In our last blog we considered the immediate ESG implications of the Ukraine situation on trustees of UK pension schemes (link here). This article covers the implications of wide-reaching international crises from a wider social investment perspective – the 'S' in ESG – and what it means for sponsoring employers.

Considering the social factors

As we noted in our last article, there is leeway for trustees to consider non-financial factors when making investment decisions.

The UK’s Occupational Pension Schemes (Investment) Regulations 2005 (the Regulations) recognises the overlap between social and financial factors in its definition of 'financially material' considerations. These include 'environmental, social and governance considerations (including but not limited to climate change) which the trustees of the trust consider financially material'.

The link between social and financial factors is clearer when the 'S' crisis is a situation such as the invasion of Ukraine, given the international sanctions and depreciation of Russian assets that followed.

The same might not necessarily be said for more contentious issues where there is less of a clear-cut view on the ethics or financial sense of divestment. One example is investment in fossil fuels or industries with a negative impact on the environment. Another is investing in countries with poor human rights records or antidemocratic political regimes. In such situations, moral outrage triggered by a one-off headline might be shared by only a vocal subsection of a scheme’s members. In defined benefit schemes in particular, the views of members might conflict with the sponsoring employer who is ultimately financially responsible for the underperformance of a scheme. Trying to gauge the majority held view of scheme members is also an arduous task and might inadvertently result in backlash from members who feel their views are not being taken into account. It may also be the case that withdrawing investments, outside of a crisis scenario, would be significantly financially detrimental.

What is the position of UK scheme employers?

There are several ways in which taking into account ESG more widely will be of relevance to sponsoring scheme employers:

  • failure to acknowledge the role of ESG in ordinary course business operations might have an adverse impact on the employer covenant supporting the scheme (e.g. where operations in a country are stalled by conflict);
  • as noted above, becoming conscious about ESG considerations for pension scheme investments could help avoid unpleasant scrutiny in the future about where and how assets are being invested and subsequent reputational consequences;
  • engagement with ESG can be an important tool to attract and retain an ESG-conscious workforce particularly where an effort is made to understand the social and environmental causes that are important to members; and
  • a top-down message to scheme participants that their pensions could be used to make a valuable social impact might also prompt more active engagement by employees with their pensions.

A sponsoring employer may therefore wish to consider ESG early and before significant financial losses on its own balance sheet place pressure on the company to look at this topic more closely.

One point which may not be commonly understood by shareholders and wider society, however, is that for occupational pension schemes a sponsoring employer has no direct decision making power over investment matters. UK pension law provides that only trustees can make investment decisions; the employer’s only right is to be consulted by the trustee about a scheme’s statement of investment principles. The position may change in future, at least for those schemes where an employer’s agreement is currently required for funding matters. This is because draft new legislation (yet to be brought into force) may require trustees of such schemes to agree a long-term strategy covering funding and investment with employers.  However, it remains to be seen whether the legislation will be introduced with this requirement and how this would operate in practice. 

In any event, trustees should ideally be receptive to and cognizant of the views of the sponsoring employer and member participants on ESG considerations. Since, as noted above, trustees will already be taking ESG into account in their decision-making process a sponsoring employer who is similarly invested in ESG considerations will be able to engage more effectively with trustees on this topic.