How Fiduciary management can help you reach your ESG and climate goals

Environmental, Social and Governance (“ESG”) demands on UK pension schemes have mushroomed over the last 18 months as the government looks to pursue its green agenda. In what was already an extremely governance heavy role, trustees are now expected to understand a new raft of terminology and dedicate time to ever more complex climate and stewardship requirements.

We believe strong ESG integration makes good business sense and should generate better risk-adjusted returns over the long term. But as trustees can only dedicate a set time on agendas for investment, we now see ESG taking up much of that space with high-level strategic discussions and governance having to compete with these new demands. For some, this new governance burden is making them reconsider their level of delegation. If you don't have the governance budget to have an Investment Sub-Committee and an ESG Sub-Committee, it might be time to consider fiduciary management. Trustees can’t delegate their responsibilities, but they can work with a partner to help them achieve best practice in all areas of investment.

Here we’ll describe how fiduciary management can help you to:

• Meet your obligations to consider financially material factors, including all areas of ESG;
• Meet your stewardship requirements on voting and engagement; and report on your climate data and implementation of the most significant votes.

Considering financially material factors

Every investment must be evaluated based on its ability to generate return and the risks associated with that return. Those risks may be because of ESG factors and the recent focus on this reflects the fact that the first two - Environmental and Social - have probably not been considered that specifically in the past. But if you consider the fines companies can receive from polluting the environment or the significant reputational damage from human rights abuses in their supply chain, these risks are most definitely financial. The Department of Work and Pension’s (DWP) guidance[1] specifically states that “Climate change risks are financial risks” and that this is a “systemic risk”. And in its recent publication in July 2022[2], the DWP highlighted trustees should include “all elements of ESG” when taking financial material considerations into account–highlighting, in particular, the links between climate and social factors "as millions of people will face challenges" because of climate change. So, it’s no longer a point of debate-these are factors trustees must consider and document the actions that they are taking.

Implementing ESG philosophy

When selecting a fiduciary manager, it is important to understand the manager’s ESG philosophy and whether it aligns with the trustees’ views as well as the flexibility within their toolkit to cater for specific preferences. There are a multitude of ways to implement an ESG philosophy into investment portfolios. These can include exclusions, targeting minimum ESG scores, ESG factor tilts, or targeted engagements.

At Schroders, our ESG assessment is a core component of our fiduciary management investment process, with managers and companies subject to minimum sustainability standards concerning “People” and “Planet” as described below.

For our fiduciary clients, we assess companies on People factors, including training & development opportunities and employment benefits & initiatives, with Planet factors ranging from carbon footprint to toxic emissions to implied temperature rise. Where we use external managers, ESG is factored into the selection and monitoring process, from the manager’s corporate sustainability strategy (e.g. D&I initiatives at their own company) and ESG policies, right down to ESG integration in their investment process and their approach to stewardship with underlying portfolio level companies.

The merits of engagement versus exclusion must also be considered. Whilst our preference is for engagement over exclusion, we believe there must be a threat of divestment for poor progress. Hence we won’t hold companies or managers that don’t meet our minimum standards (and show no signs of improvement). But we recognise that sustainability is a journey! We look for positive ESG momentum (even if from a low starting point), and we value a willingness to engage.

Stewardship

The pensions industry has published its first round of Implementation Statements, and the result is? Must do better. DWP has produced further guidance to say these should reflect trustees’ stewardship policies and their most significant votes. In addition, the DWP’s recent statutory and non-statutory guidance[3] states that trustees cannot “simply report that they delegate engagement”–if they can’t engage with companies directly, they must engage with investment managers and other providers to understand their engagement policies and whether they align with the trustees’ own.

One of the benefits of having a fiduciary manager is that they can do much of the legwork for you. The first step is to define stewardship priorities and then work with your fiduciary manager on a policy document. Not only should client priorities guide your fiduciary manager when carrying out votes on your behalf, but by knowing your priorities Implementation Statements can be tailored to showcase the engagement activity most relevant to you. For our clients, we highlight their largest holdings, the votes aligned with their stewardship priorities and explain how we voted. If they don’t agree with our stance, they can provide challenge and feedback.

There are some cases where we pre-declare our voting intentions and we can take feedback on board in advance. We specifically designed our survey, SchrodersAsks, to capture clients’ stewardship priorities and feed them into our Engagement Blueprint. We believe in the power of our size in voting and engaging and that stewardship should be linked to the investment decision, i.e. if you buy a company because you believe in their future potential for decarbonisation, your voting should be consistent with this thesis. However, if we hear from our collective clients that their wishes are different, we can adapt - both the investment and engagement strategy. We help trustees engage with us so they are informed and able to challenge, and then we ensure our engagement with the underlying managers and companies is aligned and executed efficiently.

ESG Data and reporting

Introducing mandatory reporting on climate metrics and climate scenario analysis represents another new challenge for trustees. This is another area where fiduciary management can be invaluable. The data needed to report on climate and ESG metrics is difficult to collate and patchy at best. But it's crucial to allow trustees to govern their climate impact and as a basis for engagement in this area. Sourcing data from multiple managers and trying to aggregate is cumbersome and a recipe for inconsistency. Many players are working to standardise data across the industry to make this more workable, but in the meantime, a fiduciary manager with oversight of your entire portfolio can take ownership of sourcing the data and ensuring it is consistent and aggregated meaningfully. Whilst some fiduciary managers are still struggling to produce timely data[4], our clients have been receiving climate metrics every quarter for the past 18 months. We’ve also helped our clients meet their reporting requirements in line with TCFD , providing scenario analysis and helping them set targets for carbon metrics to reduce overtime. And we're watching the developments for Taskforce for Nature-related Financial Disclosure (“TNFD”) very closely. All of this is part of the service.

So we believe it is part of your fiduciary duties as trustees, and our duty as a fiduciary manager, to make sure material financial considerations are taken into account in all investment decisions, that stewardship is implemented effectively, and regulatory reporting is in line with best practice. You cannot delegate your responsibilities as trustees, but you can partner with an expert to manage these additional governance burdens every step of the way.

[1] Governance and reporting of climate change risk: guidance for trustees of occupational schemes - GOV.UK (www.gov.uk)

[2] Government response: Consideration of social risks and opportunities by occupational pension schemes[1]Consultation version: Reporting on stewardship and other topics through the Statement of Investment Principles and the Implementation Statement: statutory and non-statutory guidance (October 2021) - GOV.UK (www.gov.uk)

[3] Consultation version: Reporting on stewardship and other topics through the Statement of Investment Principles and the Implementation Statement: statutory and non-statutory guidance (October 2021) - GOV.UK (www.gov.uk)

[4] Source: EY Parthenon, ESG investing under fiduciary management, September 2021This document is issued in October 2022 by SISL