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There has not been a shortage of industry coverage on ESG adoption, but little is being said about managing the conflicts between ESG and fiduciary duty, the focus on outperformance, the importance of data and the need for clarity and simplification. mallowstreet Insights surveyed 60 UK pension trustees and their consultants to fill in the gaps.
Stuart Breyer, CEO of mallowstreet, commented on the findings saying: “Our Report gives a nuanced picture of how trustees and advisers view ESG, where they need greater clarity and which misconceptions are yet to be overcome. It offers some surprising and unique insights into one of the biggest issues for pension funds today.”
1. The relationship between ESG and fiduciary duty is perceived as complicated.
Compliance with new regulations has been without doubt one of the top drivers of ESG adoption, but not the top one. ESG tradition is deeply rooted in good governance and risk management, with 77% naming investment or reputation risk a top driver.
“Compliance with new regulations has not been the top driver of ESG adoption – ESG tradition is deeply rooted in good governance and risk management.”
However, the relationship with fiduciary duty has proven to be complicated. While 72% think that ESG impact should be part of fiduciary duty, 60% are deterred by clashes between competing objectives when they consider ESG criteria. ESG considerations may not only clash with each other, but also with investment objectives and fiduciary duty.
"The relationship with fiduciary duty has proven to be complicated because trustees believe ESG and ethical considerations clash with other objectives."
Some trustees and consultants perceive expressing or even considering ESG to be at odds with fiduciary duty because these views are subjective. This is perhaps why only 45% are driven by ethical considerations.
2. ESG is not thought to improve returns, but the focus on performance is misplaced.
One of the root causes of these conflicts is a perceived lack of return improvement associated with applying ESG criteria, even though there is growing evidence to the contrary. Less than 10% think ESG leads to better performance, and many believe that, in particular, impact investing detracts from returns.
"There is a perception that ESG detracts from returns, even though there is growing evidence to the contrary."
It is not surprising to hear pension schemes talk about a lack of investment opportunities in ESG, and we have uncovered further insight on this topic in our upcoming inaugural Trustee Report. But the focus on performance may be misplaced.
"The focus on returns may be misplaced given the plans to increase ESG integration rather than reallocate assets."
73% of UK pension schemes and consultants are focused on ESG integration rather than reallocating assets. Engaging and influencing investee companies and borrowers, mostly via the asset managers that pension funds invest with, should not have an immediate negative impact on returns, and the long-term risk benefits are clear to the industry.
3. You cannot report or understand what you cannot measure.
67% of UK pension schemes and their consultants see a major challenge in missing data and transparency, and 63% have difficulty assessing and managing ESG risks and impact. As a result, only a minority use data and measure impact.
This may throw a spanner in TPR’s plans for impact reporting requirements. While an alignment with the recommendations of the Task Force for Climate-Related Financial Disclosures (TCFD) is a good approach, very few schemes are using these standards at present.
"A lack of data and transparency is making it difficult to assess and manage ESG risks and impact – consensus metrics are needed to understand environmental and social effects in present terms."
Some schemes and consultants also think that a lack of consensus definitions and metrics for environmental and social factors has slowed down their understanding. These effects often manifest too far into the future, which makes them less important and understandable now.
4. There is a stark need for clarity and simplification, and asset managers have to do their part.
The reason for the slow adoption of industry standards is that 48% believe they lack clarity and cohesion. UK pension funds and their consultants use the UN Principles of Responsible Investing (PRI) and the UK Stewardship Code the most, but even those using a maximum of 1-2 standards complain about inconsistencies between them.
But the lack of clarity is felt even stronger when dealing with asset managers. 73% of UK pension schemes and consultants state they would like a clear explanation of how ESG considerations are implemented on the fund or mandate level, and 77% would engage with their asset managers to seek alignment.
"ESG standards are not cohesive and clear, but the lack of clarity is even stronger amongst asset managers – they need to provide a clearer explanation of how they implement ESG policy on the fund or mandate level, and across asset classes beyond equity."
Furthermore, only 43% of schemes and consultants consider engagement in fixed income because the industry has a poor understanding of the link between ESG and fixed income. Yields, spreads and cashflows are perceived as less sensitive to events impacting the stock price, and it is not clear how to engage with borrowers, yet a majority of the most fossil fuel intensive companies do not have publicly traded equity.
What can you do right now?
Think proactively – find the areas where you or your clients lack clarity and simplicity, discuss ways to fix this and enlist the help of experts if needed
Be specific – lay out a clear ESG policy and requirements to be met by your providers and partners, and follow through on them
Engage proactively – talk to your clients, members and providers and think about how to reconcile the friction points
Learn from others – talk to peers who are further ahead in the ESG implementation process, share your challenges and learn how they have overcome them