Last year, the Government updated the Regulations for pension schemes, requiring both defined contribution (DC) and defined benefit (DB) trustees to reconsider their approach to responsible investment by 1 October this year. This article focuses on the issue from a DC trustee perspective.
What the regulations require
The 2018 Regulations require that, with effect from 1 October 2019, trustees must set out, in their Statement of Investment Principles, their policy on:
• How they take account of ‘financially material considerations’ which include, but are not limited to, Environmental, Social and Governance (ESG) factors, including climate change.
• Their approach to stewardship activities for the assets held.
• The extent to which any non-financial matters are taken into account.
In addressing these requirements, trustees need to consider and set out how their approach is appropriate for determining both the strategy, which includes the structure of the default arrangement, and its implementation.
Reference is made to an “appropriate time horizon”, the intention being that trustees consider longer-term risks within their investment arrangements. Clearly, the time horizon for a DC member will depend on how far they are from their selected retirement age, assuming they are invested in a default arrangement that is structured either as a lifestyle strategy or a target date fund. Stewardship policies should cover voting, engagement and monitoring. This should include how trustees engage with companies and investment managers on matters such as “performance, strategy, risks, social and environmental impact, and corporate governance”. It should also include the exercise of any rights that come with particular investments.
Disclosure requirements for DC trustees
Trustees of DC schemes have additional requirements to disclose their approach, being:
• From 1 October 2019, trustees must publish their Statement of Investment Principles on a publicly accessible website. This ties in with the requirement to publish Chair’s Statements online.
• From 1 October 2020, trustees must also publish an annual report demonstrating how they have complied with their policies.
Trustees need to understand Responsible Investment across the investment process
The Regulations encourage trustees to take greater ownership and be aware of the consequences of their responsible investment policies, rather than adopting a ‘box ticking’ approach. Where trustees’ approaches have historically been somewhat manager centric, greater emphasis is now being placed on the consideration of financially material factors beyond implementation and there is a broader requirement for trustees to consider Responsible Investment issues at each stage of the investment process.
Trustees should pose themselves a number of questions about their current approach in developing their policy, including:
• To what extent are Responsible Investment (RI) factors relevant given the members’ timeframes?
• Has consideration been given to setting investment beliefs or specific RI objectives?
• Are there any views expressed by members that need to be considered?
• Do we need to update our default arrangement to take account of ESG factors?
• Can we demonstrate that any change to our default arrangement will leave members no worse off than at present?
• Does the self-select fund range still meet the needs of members?
• How relevant is RI for the mandates in the strategy?
• Are manager RI policies explicitly considered in manager selection?
• How good are managers at integrating the consideration of ESG risks into their approach?
• Should RI be a differentiator in picking managers?
• Can we implement an RI strategy within the charge cap?
• Do the trustees receive any information (e.g. metrics, case studies) relating to the ESG characteristics of their mandates in reporting?
• Do the trustees review manager reporting on ESG issues and challenge manager activity?
• Do the trustees actively question managers on their stewardship activity?
• How frequently is this done?
Consider what sort of Responsible Investor you want to be
Trustees should take time to consider what sort of responsible investor they want to be. By recognising that there is a spectrum of positions that they could take, trustees can determine an approach to RI that is right for them and their scheme members, recognising this should be both proportionate and scheme specific. The factors that inform trustees’ approach to RI should include their investment beliefs, the complexity of the investment arrangements and their governance budget. Trustees should not, however, feel constrained in their approach and, where they believe it appropriate, they should strive to demonstrate higher standards of behaviour.
Addressing the default strategy
Many trustees have historically consigned more ESG friendly strategies into selfselect fund ranges, both in the belief that ‘responsible’ and ‘ethical’ were the same and that investing responsibly would impact on future returns. The revised Regulations mean that trustees need to review how RI considerations are reflected in the default arrangement. DC default arrangements generally make use of pooled funds which may be accessed through a platform structure. Changing the default arrangement may not, therefore, be straightforward, but trustees still need to consider their RI beliefs and policy, and how these are implemented in practice within the default strategy.
What do trustees need to do next?
Trustees need to ensure that their Statement of Investment Principles is updated and published by 1 October 2019. This is just the start. Policies define the behaviours and practices that trustees intend to demonstrate going forward and we suggest that, as a minimum, trustees focus on the following activities:
• Ensure investment beliefs are defined and documented.
• Schedule responsible investment training into the ongoing trustee education programme.
• Review your default arrangement and ensure that it remains fit for purpose.
• Ensure that the self-select fund range offers sufficient alternatives to meet members’ needs.
• Confirm that your managers properly integrate the consideration of material ESG factors into their investment processes and if not, understand why not. Your investment consultant could help with this, for example, by providing RI ratings.
• Ask investment managers to include suitable RI information in their updates and ensure that managers are challenged to explain their actions. You may wish to discuss with your investment consultant what information would be useful.
• Plan how you will report on compliance with your policies. Setting out a longerterm journey plan to address RI may help you achieve this.
Head of DC Investment, Hymans Robertson