British pension funds are coming under renewed pressure to consider the environmental, social or governance impact of their holdings as policymakers and consumers demand a bigger focus on sustainability.

In September, the UK’s Department for Work and Pensions shone a spotlight on the subject when it introduced new regulations for pension funds. Under the rules, which are due to come into place from October 2019, trustees who disregard the long-term financial risks or opportunities from ESG will have to justify why this does not hurt their investment returns.

The move came just months after the UK’s Environmental Audit Committee launched a probe into how the country’s largest pension plans manage environmental risks.

Janice Turner, founding co-chair of the Association of Member Nominated Trustees, a trade body for pension fund representatives, described the new regulations as a “huge step forward for the ESG agenda”.

“In order to become more responsible investors, it’s important that pension trustees are able to take a more active asset ownership role.”

The government’s renewed focus on sustainability comes as many pension funds globally grapple with the role ESG should play in their investment process — not least because the concepts of ESG, sustainable investment, socially responsible investing and impact investing are ill defined.

Four in five European (83 per cent) institutional investors said sustainable investing was becoming more important, against 74 per cent globally, according to a survey of 650 investors published in June by Schroders. Despite this, only a quarter of all the companies surveyed — which collectively manage $24tn in assets — said sustainability had a significant influence in investment decision-making.

Carola van Lamoen, head of active ownership at Robeco, an asset manager, says the added scrutiny from policymakers would help “steer laggards” across the pension industry and encourage them to pay greater attention to responsible investing.

“We consider the involvement of policymakers a logical step as ESG risks are material and relevant — and not all pension schemes are moving at the same pace,” she says.

Defined contribution pension schemes in the UK invested much less in ESG than their peers in other countries because they were unclear on whether they were permitted to do so, according to findings last year by the Law Commission, a body that makes recommendations on legal reform. Some schemes were deterred by a perceived conflict with their fiduciary duty to maximise returns.

The commission stated that the barriers to social investing by pension funds were “structural and behavioural rather than legal or regulatory”.

Chris Anker, lead analyst (Emea) for responsible investment at Columbia Threadneedle Investments, says the new rules from the DWP would bring much-needed clarification for pension funds about how they should approach ESG. “The fact that we now have such clear and unambiguous guidelines is really welcome,” he says.

“Some pension funds are engaging very much with the [ESG] agenda and are thinking out over decades and trying to position themselves at the forefront of the responsible investment community. But there are very different starting points for pension funds and their willingness to take action.”

Announcing the new rules, Esther McVey, the work and pensions secretary, said the changes came on the back of growing interest from younger savers, arguing it was important there was transparency about investment decisions made on their behalf.

Gareth Davies, head of UK institutional clients at DWS, the asset manager that was recently spun off from Deutsche Bank, believes the British government and regulators are “providing important leadership” by introducing the requirements for pension funds to report annually on their progress in including climate change and sustainability in their investment decision-making.

“The new policies will ensure the UK remains a leader and example to other countries on responsible investing, which is important as more governments and regulators are considering similar regulations,” Mr Davies adds.

The UK government is not the only policymaker to look at ESG and investing. In June, the European Commission announced its own plans to force investment managers to consider environmental risk as part of their duty to act in the best interest of clients.

Yet not everyone is convinced policymakers should be mandating that investors consider these factors.

Ian Simm, founder and chief executive of Impax Asset Management, an asset manager that focuses on sustainable investment, says because there is no definition of ESG investing, there is “potential for significant misunderstanding” among pension funds. “ESG lacks a robust definition and the three components [environmental, social, governance] don’t together form an effective framework for risk analysis,” he says.

“It would be much more useful for the DWP to focus on reminding pension funds that they should be taking a broad view on investment risk and reflecting on long-term factors as well as the short-term ones.”

The AMNT also questions the extent to which the asset management industry is willing to work with pension funds on the matter.

It pointed out in September that there has been a reluctance among some fund managers to accept trustees’ voting policies, such as the association’s Red Line Voting initiative, which sets out standards on ESG issues.

Mr Anker is also cautious about the immediate impact of the new rules. “I don’t think mandating consideration of ESG will suddenly make some trustees more sympathetic to the ESG agenda,” he says. “It will take time for trustees to figure out how this applies.”

However, he adds that for those pension funds doing nothing, the rule change will be a wake-up call. “They will no longer be able to get away with the idea that their pension fund clients aren’t interested in this and that they can push it to the margin.”

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