Social factors come into focus: a coming-of-age moment for good stewardship
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The Taskforce on Social Factors (TSF) has published its long-awaited guidance, thus laying out a comprehensive framework to help schemes integrate social risks and opportunities. What are the main takeaways from the guidance and how can trustees best factor social considerations into their strategies?
Embracing social factors brings added benefits for pensions funds
In 2022 TSF was formed to develop best practice solutions which helped schemes incorporate social factors into their investment approach. This came in response to a 2021 call for evidence from the Department for Work and Pensions (DWP) which uncovered that many schemes struggled to adopt policies on social factors.
Despite the challenges social factors pose, TSF stresses that addressing them is important because doing so helps schemes increase their investments’ resilience and impact as well as secure better outcome for members. The guidance further notes that social factors can best be understood using the following lenses:
practices within a company;
practices within a company’s supply chain;
the company’s products and selling practices; and,
the impact a company has on the community.
Active stakeholder engagement is key to deliver positive social outcomes
One of the main recommendations in the guidance calls for schemes to engage with providers on social considerations at both the point of appointment and during formal reviews. Interestingly, data from our annual Trustee Report 2022, produced in partnership with Janus Henderson Investors, highlights that while many schemes engaged with managers on broad ESG considerations, they were less likely to address social factors directly by adding them to the risk register. In addition to working with providers, TSF also encourages trustees to engage with governmental stakeholders and standard setters to positively affect social issues. To help further, TSF has also produced detailed guidance for trustees on effective social stewardship, investment and advice services.
Trustees should embed social factors as part of their ESG risk considerations
TSF highlight that trustees have a duty of care to consider financially material factors, including social considerations, when making investment decisions. Therefore, schemes should, at the very least, include social factors as part of their risk analysis and investment principles. The best way for pension funds to do this is by accounting for salient risks (i.e., risks to people like human rights abuses) as well as the materiality of social risks.
Promisingly, data from our annual Trustee Report 2022 shows that many trustees are already aware of the potential impact of social issues, especially those with longer time horizons.
Schemes have a diverse range of approaches at their disposal to integrate social risks
According to the guidance, material risks are those with the most potential to negatively impact an investee company. To assess the materiality of these risks, the guidance includes a three-stage materiality assessment framework, which is broken down into a country assessment, a sector assessment and lastly a corporate assessment.
The next area of importance concerns salient risks, which according to the TSF are essentially the risks to people. TSF notes that trustees should consider evaluating these risks these using the following parameters:
scope, which assesses the number of individuals impacted;
scale, which covers the severity of the impact on the affected individuals;
remediability, which entails limits on the ability to restore affected individuals to their previous situation; and finally,
the likelihood of a negative social risk occurring.
In addition to integrating financially material social factors and systematic risks in the scheme’s ESG approach, schemes can also generate positive social outcomes through actions like impact investing.
Approaches can be tailored to meet each scheme’s unique circumstances
To reconcile the differences between schemes, TSF favours a flexible approach for trustees to take when addressing social factors. This three-tier framework scales from baseline practice to good practice and finally leading practice:
Baseline practice: best suited for those with limited resources or ESG experience as it emphases knowledge-building, engaging with providers on social factors and developing high-level investment and stewardship policies.
Good practice: this approach meets baseline requirements and expands on them via materiality assessments and prioritising social issues as part of scheme stewardship policies and voting guidelines. Trustees will then integrate these in provider selection and oversight or execute their own proxy voting or direct engagement. Good practice also calls for enacting social policies at the operational level (e.g., diversity and inclusion, gender pay gap, etc.) and requiring reporting on social factors from providers.
Leading practice: in addition to meeting baseline and good practice requirements, this approach also calls for a dedicated voting policy on social factors, consideration of social impact investments, industry leadership through social factors initiatives/working groups, and demonstrating industry leadership by being signatory to notable standards or codes (e.g., UK Stewardship Code).
Sourcing social factor data is an essential part of best practice
Historically, the lack of adequate metrics or data is among the top challenges trustees face when implementing their ESG strategies. Data from our annual Trustee Report 2022 underscores that this is especially the case for those looking to integrate social considerations in their ESG approach. Although some social issues may remain challenging from a measurement perspective, the Taskforce’s guidance includes several useful tips to help trustees with social data, metrics and risk modelling.
TSF highlights that a natural starting point for those looking to gauge social impact are the UN Sustainable Development Goals (SDGs). For example, trustees can align their strategies with SDG 5 (gender equality) or SDG 8 (decent work and economic growth).
A more robust way to address social factors is with standardised metrics such as gender or ethnic pay gap data, accident or fatality incidence rates, maximum supplier payment terms, the proportion of full-time employee roles or the number of employees paid a living wage.
Finally, if accessing social issue data proves too difficult, TSF recommends alternative approaches like scenario analysis, stress testing or qualitative assessments. Moreover, they note that there are several useful frameworks, initiatives and data sources trustees can use to aid their knowledge building and reporting. TSF also produced a series of case studies and a directory of data sources to further assist schemes.
Now the hard work begins
The pension industry’s recent progress with TCFD recommendations shows that schemes are capable of achieving high ESG standards when they have a coherent framework in place to get started. While the road ahead may prove challenging, schemes are well equipped to overcome difficulties thanks to the breadth and depth of TSF’s social factors guidance. Moving forward, it will be important for service providers and standard setters to make the journey smooth by providing readily accessible data and best practice frameworks.
What approach to social factors does your scheme favour? Tell us in the comments below.
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