New rules mean trustees need to take a hard look at the way asset managers tackle environmental, social and governance (ESG) risks says LGIM’s Head of DC Client Solutions Simon Chinnery.
What will the new ESG disclosure rules require trustees to do?
The new DWP rules have come in to clarify and strengthen the requirements on trustees to have a specific focus on ESG information. This builds on previous clarification from the Law Commission which stated that fiduciary duty poses no obstacle to considering ESG information as part of the investment process, and in fact may even require it.
The DWP has clarified and strengthened the rules by requiring trust-based schemes to have a policy on financially material ESG factors, with climate change mentioned specifically. Schemes are also required to outline their policy on stewardship, including giving detail around how they engage with the companies they invest with and how they exercise voting rights.
DC trustees also need to update their statement of investment principles (SIP), particularly in terms of what the new rules mean for the default fund.
And from October 2020 trustees will have to publish an annual implementation statement, explaining how the SIP has been implemented and any changes to it.
How tough are the new rules?
Trustees might hope they can meet their obligations by outsourcing the issue to asset managers, but the DWP has made it clear they will not accept a boilerplate approach. Trustees have therefore got to understand and engage with ESG issues themselves. We are currently preparing a paper that will help trustees improve their
knowledge of the materiality of ESG risks and give them a framework for understanding what is available in the market and what they need to do to be compliant.
How would you distinguish ESG and ethical investment factors? Are the two sometimes confused?
ESG and ethical factors have been conflated in the past and the old regulations didn’t help. Going forward the key obligation for trustees is about assessing and managing material ESG risks. Ethical views may be taken into account but it is not obligatory to do so. The old world of ethical filters was about exclusions – screening out particular stocks and sectors based on ethical grounds. The new rules, which are mandatory, require trustees to understand ESG principles, which require consideration of the sustainability of companies in terms of their environmental, social and governance practices.
Do ESG funds perform better?
There are many examples of how failures in the way companies are run can have a harmful impact on the environment, society and investor returns. We believe responsible investing can mitigate these risks and has the potential to improve returns. Crucially, it can also unearth investment opportunities, which the market may not fully appreciate, and should not require a trade-off with performance.
Do all ESG asset managers follow the same approach?
No. There is no standard definition of what an ESG approach is. Some asset managers, like us, have been using ESG principles in their processes for years, but not all have.
LGIM has a track record of using shareholder power to drive company progress on ESG. We do not abstain, and vote with a single voice. Compared to the world’s 10 largest asset managers, we supported more resolutions calling on companies to report on their approach to climate change or political lobbying. In 2018, LGIM supported over 80% of such resolutions, while the average for the 10 largest asset managers is around 30%.
To maximise impact, the important question concerns the alignment at a firm level between the allocation of capital, voting and engagement, as well as the policy advocacy positions. Pressure groups are alive to the possibility that some asset managers might talk about ESG without actually doing anything about it. So trustees should not just look at what asset managers say about ESG but what they actually do.
Should trustees offer an ESG strategy as an extra option for members, or should it be the default?
We believe that members of a DC scheme should have the choice. We are definitely seeing trends towards full ESG default options being more in demand and expect this to grow. For some employers moving to full ESG for the default will be a simple decision, while for others, trustees will debate the extent to which they want to adopt an ESG tilt in the default and offer a full-blooded ESG fund as an option.