In a recent Let’s Talk, we noted that new guidance from The Pensions Regulator requires trustees to take into account Environmental, Social and Governance (ESG) factors where they consider these to be financially significant risks.
At JLT, our Responsible Investing (RI) Group, with representatives from across JLT Investment Solutions, provides research and guidance to our clients in the area of Sustainable and Responsible Investing. This, the first in a series of JLT updates from the RI Group, focuses on ESG.
Responsible and ethical investing are not new concepts. Certainly, investment managers have historically been keen to launch “green” funds to enable investors to be more aware of the source of their investment returns. However, there has perhaps been a reluctance amongst trustees of pension schemes to adopt responsible investment strategies, with the concern that such strategies would impact on investment returns. This could have led to an increasing reliance on employers when balance sheets were under pressure in an already low-yield environment. There has also been a concern that by adopting an “ethical” approach there is always a question around which ethics are appropriate.
What are Environmental, Social and Governance risks?
Environmental: Whilst climate change and carbon emissions grab the headlines, environmental responsibility doesn’t stop there. Other examples include:
An investment which has high exposure to these factors must have risks over the sustainability of investment returns. A responsible investor should consider how are these risks being managed.
Social: The source of investment returns should not just be viewed in terms of the impact on the planet. There is also the impact on communities to consider.
Social risks that could affect long term investment returns, include:
Removing discrimination in the workplace will provide greater long term opportunities for organisations.
Governance: Trustees are all too aware that strong governance arrangements lead to better long term outcomes for their pension scheme members. It seems logical that strong governance will result in better and more sustainable long term investment outcomes for investors. Areas for review and consideration include:
- Whistleblower arrangements;
Responsible Investing considers each of the ESG risks in relation to the impact on sustainable investment returns. This does not mean that investors (trustees) should be investigating the long term viability of each of the stocks or corporate bonds they hold. Exercising good stewardship with funds and companies, and using active engagement, can create a framework for Responsible Investing.
RESPONSIBLE INVESTING FRAMEWORK
The Financial Stability Board created the Task Force on Climate-related Financial Disclosures (TFCD) to develop recommendations for “effective climate-related disclosures”.
The TFCD published its final report in June 2017, setting out four core elements for Climate-Related Financial Disclosures:
- Governance – around climate-related risks and opportunities;
- Strategy – actual and potential impacts of climate-related risks and opportunities on an organisation’s business;
- Risk Management – the processes used by an organisation to identify, assess and manage climate-related risks;
- Metrics and Targets – used to gauge and manage climate-related risks and opportunities.
In addition to this, the TFCD developed supplemental guidance for financial and non-financial organisations. The four key areas in the financial industry were identified as:
Clearly the impact on trustees as asset owners will depend on which of the recommendations are adopted in regulation. However, there is now a momentum behind increased and more transparent disclosure of climate-related risks.
RECENT DEVELOPMENTS – PRESS ANNOUNCEMENT
In September 2017, JLT announced that it had joined with the Association of Member Nominated Trustees (AMNT) and the UK Sustainable Investment and Finance Association (UKSIF) to recognise that The Pension Regulator’s guidance put an obligation on trustees and their advisors to consider the long term sustainability of investments, and ESG in particular.
At JLT we believe that ESG is a fundamental part of success in long-term investing.
A responsible approach to achieving investment returns is important for the end beneficiaries of those investments. In addition, strong governance structures, including but not limited to; accounting, environment impact and employee treatment, offers investors an enhanced risk/reward trade-off.
Companies and projects that are proactive and progressive in promoting diversity gain a competitive advantage. However, those that do not adequately consider the impact of their activities on the environment and the communities in which they operate exhibit an unacceptable downside risk to investors.
Taking into account ESG factors means looking for long-term investment opportunities that will further refine a scheme’s existing risk/reward balance, or to put it another way: do you want to be seen as a responsible investor, or an irresponsible one?
To discuss how best to benefit from a review of ESG factors please contact Nick Buckland on 020 7528 4188 (Nick_Buckland@jltgroup.com) or John Paterson on 0131 203 2864 (John_Paterson@jltgroup.com) or get in touch with your usual JLT Investment Consultant.