Changes to the Statement of Investment Principles

Following an interim response to the Law Commission’s 2017 report on pension funds and social investment, the Department for Work and Pensions (‘DWP’) has proposed changes to regulations and confirmed that trustees must update their Statement of Investment Principles to take account of the following:

  • how they take account of financially material considerations over the appropriate time horizon of the investments, including (but not limited to) those arising from Environmental, Social and Governance (‘ESG’) considerations, including climate change;
  • their policies in relation to the stewardship of the investments, including engagement with investee firms and the exercise of the voting rights associated with the investment; and
  • a policy on the extent (if at all) to which non-financial matters are taken into account in the selection, retention and realisation of investments.

These changes apply to both Defined Benefit (‘DB’) and Defined Contribution (‘DC’) schemes.  For DC schemes they will apply to the default strategy.   The new legislation is effective from October 2019.

Financially material considerations

The DWP are proceeding as above to encourage trustees to consider ESG issues and climate change as part of the investment process and not just to maximise investment returns. This could lead to more schemes allocating to investments in specific ESG funds.   However, the DWP has clarified that the intention is not to encourage all schemes to invest specifically in these funds. The purpose is to ensure trustees are thinking about these areas, when in the past they may have been neglected.

The other important point to note is the time horizon over which these factors should be considered. If a scheme is ready to buyout they have a much shorter time horizon to consider the impact of these considerations than a scheme that will run on an ongoing basis.

Trustees will need to explore their own stance on ESG issues and investigate whether the investments made are in line with these views. Trustees may need to question the fund manager on the policies and practices adopted by them in order to get a better understanding.  If the trustees’ policy is not aligned with their current investments, it could lead to a review of some or all of the funds.

Stewardship

Trustees will need a policy on exercising their rights (including voting rights) attached to the investments. They will also need to set out how they intend to engage with and monitor companies (directly or via the investment managers) as well as the circumstances under which this will be done.

Once trustees have agreed on their ESG views, it will help in setting this policy and the circumstances under which they need to engage with companies and how it will be monitored. We expect that many schemes will look to understand the fund manager policies and see if they are happy with them. For those that have specific ESG criteria, trustees may engage with the manager to encourage them to vote in a particular way or engage with companies to encourage particular behaviours. 

Non-Financially material considerations

The regulation defines “non-financial matters” as the views of the members and beneficiaries including (but not limited to) their ethical views and their views in relation to social and environmental impact and present and future quality of life of the members and beneficiaries of the scheme.

Whilst this is an optional policy, trustees should note that they are accountable to members so will need to explain any policy that is adopted. However, they are still responsible for making the investment decisions and would need to comply with the policy.  However, trustees are under no obligation to take on board the views of the membership.

Trustees need to consider these issues as part of the investment process and document any changes in policy in the SIP, before the October 2019 deadline.

We see this change in legislation as a positive step in widening the scope of areas the trustees should consider in the investment process, if it was not already being covered.