oil workers istockCan DB pension schemes consider climate and other ESG factors? Yes they can!

March 2017 TPR DB pension scheme guidance clarifies ‘the ethical question’ for trustees and advisers…

The Pensions Regulator has recently clarified what had been a major issues for those involved with the management of defined benefit (DB) pension schemes, namely: whether or not it is acceptable to bring ‘ethical’ factors – or whatever term you might prefer to use – into account as part of an investment strategy.

The answer is a resounding ‘yes’.

As you might expect, their paper falls short of recommending trustees and advisers exclude controversial sectors such as major emitters of carbon or abusers of human rights – but it does open the door for trustees to do so if they wish.

The first section of their paper  ‘What you need to do’ makes clear reference to the area I refer to as ‘SRI’ and others may call ‘ethical’ or ‘ESG’ investing – which typically encourage investors to consider issues such as climate change, business practices and governance both on ethical on financial grounds.


‘Pension trustee and adviser guidance paper’ extracts

This first section of the (33 page)  reads as follows:

What you need to do

Decide as a trustee board whether to develop investment beliefs, ensuring your investment strategy then reflects these beliefs.
Establish your risk capacity and risk appetite.
Set investment objectives and an investment strategy consistent with your risk appetite.
Take an integrated approach to investment strategy, which considers the employer covenant and funding level.
Seek to work collaboratively with the employer to set the investment strategy.
Understand your scheme’s principal investment risks, balance appropriately the risks you are taking and put in place suitable mitigation strategies including contingency plans.
Take environmental, social and governance (ESG) factors into account if you believe they’re financially significant.
Carry out an appropriate level of analysis on investment options and understand the limitations of the analysis.


The paper goes on to develop these points including examples of opinions that schemes may arrive at and wish to reflect through their strategies.

These include the following, points:

Example investment beliefs (Example 3):

-Well governed companies that manage their business in a responsible way will product
-Climate change could be a long term risk for the scheme and has the potential to impact the scheme’s investment strategy
-Investing responsibly and engaging as long-term owners reduces risk over time and may positively impact investment returns
Pages 3 – 6 develop this thought process in their references to ‘Financial and non-financial factors’, which make the relevance of climate and other environmental, social and ethical concerns as clear as can be.

To avoid over-egging my support for this paper I have reproduced the next few pages of its text verbatim:

Financial and non-financial factors

The Law Commission has produced guidance on the legal obligations trustees have when considering financial and non-financial factors when making investment decisions. In summary:

-You are required to take into account factors that are financially material to investment performance.
-You may take into account financial factors which are not financially material to the scheme.
-Where you think environmental, social and governance (ESG) factors or ethical issues are financially material, you should take these into account.
-While a financial return should be your main concern, the law is sufficiently flexible to allow you to take other, non-financial factors into account. This may be the case if you have good reason to think scheme members share your view and there is no risk of material financial detriment to the fund.

View the Law Commission guidance (PDF, 123kb, 6 pages). [This link is not currently working on the TPR website]

Example 4: considering financial factors

The trustees of ABC Scheme set an investment strategy to deliver a required level of return over the long-term.

When reviewing the statement of investment principles (SIP), the trustees consider market developments and conclude that climate risk is financially material to the investment strategy.

They set out the following investment belief:

‘As long-term investors, we believe climate risk has the potential to significantly affect the value of our investments.’

They develop this belief in the SIP as follows:

We expect fund managers to have integrated climate risk into their risk analysis and investment process.
We will try to ensure that we manage all new and existing investment arrangements in a way that takes account of climate risk.
In monitoring the performance of our fund managers, we will also regularly consider how they are performing with reference to climate risk issues.
In addition, the trustees decide to report annually to members on how the climate risk policy has been applied.

Learning points: Many factors can impact investments over the long-term. Where you consider these to be financially material, you are required by law to factor them into your investment decision-making.

Example 5: considering non-financial factors

The trustees of ABC Scheme receive a number of communications from members setting out ethical concerns about some individual investments held within the scheme’s investment portfolio.

The trustees don’t have a position on the relevant ethical issues and the scheme investment arrangements are currently unrestricted. The trustees conduct a survey of members and beneficiaries to ascertain whether the ethical concerns are reflected within the scheme’s membership.

The trustees receive a high number of responses from the survey and, of those members who responded, the majority were strongly in favour of factoring ethical considerations into investment decision making. The minority respondents were not strongly opposed to doing so, provided the returns for the scheme were not expected to be materially less as a result.

The trustees seek advice from their investment adviser, who performs a comparison of products with investment characteristics suitable for inclusion in the scheme’s portfolio, including the existing investments in question, and alternative market products, including those which address the majority members’ ethical concerns. They indicate that investing in a way which would address the ethical concerns expressed would not be expected to materially reduce the scheme’s expected returns (net of fees) nor increase the scheme’s investment risks.

The trustees review their investment beliefs and develop a new ethical principle for their investments. They also engage with their investment managers to embed the ethical principle in their existing mandates and all new investment mandates, where that is possible.

Learning points: You may take non-financial factors into account if you have good reason to consider the membership holds a similar view and you are satisfied that the investment does not present a risk of material financial detriment.


Most investments in pension schemes are long-term and are therefore exposed to long-term financial risks. These potentially include risks relating to factors such as climate change, unsustainable business practices, and unsound corporate governance. Despite the long-term nature of investments, these risks could be financially significant, both over the short and longer term.

You should therefore decide how relevant these factors are to inform your investment strategy. You could ask your investment manager(s) and investment adviser for help with this.


The report then goes on to talk about risk, monitoring, employer collaboration, hedging and models…

So to finish off – my view is that this is a useful and unambiguous paper, particularly for those who have been led to believe that schemes can not or should not consider ESG, ethical and or environmental concerns.  It is also consistent with previous statements made by the TPR and its senior staff and others.

In addition we await the results of a related Law Commission ‘DC schemes and Social Investment’ review (May 17) and a related EU PRIIPS consultation (Jan 18).

My expectation is that this paper not only opens to the door – but fixes it open – for many pension scheme members  who care about such issues because of their financial implications, their personal beliefs – or a mixture of both.  My hope is that these other papers will follow suit so that this message is received loud and clear by all.








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