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New requirements on stewardship and climate change

  • United Kingdom
  • ESG
  • Pensions

02-11-2021

New consultation: an overview

The Government has issued a consultation which proposes changes to the climate change reporting required from larger schemes and updates to the guidance on the investment reporting that most schemes are required to do via their implementation statement – much of this guidance is statutory guidance and therefore mandatory.

The key changes proposed are:

  • a requirement for trustees that are in-scope of the climate change reporting requirements to calculate and disclose an additional metric describing the extent to which their investments are aligned with the goal of limiting the increase in the global average temperature to 1.5 degrees Celsius above pre-industrial levels
  • new guidance which will set out the Government’s expectations in relation to the content of implementation statements around disclosing voting and stewardship activities. Trustees will be expected to make fairly detailed disclosures in connection with voting and stewardship and to explain why their policies were in the best interests of their membership

The proposed changes to the climate change reporting requirements will apply to schemes required to publish a Taskforce on Climate Related Financial Disclosures (TCFD) report with effect from 1 October 2022. We expect the new investment guidance will also come into force during the course of next year and apply to all schemes.

Climate change – the detail

In 2015, 195 countries committed in the Paris Agreement to pursuing efforts to limit the global average temperature increase to 1.5 degrees Celsius above pre-industrial levels. The Government says that to achieve this, carbon emissions need to reach net zero by 2050. It is anticipated that this “transition will lead to a fundamental transformation of the global economy, affecting all types of pension schemes regardless of their investment portfolios”.

The Government believes that requiring trustees to assess additional forward looking climate change metrics will help schemes cope better with this transition. This is in line with updated guidance from the TCFD which now recommends that financial institutions should describe the extent to which their activities are aligned with a well-below 2 degrees Celsius scenario.

Under existing regulations, in-scope trustees are require to select and, as far as they are able, calculate and include in their TCFD report, an absolute emissions metric, an intensity metric and one additional climate change metric. Existing statutory guidance from the DWP provides details on the its expectations around the metrics used by trustees. It is proposed that from 1 October 2022, trustees will need to calculate and publish a fourth climate change metric which describes the extent to which their investments are aligned with the goal of limiting the increase in the global average temperature to 1.5 degrees Celsius above pre-industrial levels.

Where trustees were already using alignment with the Paris Agreement targets as their third “additional climate change metric”, they will need to select an alternative additional metric from 1 October 2022.

The Government proposes amendments to the statutory guidance on climate change to reflect this change and provide trustees with more guidance on how they can approach complying with the new requirement.

Investment guidance – the detail

The Government is concerned that, despite existing statutory requirements, many schemes are only engaging with investment stewardship in a limited way. However, it sees stewardship as a “key tool by which… trustees can improve investment returns, by encouraging, developing, and supporting behaviours and practices that ensure long-term value for savers.” As a result, the Government has issued draft guidance setting out its expectations around the existing stewardship and reporting requirements.

Currently, trustees are required to include in their statement of investment principles (SIP) their policy on a variety of things including:

  • financially material considerations over the appropriate time horizon of the investments, including how those considerations are taken into account in the selection, retention and realisation of investments
  • the extent (if at all) to which non-financial matters (i.e. the views of the members including their ethical views and their views in relation to social and environmental impact) are taken into account in the selection, retention and realisation of investments
  • the exercise of the rights (including voting rights) attaching to the investments
  • undertaking engagement activities in respect of the investments
  • how they incentivise managers to align their investment strategy and decisions with the trustees’ investment policies, make decisions based on the financial and non-financial performance of investee companies and engage with investee entities, in order to improve performance in the medium to long-term

In addition, both DC and DB trustees are obliged to include information in their annual report on how they have complied with various aspects of their SIP and publish this information on a website. The information on the website is referred to as an implementation statement.

The information required in the implementation statement is different for DB and DC schemes but both need to set out how they have complied with the policies in their SIP on engagement activities and exercising voting rights. Implementation statements also need to describe the voting behaviour by, or on behalf of, trustees during the year. This will need to include the most significant votes cast and any use of the services of a proxy voter during that year.

The draft guidance, much of which will be mandatory, says that trustees should explain in their implementation statement how their stewardship activities are in members’ best interests.

In addition, in relation to voting information in the implementation statement, the guidance says the trustees should be reporting considerable detail, including:

  • relevant statistics to help describe voting behaviour and outcomes
  • where trustees have their own policy but voting is controlled by another person, they should explain whether that person has agreed to follow their policy and if not, why not
  • if asset managers, or any other third party making decisions on the trustees’ behalf, are unable to give the trustees details of significant votes or other voting information, trustees should include as much detail as possible, including what information is missing and why
  • details of any proxy adviser advising the trustees
  • how voting and engagement undertaken by trustees or by others on their behalf have been in the members’ best interests
  • in relation to providing information about the “most significant votes” cast, these votes should be linked to the scheme’s stewardship priorities and there should be a narrative explaining why each vote is significant, what the vote was, and why the scheme voted in the way it did. The guidance sets out considerably more detail that must be included in relation to significant votes but does not explain how trustees should determine what they are

There is additional guidance for trustees of DC schemes who are required to include details of how the SIP has been complied with during the year and details of any review undertaken in relation to it. The guidance says that where are there any instances where trustees have not followed their SIP, they should set out the occasions and the reasons for this, and whether action is necessary to remedy the situation. Trustees should also explain how investment mandates integrate stewardship in the investment time horizons, and what monitoring has been carried out to ensure that assets have been managed in alignment with the time horizons of the scheme.

Finally, trustees of all schemes are encouraged to have a mechanism by which members may express views about the consideration of non-financial matters in the selection, retention and realisation of investments, including about stewardship.

Action points for trustees

Trustees of schemes that are required to comply with the climate change requirements will need to prepare to assess the new metric and talk to investment advisers about what information they will need and whether it is available. Trustees already using a Paris Agreement metric will need to select another one.

Trustees of all schemes required to prepare SIPs and implementation statements will need to have regard to the new guidance once finalised. The detail expected by the Government in relation to implementation statements may go well beyond what many schemes have included in implementation statements published so far and will require the trustees to collect considerable additional information. In addition, few schemes will have articulated how their stewardship policies are in members’ interests and how their stewardship priorities link to their analysis of significant votes.They will need to think about how to express this.

When reading through the draft guidance, trustees and advisers will need to take care to identify which parts are mandatory and which parts are best practice only. Many sections specifically state this but some do not. There is also a table at paragraph 7 of the draft guidance which sets out which provisions are intended to be statutory.

These new proposals are likely to represent a considerable amount of additional work for trustees and they need to ensure that they leave themselves with sufficient time to consider what is required and collect any necessary information.

For anyone wishing to reply to the consultation, it closes on 6 January 2022.