Articles - Pension schemes playing catch up to improve ESG outcomes

New analysis by Mercer of more than 650 UK occupational pension schemes, covering over £250 billion in assets for over 3 million members, shows Environmental, Social and Governance (ESG) factors are being taken seriously, with 98% of trustees believing ESG issues can have a material impact on financial returns. However, like the rest of the financial industry, pension schemes are now playing catch-up in a complex environment which is constantly evolving due to increased regulation.

 According to Mercer, integrating ESG is a monumental challenge for UK pension schemes. Mercer’s Responsible Investment Total Evaluation (RITE) framework helps asset owners to assess and evaluate how well they are integrating ESG into their overall investment decision making. This assessment aims to also support investors by breaking down the ESG journey into four stages based on Mercer’s Sustainable Investment Pathway, and provides recommendations on how schemes can help achieve these goals.

 Establishing trustees’ beliefs is a vital first step towards ESG integration. Individual trustees may have diverse and strongly held beliefs but they must come to a common view as a trustee board. A key step to achieving this is to carry out an ESG beliefs survey or workshop - but Mercer has found that fewer than half (46%) of trustees that have been subject to its RITE assessment had done so in the past three years. The analysis also highlighted how trustee beliefs and the policies of employers are increasingly interlinked but often with tensions. A good example is when an employer’s ESG goals are more established than those of its pension scheme as firms seek to demonstrate their ESG credentials. In a fast-changing environment, trustees should examine and update their beliefs and consider how aligned their views are with those of their schemes’ sponsoring employers.

 Pension schemes have been required to include ESG and stewardship policies in their Statement of Investment Principles since 2019. However, Mercer’s RITE assessment found that only a few had moved beyond this first step to review and enhance these policies. The analysis also found that just 10% of schemes assessed have developed a standalone policy related to responsible investment, ESG or sustainability. Surprisingly only 6% have a standalone policy related to climate change, suggesting there is more work needed to manage potential climate-related financial risks.

 Mercer’s analysis of RITE has found that almost two-thirds (64%) of occupational pension schemes assessed had adopted some measures for integrating ESG into their processes; but others have work to do to ensure their assets are invested in line with their beliefs, if those beliefs have been established. On stewardship, a minority of schemes (10%) are moving beyond meeting regulatory requirements by engaging directly with companies in which they, or their investment managers, have invested. For many schemes, stewardship is carried out on their behalf by investment managers, especially where asset owners utilise pooled funds. In addition, the majority of schemes assessed do not carry out regular reviews of asset managers’ stewardship records. Interestingly, only a small proportion of schemes (13%) have conducted analysis of carbon intensity and climate change scenarios, but this will become a more pressing matter in light of forthcoming climate disclosure requirements.

 Mercer’s RITE analysis has revealed that many defined contribution (DC) schemes are failing to include meaningful allocations to ESG investments in their default strategy. It found that 38% of DC schemes analysed include an ESG fund in their default strategy and around one-half of schemes make these funds available to members who self-select. If this is representative of the whole market, this leaves tens of billions of pounds of pension savings without explicit access to ESG funds. The picture is different for defined benefit (DB) schemes, most of which are invested heavily in bonds with currently fewer ESG options. However, there is growing focus on developing sustainable fixed income products.

 “Our analysis shows that some pension schemes are racing ahead on their ESG journey, while others are left not knowing where to start,” said Brian Henderson, Partner and Director of Consulting at Mercer. “Schemes don’t need all the answers to start their ESG journey, but they need to assess how well integrated their existing plan is on ESG issues. From there, they should establish a plan in line with their defined ESG objectives, with actions on how to improve their position, and importantly, determine how they will show their stakeholders and members how they are tracking that progress.”


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