory push or in some cases it could be both, but the sponsor has a real interest, so increasingly corporates are coming out there with their own net zero targets and they're racing against one another to see how close that they can bring that, and they want to see similar actions in their pension scheme. So, it's definitely those that are in the BAU camp now, so they've gone through that process that George described of setting policy, engaging with their managers and I think they're really on to round two of that so really trying to refine that and perhaps setting targets mandate by mandate, rather than at scheme level to try and make that as meaningful as they can.
On the other side of the coin, you've got sponsors which perhaps don't have their own ambition in that space and smaller schemes whether it's not the same regulatory driver, but that said I've got a scheme that is 30 million and they've gone through a process of having the training around it, some discussion, asking for input from the sponsor as well, and they are pausing before actually going as far as moving assets that they invest by appalled funds, so their only choice really is to move those assets to a different fund, and they're pausing before they do that because they really want to understand how long they're going to be invested in growth assets as a whole, before taking the leap on the equity side, which I think is very sensible, so yes you've definitely got people at both ends of the spectrum at the moment.
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Chris
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Yes, interesting different approaches and also that there are schemes in the tens of millions of pounds, so not yet within the scope of the like the really big billions of pound schemes, but taking steps and moving forward which is which is really, really good.
Just very briefly Tegs, some employers are taking the lead and driving forward to fit in with their agendas, are you seeing on the trustee side lots of member engagement or not so much?
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Tegs
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I think it's a real mixed picture. Obviously with defined benefit there's less opportunity for members to engage and that's one of the challenges that we've been thinking about on a few schemes actually is how do we get the best get the message out there, because often it's quite nuanced and quite detailed and how do we get a short summary of what we're doing in that space across to members.
On the dc side, obviously you have got more opportunity for engaging with members when you're doing workshops with members and things like that, and it is coming up as a priority, I'd say not the overriding one, but certainly members are interested in in how trustees are essentially investing their money on their behalf.
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Chris
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Yes, that's helpful, thanks. And Kate perhaps I could bring you in here, so I wonder if you could give an overview from your perspective of what trustees need to be doing now?
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Kate
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Thanks Chris. So, basically all trustees, no matter what their size of the fund or their benefit structure, need to be thinking about ESG, as Tegs and George have said.
Although the issues that they face will vary, all schemes are exposed to the ESG risk. Fundamentally, trustees have a legal duty to consider matters which are financially material to their investment decision making and ESG factors do pose a financial risk to trustees as asset owners, but it also presents opportunities for them as well and as George said trustees of db scheme also have to bear in mind that there may be ESG implications in relation to the employer covenant too.
Trustees also have particular duties under legislation, so most schemes will have to produce a statement of investment principles where trustees need to include their policies in relation to a financially material consideration, including ESG considerations, and they also must set out the trustees policy on the extent to which non-financial matters are taken into account, such as the ethical views of members and their policies in relation to the exercise of voting rights and engagement activities. So trustees don't necessarily have to take members' views into account, but they need to have that policy there and be documenting what they're doing about member views.
The good news is we understand that there's a lot of material regarding ESG and there's the regulatory side and there's also fiduciary duties to cover, so what we're doing at Burges Salmon is developing a trustee tool so that trustees can have a look at this tool and be able to identify what matters are relevant to them and then get some information on it so that they can start those discussions amongst themselves and perhaps with the sponsor. So watch this space for developments in that area, Chris.
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Chris
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Yes thanks Kate, and from what I've seen of the planning for that tool, it looks as though it's going to be really, really useful. How will our listeners access it and will it be free and when do you expect it to go live, Kate?
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Kate
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Thanks Chris. Yes it will be free and I suggest our listeners watch out for updates on our mailing list or they can contact you or I due course. We're hoping that it's going to be available probably in the next couple of months, if not before.
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Chris
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Yes super, thanks very much.
Tegs, perhaps I could bring you back in now to focus on some highly topical themes if that's okay. So the war in Ukraine and the cost of living crisis is changing some market participants' stance on climate engagement, particularly in the oil and gas sector, how are clients reacting to that?
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Tegs
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Yes, so initially there was certainly a flurry of activity in everybody trying to understand what exposure they had to Russian assets in their pension schemes. And that was swiftly followed by a realisation that actually we really do need to pay close attention to what our exclusions policy is.
Firstly, is there one? What decisions are those managers making on our behalf and what rules have we set down.
And I think the second one is then engagement and voting because you've got some asset managers coming out there talking about the need for energy security and how that might actually dominate over some longer-term climate concerns when they're engaging in particularly with the oil and gas sectors. And for their trustee boards are really thinking how are they going to react to that, how are they going to engage with their asset manager and should they be taking more direct control over that voting behaviour themselves in certain circumstances.
