Fiduciary duty is no obstacle to ESG integration, says LGIM

Trustees of pension schemes have a duty to make decisions in the best interest of scheme members, and the new proposals from the Department of Work and Pensions reaffirm the value of environmental, social and governance (ESG) information in helping trustees manage risk and meet these best interests. In our response to the consultation, we called on the Department to make clear to trustees that fiduciary duty poses no legal obstacles to ESG integration.

With insurance losses from extreme weather events reaching record highs in 2017, investors are beginning to grapple with the implications of climate change and the transition to a low-carbon economy.

As a large and long-term investor, at LGIM we increasingly recognise that ESG factors play a crucial role in determining asset prices and are important in identifying companies that will succeed in a rapidly changing world.

We therefore welcome the proposal from the Department which asks trustees of pension schemes to set out clearly how they take into account financially material factors including (but not limited to) those arising from Environmental, Social and Governance (ESG) considerations, including climate change.

It has been four years since the Law Commission first clarified that there is no legal conflict and barrier between the consideration of ESG factors and fiduciary duty. ESG information should not be seen as something additional, or client-specific, but as a fundamental part of the investment process and as important a factor when considering investment risks as any other. That is what we mean by ESG integration.

The important question, and challenge that trustees face, is what is the best way to include ESG considerations in their approach. We agree with the government that incorporation into the Statement of Investment Principles (SIP) is a key starting point. The SIP guides the decisions of pension schemes, outlining the schemes’ investments and approach to risk and opportunities. Schemes should be able to show that any changes lead to concrete action being taken.

The requirement by the government that trustees provide more visibility on how their default strategies are managing ESG risks is a welcome one. Over 90% of defined contribution (DC) pension savers are invested in the default option. Trustees must beware that simply offering members an ESG fund choice among many does not, as the government notes, equal adequate discharge of fiduciary duty.

Stewardship is another area where we would encourage improved transparency and accountability. In its current form, the UK Stewardship Code does not provide sufficient incentives to take into account the environmental or social impact of companies. With UK pension schemes in possession of over £2trn in assets, more explicit expectations from asset owners and government oversight around stewardship can send a powerful signal to asset managers that ESG concerns cannot and will not be ignored.

Historically, too much of the ESG debate has been focused on what investments should be avoided rather than the opportunities these considerations may present. ‘Negative screening’ is just one of a multitude of approaches, which include ‘positive screening’ (according greater representation to companies with good ESG characteristics), thematic investing (organised around key topics such as energy efficiency), as well as broader stewardship and corporate governance activities.

We believe the government’s proposals are timely, and have the potential to lead to change. Implemented adequately, they can help protect and enhance members’ retirement savings – and may also help finance a world worth retiring in.

Emma Douglas, head of DC at Legal & General Investment Management

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