One of my very first memories at mallowstreet is of the discussions I had with my new colleagues about our survey in March 2019. I remember us debating what to call it: Sustainable Investing Survey? ESG Survey? SRI Survey? How can they all sound so ‘same same, but different’? 

Last week, I laid out some of the topics that mallowstreet Insights is working on in preparation for the next ESG Survey. But will UK pension schemes overcome the lack of clarity and coherence in language, implementation approaches and data? How can asset managers and standards help? In attempting to answer these questions, mallowstreet Insights reviews further recent developments. 

While ESG has now officially entered the mainstream, it originally started off as a specialised product category which lacked standardisation. Different ESG definitions and implementation approaches helped asset managers differentiate themselves from the competition. But one unwanted side effect was the proliferation of jargon, which made ESG difficult to understand. 

In response to this, the Investment Association (IA) has launched a framework for a consistent language around responsible investing. Albeit focused on retail funds, it defines sustainable investing, impact investing, stewardship, engagement, voting, exclusionary screening and integration as different ways to incorporate ESG criteria into the investment process. 

While the IA is currently considering a retail product label, organisations partaking in its consultation have suggested that the institutional market may benefit from one too. 

The British Standards Institute (BSI) has developed an equivalent framework for a coherent approach to embedding sustainable finance principles within financial institutions. The BSI is further planning a second framework for sustainable and responsible investing. 

The mallowstreet ESG Report points out that UK pension schemes struggle with understanding how their managers incorporate ESG considerations in different funds and strategies. Consulting firm Lane Clark Peacock (LCP) finds that asset managers now offer more transparency on stewardship practices, but asset owners still need to hold them to account. 

Both UN PRI’s guidance on ESG integration and MSCI’s Principles for Sustainable Investing detail how managers and pension funds can integrate ESG fully into their investment process, from setting strategy through analysis and portfolio implementation. 

While such integration is still nascent amongst pension funds, asset managers need to be further ahead given their key role in ESG decision-making. They also need to be able to explain clearly how ESG is applied in various processes. 

Can the adoption of ESG standards and frameworks help pension funds get more clarity? 

The new UK Stewardship Code, which took effect in January 2020, comes with greater stewardship requirements in listed and private asset classes beyond equities, notably including fixed income and pooled funds. The new code also comes with greater requirements on engagement reporting. 

But the new code applies only to signatories, and its reach amongst pension funds is limited. While research by consulting firm Lane Clark Peacock (LCP) claims that many asset managers have already adopted the UK Stewardship Code, less than half of UK pension schemes and consultants surveyed by mallowstreet are signatories. The UN Principles for Responsible Investing are adopted by just over half of the schemes surveyed. 

The mallowstreet ESG Report pinpoints a possible reason – UK schemes and consultants think ESG standards lack clarity and cohesion. The use of ESG reporting standards like the recommendations of the Task Force for Climate-related Financial Disclosures (TCFD) or the Sustainability Accounting Standards Board (SASB) is even rarer. 

It is vital to understand what each framework is meant to accomplish. The TCFD disclosures are entirely-climate related, whereas the SASB materiality map looks well beyond environmental concerns. While such standards may be complex, both the SASB and TCFD now offer simple tools – see for example the TCFD Knowledge Hub or the SASB Materiality Map. 

Climate reporting requirements for pension schemes are already in the making, a logical step given the public urgency on climate change. TPR has set up a working group to produce climate reporting guidelines which would apply to all pension schemes and be based on TCFD disclosure recommendations. 

What cannot be measured cannot be explained or reported, and ESG data has a focal role to play. Yet, the mallowstreet ESG Report reveals that schemes and consultants are not happy with the quality and consistency of ESG data and therefore use it rarely even if it makes them nearly twice as likely to measure ESG impact. 

NN Investment Partners is one of several firms who are equally concerned about incoherence in ESG data. They highlight that different ESG ratings amongst data providers and the lack of standardisation are just causing additional confusion. 

Perhaps one step in the right direction has been MSCI making its ESG ratings on 2,800 companies publicly available. Another is a tool provided by the Transition Pathway Initiative (TPI), which looks specifically at how much companies are doing to lower carbon emissions. 

The EU has further proposed two benchmark labels for equities and corporate bonds indices. The label would signify that the combined emissions of the companies included in an index are at least 30% lower compared to the investable universe. The index would also have to ensure it is reducing carbon emissions by 7% year on year. This development follows new EU ESG disclosure rules for benchmark providers, which are expected to come into force in 2021. 

S&P Dow Jones Indices have already developed an index concept aligned with the two new EU standards. 

So far, it has been challenging to align passive investments with climate change goals because passive managers have been restricted in how much they can deviate from their benchmark. As a result of these developments, schemes investing passively may enjoy more choice and information in the future.