There has been a growing demand on UK defined benefit pension schemes to consider environmental, social and governance (ESG) factors. Since October 2019, trustees need to set out how they take account of those issues in their statement of investment principles (SIPs).
This has led to investment managers adjusting their funds to meet the new requirements and satisfy the needs of trustees on considering ESG. However, defining ESG is open to debate. Different individuals have a different view on what it means, which could give rise to ‘greenwashing’, the term used to describe investment managers veiling their funds as greener than they truly are.
To combat this potential issue, the European Parliament has voted on new disclosure requirements for sustainable investments. Also, the Investment Association in the UK has released a framework to try to prevent confusion around responsible investment stemming from inconsistent use of terms and phrases. We believe this will naturally make it harder for managers to greenwash their funds, giving investors more confidence to invest in genuine sustainable funds.
A potential issue caused by the increased disclosure requirements is the reliance on ESG data to ensure managers consider sustainability risks and opportunities. Currently, the main ESG data providers have vastly different methodologies for scoring companies, resulting in a wide range of results. One provider may score a firm highly and another, using a different scoring metric, may score it lower. We feel it is important for the ESG data providers to score firms consistently and recognise that the new classification system should help.
Investment managers place a heavy reliance on ESG data, which increases pressure to provide overly positive results for a higher score. Many ESG metrics are currently not audited in the same way as financial information, so it is easier for firms to inflate their ESG credentials. We would hope regulations will prevent this from happening.
No overnight fix
We feel the most important thing pension schemes can do to ensure they are really investing in line with their own sustainability objectives is to discuss the topic more frequently and understand what their aims are. We are pleased to see ESG and sustainability aims are a more common feature of trustees’ meeting agendas. While the change won’t happen overnight, we feel that over time, as more people become aware of the benefits of considering sustainability, it will get much more attention.