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George
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Yes and Chris, I echo what Tegs said in what I've seen, I think where some of the debate has changed over the last few months is I think if you roll back six months ago, there was starting to become this general perception in the market well if I have a bias to ESG almost however I
do it, it will lead to better long-term returns, and I think what the last six months has shown is that actually even though, as Tegs said, ESG may be a long term trend which is positive, there will be times when it is out of favour and so it shouldn't be seen as a sure-fire bet where it's always going to add to returns or lead to better management of risk.
And also the second point, again I'd agree with Tegs, that the how you implement ESG in some ways is more important to me than making that decision to have a bias to ESG. So using resource stocks is a great example, do you exclude resources totally or do you actually try to invest in the resource companies that are genuinely aware of these long-term trends and are trying to invest in line with them?
And so I think in some ways that shake-up is healthy because I think there was a there was a view generating that we just need to do this and why wouldn't you because it's always going to make us money, whereas actually with all of these long-term trends, whether it's ESG or other long-term trends, actually thoughtfully implementing it is really, really important and recognising there might be times where actually having that bias to ESG doesn't work in your favour and being aware that that will happen, so I think it's been a bit of a reality check, both to clients, but also to the industry as a whole.
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Tegs
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Yes, I think the other impact that it's making people wake up to is that for those that have set net zero targets that this might not be a straight line down to zero 2050, and actually for the next five years we might well see emissions go up, even if you have ESG tilts in your portfolio.
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Chris
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Yeah thanks Tegs, and also George, that's really helpful.
And Kate, I suppose from the legal side it leads into the question of what's the legal position on considering non-financial factors in investments and things like that, what's the trustee's legal position?
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Kate
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Thanks Chris. Yes, I was interested to hear from Tegs about member engagement because I imagine this is an area where there could be increasing member engagement with publicity in the press around pension schemes and ESG. So basically, as I said, trustees have to outline in their SIPP the extent, if at all, to which non-financial matters are taken into account, including the ethical views of members.
Essentially if the wider membership is likely to support a proposed ethical investment position, and it will not present an additional risk of significant financial detriment to members, it could be adopted as part of a trustee's board investment principles. So you could for example carry out a survey to understand member, or set up a member panel or perhaps glean this from the mnts.
So trustees don't have to take into account members ethical views, but they do need a policy and to record this in the SIPP, but I am very much interested to see how much member engagement is going to increase in this area over the coming months and years.
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Chris
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Yes absolutely, I suspect it will and in terms of ESG fitting in, of course the trustees have their wider fiduciary duties and it reminds me, I won't get too legal, but Kate it reminds me of that of Whitely case, which I always like to go back to in terms of investment duties, which is the one that says that trustees, when they're investing, should take such care as an ordinary, prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide, and I always like that as an overview of trustee's approach to investment, that moral duty there.
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Tegs
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I think that's a pretty interesting point Chris, because a lot of the public schemes have now come out there with dual objectives, essentially saying we're always going to act in members’ best interest but we have this secondary objective of making sure that they have a world to spend their pension in. Do you think the law as it stands is a barrier for more private sector schemes adopting something similar, or do you think there'll be a slow convergence of the two over time?
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Chris
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I don't think it's a barrier because I think it's consistent with the current law that you've got your duty to invest in best interests and members, that's paraphrasing, which is the best financial interest of members, coming out of Cameron and Scargill, but as I say you've got that even older case law which talks about moral duty to provide and so yes I think you can take into account wider considerations in that. So no, I would hope the law's not a barrier.
Okay, so moving on. I saw on the 1st of June, Make My Money Matter hosted the world's first net zero pension summit, so Tegs thinking about net zero targets, are they meaningful and what are the barriers and what's the alternative?
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Tegs
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A lot of the challenges around net zero are around data.
We all know that it's not perfect. We haven't got every company covered, it's not audited so it's not necessarily consistent between companies and it's not giving you the complete picture at the moment, so without getting too technical it's what's on scope one and two but it doesn't take into account scope three, which is you know a company's outputs. And that might give you some strange results if you were shaping your portfolio strictly on those two metrics alone. Whereas when you're setting a net zero target, you really want to have the biggest impact you can on real world emissions, so just simply cutting those companies with high emissions from your portfolio may not do that, and it leads to the wrong behaviour within companies, so companies ditching the most highly emitting parts as well, we don't want to encourage that either.
