The Pensions Regulator has updated its Investment Governance guidance for DC schemes to reflect recent changes in legislation, requiring trustees to set out their policies on environmental, social and governance (ESG) issues when making investment decisions.

Regulations making changes to the disclosure regime for pension schemes were published in September 2018 and will come into force on 1 October 2019. Further changes made by regulations published in June 2019 will come into force on 1 October 2020.

Background to ESG and investment governance

Under the current regime, trustees are required to disclose in their scheme’s statement of investment principles (SIP) ‘the extent (if at all) to which social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments’.

However, the government has been considering for some time whether to make changes to the 2005 investment regulations in which this requirement is contained. There has been an increased focus on the importance of ESG issues for businesses generally in recent years, as well as in relation to investment and finance; the government’s Green Finance Strategy published at the start of July ‘recognises the role of the financial sector in delivering global and domestic climate and environmental objectives’.

Within this environment, two reports by the Law Commission considered how pension schemes should approach ESG factors when making investment decisions. The reports recommended that trustees should be required to state their policies on evaluating long-term investment risks and on the scheme’s approach to stewardship (which includes the exercise of voting rights as well as other methods of engagement). The government subsequently consulted on changes to the disclosure requirements relating to ESG issues, resulting in regulations being published, details of which are set out below. The DC Investment Governance guidance was revised to incorporate these regulations and to respond to requests from the pensions industry for further guidance and clarity in certain areas.

Changes to the disclosure regime

In regulations published in September 20181, the disclosure regime for pension schemes was amended to strengthen trustees’ investment duties. Those regulations will come into force on 1 October 2019 and require that trustees set out in their SIP their policies on financially material considerations and the stewardship of scheme investments. The regulations also make clear that financially material considerations now include, but are not limited to, ESG factors, including climate change.

Further regulations were published on 6 June 20192, which extend some of the disclosure obligations to include details of the trustees’ policy in relation to arrangements with their asset manager, and which require further details to be included in the trustees’ stewardship policy. These regulations implement certain requirements of the Shareholder Rights Directive II, and come into force, for the most part, on 1 October 2020.

The changes introduced in both the 2018 and 2019 regulations are broadly summarised in the table below. While the revised TPR guidance relates to DC schemes, many of the changes to the disclosure requirements also apply to DB schemes.

Note that the timings of the requirements vary in some cases between DB and DC schemes, notably in relation to the requirement to make information freely available on a website. Schemes with both DB and DC sections will, therefore, have different compliance deadlines for each section.

What’s included in the revised guidance?

The updated guidance from TPR (available here) provides further guidance on stewardship generally; on the scope of ‘financially material considerations’; and clarity on what should be included in an implementation statement. In relation to all these areas, the guidance emphasises that trustees should include relevant information rather than producing a tick box report.

The guidance gives an example of trustees concluding that climate risk is financially material to their investment strategy and therefore the return their members may receive. This conclusion is developed in the SIP and worked into a policy, setting out how the trustees will consider climate risk and opportunities when appointing, monitoring, engaging with and replacing investment managers. The guidance points out that trustees are required by law to factor into their investment decision-making any factors that they determine are financially material.

In contrast, there is no legal requirement for trustees to take non-financial factors into account, but they may do so if they have good reason to consider the members hold a similar view; they are satisfied that the new investment does not present a risk of significant financial detriment; and the costs involved with making the changes are justified. The guidance gives an example of trustees receiving communications from members setting out ethical concerns about some individual investments held within the scheme’s portfolio. In the example given, the trustees survey the membership and take advice from their investment advisers as to the impact on the scheme’s risks and returns; following which the trustees revise their SIP to include their position on non-financial factors.

Compliance with the disclosure requirements coming into force in October will involve a more detailed consideration of ESG factors than has previously been required, and trustees who have been working to update their SIP ahead of the 1 October 2019 deadline should find the examples and commentary within the revised guidance from TPR helpful in this regard. Trustees may also find it worthwhile to review the additional requirements coming into force in October 2020 (and beyond), to consider whether these requirements could usefully be addressed at this stage, to save repeating the exercise next year.

  1. The Pension Protection Fund (Pensionable Service) and Occupational Pension Schemes (Investment and Disclosure) (Amendment and Modification) Regulations 2018
  2. The Occupational Pension Schemes (Investment and Disclosure) (Amendment) Regulations 2019