The year ESG became mainstream

The year ESG became mainstream

Caroline Escott reports on the irresistable rise of sustainable investing.

At every PLSA conference, I have a tradition: after the exhibitors’ stands have been set up, but before the delegates arrive, I walk around the main hall and see what each exhibitor is choosing to focus on. This can give an interesting perspective on what’s ‘hot’ (and what’s not) in the industry.

This March, at our Investment Conference in Edinburgh, perhaps half of the exhibitors chose to talk about their ESG approaches – a marked increase over previous years. And it’s not just the asset managers who are keen to discuss sustainable investment. Before planning for each conference starts, the PLSA team surveys our pension scheme members to ask what they would like to hear about. For Investment Conference, ESG investment was the third-most-requested topic by schemes. Taken together with the number of standalone ESG editorials and conferences that seem to be popping up across the UK, it would appear that ESG has well and truly entered the investment mainstream.

But what do we mean, when we talk about ESG? And how does it differ from impact investment? These questions are among those I hear most frequently from schemes. Given the number of terms used in the industry (sustainable/responsible/socially responsible etc.) it is unsurprising that confusion remains. The PLSA perspective goes like this: although every asset manager will have a slightly different house style, at its core ESG investing draws upon the recognition that many E, S and G factors – like climate change, gender diversity or human capital – are material to a company’s bottom line. As a result, it makes good financial sense to consider these factors in any investment analysis and management process to seek to improve risk-adjusted returns over the long term. 

New ESG duties

Impact investment differs primarily owing to the additional intentionality factor. The Growing a Culture of Social Impact Investing in the UK Advisory Group – chaired by Elizabeth Corley and on which the PLSA has had a continuing role – notes that “social impact investing specifically targets companies and organisations that intentionally create a positive social benefit, either as a primary or secondary purpose.” So where ESG investing is often undertaken to boost investment returns over the long run, impact investing aims to achieve both a financial objective and a positive (environmental, social or governance) impact objective.
Although momentum on ESG or impact investment approaches had been building in the industry for a few years, one of the most clear-cut reasons for this happening has been the Department for Work and Pensions’ (DWP)’s changes to the Occupational Pension Scheme (Investment) Regulations. This places new duties upon DB and DC scheme trustees (as of 1 October 2019) to:

  • Clarify in their Statement of Investment Principles (SIP) how they take into account financially material1 E, S and G factors, “including climate change”
  • Clarify in their SIP how they undertake stewardship (to include both voting and engagement activities)
  • State the extent (if at all) to which the trustees take into account “non-financial matters”2.

DC schemes have an additional set of responsibilities where they will need to publish their SIP online as well as producing and publishing an ‘implementation statement’ where they will report how they have acted on the principles set out in the SIP. 

It’s not just last year’s Regulations which are encouraging schemes to consider how they incorporate and communicate their ESG approaches. This year will also see significant policy and regulatory activity on stewardship specifically, with key developments including the implementation of the EU’s Shareholder Rights Directive (SRD II) in the UK and an update to the Financial Reporting Council (FRC)’s Stewardship Code.

Which brings us to another question I’m often asked: what is stewardship? Again, the definition varies, but in its broadest (investment) sense, being a good steward means looking after the assets with which an investor has been entrusted. In practical terms, this means schemes working with their managers and advisers to monitor, and engage with, the companies they invest in on material issues with an eye to protecting the value of individuals’ savings. Material issues can include ESG topics, but also broader areas of relevance to a company’s business model and strategy. The implementation of the SRD II – depending on what shape Brexit takes – will mean all FCA-regulated life insurers and asset managers will need to become more transparent about their engagement policies and investment strategies, including how they exercise voting rights and cooperate with other shareholders in the investee companies. 

Evolving stewardship approaches

The Stewardship Code is not mandatory, but how it evolves frames the debate on stewardship practices more widely. The Code “aims to enhance the quality of engagement between investors and companies to help improve long-term risk-adjusted returns to shareholders”. Both pension schemes and asset managers can currently sign up to the Code, and signatories must comply with the Code’s Principles (or explain why they do not). To coincide with SRD II implementation, the FRC has just finished consulting on an updated Code. Proposed changes include:

  • An explicit reference to “ESG factors, including climate change”
  • Broadening the scope of the Code to asset classes beyond listed equity
  • A new definition of stewardship
  • A new section of the Code which applies to service providers (including proxy advisers and investment consultants).

With so much happening in policy land, it’s no wonder that ESG is rapidly climbing up schemes’ to-do lists. And with the 1 October deadline on the Regulations looming, ESG should be on the agenda for the next few trustee meetings. As well as helping shape the policy framework on members’ behalf, the PLSA offers several guides and resources for schemes:

Only time will tell whether next year’s Investment Conference will see further growth in the number of exhibitors advertising their sustainable investment approaches, or whether ESG will continue to top members’ session topic wish-lists. Love it or loathe it, however, it seems clear that 2019 is the year ESG finally became mainstream.

1 So where ESG issues are financially material to the performance of an investment, trustees should be taking account of them.
2 This includes members’ ethical concerns but also social and environmental impact matters and quality of life considerations.