Unlike the best romantic stories, this proposal was expected, grounded in practicalities and wholly lacking in passion. Part of it was borne from the principle that pension trustees and investment managers should develop a closer working relationship.
The Need for a Committed Relationship
Responsible investment and investment stewardship are hot topics at the moment in the pensions world. Trustees need to not only ensure their decision making takes into account responsible investment and ESG factors, but also that they can publicly account for their actions.
Why? Well, trustees will already be aware that, from 1 October 2019, their Statements of Investment Principles had to include a statement on their policies relating to the exercise of rights (i.e. voting rights) attaching to their investments and how they have engaged with investee companies. In addition to this, it is going to be necessary to report how this has been done during the year in online, publicly available statements. This requirement will come into force from 1 October 2020 for DC schemes and 1 October 2021 for DB schemes.
What is noticeable in the requirements to make such information publicly available is the tacit acceptance of the fact that pension funds are no longer regarded as private discrete trusts, whose members are the only people entitled to information. That is still the basis on which the disclosure of information regulations work but is at odds with the apparent policy objective of making pension schemes publicly accountable.
A Meeting of Minds
Trustees therefore need to be thinking about how they can engage with their investment managers in an effective way so that they can then report back on their engagement activities. But what is the best way to do this? The Financial Reporting Council’s new Stewardship Code (the Code), which came into force on 1 January 2020 (repealing the 2012 code), may have the answers.
The overarching purpose of the Code is to encourage “the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society”. Both asset owners (like trustees) and asset managers can sign up to the Code. If they do so, they are then expected to produce a report, in plain English, that clearly shows how the principles of the Code have been applied.
For asset owners, there are 12 principles which are grouped under 4 headings. These cover reporting on purpose and governance, investment approach, engagement and exercising rights and responsibilities.
The Code then contains further detail on the 12 principles that asset owners are expected to take into account. Some of the key points that are relevant to trustees and should be recorded in a stewardship report are set out below:
- Investment beliefs – Explain investment beliefs, what factors are important, and how this guides decision-making and action taken.
- Governance and resources – Are these sufficient to enable oversight and accountability? Are there appropriate resources?
- Conflicts of interest – Signatories should disclose conflicts policy, and give examples of identifying and managing conflicts.
- Taking account of client and beneficiary needs – Disclose scheme structure, size and profile of membership, as well as investment time horizon. If relevant, how have beneficiaries’ views been sought?
- Integrating stewardship, including ESG factors, into activities required to fulfil responsibilities – Disclose issues prioritised for assessing investments. Tenders/award of mandates should build these in.
- Monitor and hold managers to account – How have service providers been monitored and held to account? What action has been taken?
- Engagement with managers – Methods of engagement (meetings, writing letters, etc.) and why have they been used?
- Participation in collaborative engagement – How have trustees engaged with other investors and what was the outcome?
- Active exercise of rights – Disclose voting policies for shares, how they are used, provide voting records, explaining why decisions were taken.
The above clearly sets out a wide range of activities which some trustees may not be familiar with or may not have the resources to undertake. Nonetheless, The Pensions Regulator (TPR) has stated that the Code “outlines best practice on stewardship, and trustees are encouraged to sign up… we would like trustees to adhere to the code in their stewardship activities with a view to improving long-term returns and reducing the risk of poor outcomes due to poor strategic decisions”.
A Long Engagement?
Despite TPR’s guidance, as at December 2019, no more than 20-30 private sector final salary schemes had signed up as signatories to the Code (as opposed to a much larger number of Local Government Pension Scheme funds), meaning there is a still a long way to go before the Code is more widely adopted by the industry. TPR has also acknowledged that for many pension schemes, stewardship activities, including engagement, are likely to be undertaken by the investment manager on the trustee board’s behalf.
So what should trustees be doing? Fundamentally, the pressure to report on investment/stewardship activity is not going to go away any time soon and is only going to increase. The Code does provide a useful roadmap for trustees to achieve best practice in this area.
Trustees should consider speaking to their investment managers about how the principles of the Code could be built into current activities, and also seek legal advice on the terms of their investment management agreements as to their rights for engaging with investment managers.