The ‘S’ in ESG: What is the relevance for pension schemes?
Environmental, social and governance (“ESG”) issues are growing in importance and relevance for pension schemes. Action on ESG in the pensions industry has tended to focus on the “E” in ESG, and specifically on climate change. Less attention has been afforded to the other pillars of ESG, including the “S””.
However, social factors should not be overlooked, as the law requires trustees to explain how they take into account financially material environmental, governance and social considerations.
This blog post explores what is meant by the “S” in ESG and its implications for the pensions industry.
Defining the “S” in ESG
Social factors are wide-ranging and have various meanings according to different commentators in the pensions industry. In broad terms, they relate to how a company manages its relationships with employees, customers, suppliers, communities and society in general. They include health and safety, labour standards, human rights, product safety, privacy and data protection, diversity and inclusion, and supply chain management.
Progress to considering the “S” in ESG within the pensions industry
In a consultation running from March to June 2021, the DWP sought views on the effectiveness of occupational pension scheme trustees’ current policies and practices in relation to social factors. This consultation sought to assess how trustees understand social factors and how they seek to integrate considerations of financially material social factors into their investment and stewardship activities.
In July 2022, the DWP published its response, which did not propose new regulation, but instead highlighted several key points to move the “S” in ESG higher up the agenda. The DWP’s view is that trustees should take into account all factors they deem to be financially material to their scheme’s investments, and that social risks and opportunities can have a financially material impact on the value of the scheme’s financial assets and long-term performance of investments. We agree with this.
The response goes on to consider how trustees can take into account financially material social risks and opportunities. It says that trustees can choose how the assessment is performed: they can either take an integrated approach to ESG, or alternatively adopt a standalone policy on social risks and opportunities. Where trustees take an integrated approach, the DWP says they should still actively consider which social risks and opportunities might be financially material to the performance of the scheme and communicate them accordingly. The DWP adds that trustees should try to be aware of the links between climate change and social factors. The response includes a list of useful frameworks and reporting standards, to aid such an approach. For trustees grappling with how to address the “S” in ESG, the DWP response is useful reading and a good starting point.
The DWP does, however, recognise that trustees may face difficulties in obtaining data and metrics on social risks and opportunities. In a bid to address this issue, in March 2023, the DWP launched the Taskforce on Social Factors (the “Taskforce”). The Taskforce aims to support pension scheme trustees and the wider pensions industry with some of the key challenges around managing social factors, including the identification of reliable data and metrics. One objective of the Taskforce is to identify reliable data sources, which could be used by pension schemes to identify, assess, and manage financially material social risks and opportunities. Another objective is to monitor and report on developments relating to the International Sustainability Standards Board and other international standards. A final objective of the Taskforce is to develop thinking around how trustees can identify, assess, and manage financial risks posed by modern slavery and supply chain issues. Trustees should look out for any guidance or recommendations the Taskforce publishes at the end of its one-year term.
Overall, ESG legislation is becoming increasingly ambitious, with a particular focus in recent years on climate issues. But trustees should not lose sight of social issues in their long-term objectives and investments. The DWP response should help trustees develop their thinking and approach in this area. In the meantime, we look forward to more guidance from the Taskforce next year.