So having a net zero target is great, but you really need to think about how it's implemented, whether you're going to take an engagement first policy, if you are, are you convinced that that's really going to work, particularly in the oil and gas sector which is so controversial at the moment. What I've been doing for my schemes, where we do have one or that sort of ambition, is to really firstly frame it as an ambition, make sure that everybody is aware that it could go up before it comes down and then engage asset class by asset class with each manager, so have that stated ambition but underlying that have a suite of different metrics with targets against each one, rather than a black and white you must cut by seven percent a year.
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Chris
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Yes that's helpful. George, Kate, I don't know whether you'd want to want to chip in with anything on net zero?
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George
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I'd probably say similar to my comment at the outset around I would agree focusing on a mandate by mandate level looking at the investment managers and also I think we've talked a lot about the environmental side today, but also looking more broadly than that, so I'm seeing a number of managers looking to bring in for example the UN sustainable development goals into their mandate as well, bringing in the social and the governance side.
So my preference is to engage with each manager, think about what the art of the possible is and net zero I think does represent a good sound bite but when you've got a lot of db schemes for example where they still have quite substantial holdings and illiquid assets, where the data coverage is pretty poor, actually for a lot of schemes where we started with the let's look at ESG and everyone naturally focuses on net zero because it's what you see in the press, and then you go through the metrics and look at it and often the simple starting point is well we just need better data and let's encourage the managers to get the better data and then once we've got the better data then let's think about what an appropriate target is to do with it, so I've had a number of schemes where they've started with the let's have a net zero target and have ended with a actually let's improve our coverage and let's not just think about the environmental, let's think about how we can incorporate the social and the governance factors into the mandate too.
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Tegs
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And what are people doing with that information, George, once you've got a picture, full reporting, versus those unsdgs, are you using that to set priorities for engagement, are you using that to set your exclusions policy?
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George
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I think generally at the moment it's agreeing, so where I've done this with clients it's generally been in the last 12 months, so they've spent a lot of time structuring the mandate to say well we want to try and improve our unsdg score or our company is focusing on these three or four sustainable development goals, we're going to bring that into the manager's mandate.
I guess where I think clients and consultants are still learning is well what do we do with that over time. So we've got this objective of improving our unsdg score or removing the worst scoring companies, but I think we're still learning as to what we do with that and how that still evolves over time, which feels in some ways partly unsatisfactory but it's partly down to the fact that actually I think it's really, really hard. Lots of clients look at advisors and say what's the answer, I think it's really, really hard to sit here and say this is what I think a good ESG mandate will look like in three to five years’ time, because where it is right now is very, very different to where it was once two years ago.
So I think some of this is a learning process for everyone.
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Chris
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Yes thanks George, thanks Tegs, it's really interesting and I think it is a learning process and perhaps the way for me to finish this podcast then is if I might turn to each of you and perhaps if in one line if you could give us your main takeaways for listeners, if that's all right, from your different perspectives?
So George, I don't know if you want to go first?
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George
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I would probably say, and it sounds cheesy, but thinking about ESG and doing it right, I'd probably say is worth the effort and I would encourage people to persevere and for everyone around the table to recognize that there isn't a right answer and everyone is learning in terms of how ESG will evolve over time.
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Chris
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Yes thanks. I think that's a really, really good message for people to hear. Tegs?
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Tegs
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I'll probably give my top tip if that's all right, and that's for trustees out there, is think about the governance around this because it's not going anywhere, the volume that we're all going to have to do on this is only going to go up and that is made a lot less painful when there's some thought given to who's going to be doing the heavy lifting in the space.
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Chris
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Yes absolutely. I think that's really helpful, a great top tip. And Kate?
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Kate
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Thanks Chris. I think really trustees need to understand their ESG obligations and requirements and really develop their beliefs that are appropriate to them and their scheme and I think as we've seen today there's a lot of content and lots of detail but trustees should use their advisors to help them because that's what their advisors here are here to do, to help them on that journey.
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Chris
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Yes absolutely. Well thanks to George, Tegs and Kate, that was a really interesting discussion. I think there's lots to think about for trustees to be focusing on and things they should be doing now, no matter what the size of the scheme and I believe there's a plsa plan as well, which will be helpful for trustees to look at.
Thank you for listening to the Burges Salmon Pensions Pod. If you'd like to know more about our Pensions team and how our experts can work with you, you can contact me or any of our team via our website.
This episode is the third of our second season, and all of our episodes are available on Apple, Spotify or wherever you listen to our podcasts. So it's just leaves me to say thanks to Tegs, George and Kate and to our listeners.
Don't forget to subscribe and thanks for listening.
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