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Home / UK and Canadian Pension Fund – Impact

UK and Canadian Pension Fund – Impact

Comparative Study of U.K. and Canadian Pension Fund Transparency Practices 

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6. Impact on U.K. Pension Fund Industry of the SIP Disclosure Regulation 23

Introduction

According to our interviewees, the SIP/SEE requirement has raised awareness of SRI in the U.K. pension fund industry by catalyzing an open, vocal debate on SEE considerations in the investment process. All parties (trustees, fund managers, consultants, lawyers and others) involved in pension fund investments have participated in the debate. This section examines the general sentiment in the pension fund industry following the introduction of the requirement, the impact of the requirement on the U.K. SRI market, and U.K. government policy developments since 2000.

General Sentiment in the U.K. Pension Fund Industry

According to two well-placed commentators, the general reaction of the U.K. pension fund industry to the SIP/SEE requirement was not a problem. Indeed, the change may have improved the climate somewhat for discussions of SRI.
It [the requirement] did, in a way, remove a chill from looking at social, environmental and ethical criteria in investment selection and made it a more mainstream set of investment criteria than we find in countries that haven’t adopted this type of legislation. And in that way it’s very positive because it is seeking to basically provide more information to the market—[to] which I would say (with the financial markets) generally, the more information the better. (Hebb, see App. E) It has certainly changed the debate…nobody says it’s illegal anymore and it’s certainly got pension funds and fund managers interested in it. (Webster, see App. A)
The introduction of the requirement seems not to have been resisted by pension funds; this is evidenced by the high number of pension funds that include SEE issues in their SIPs. The interviews suggested that due to the engagement-based and voluntary nature of actions arising from the requirement, most pension funds prefer saying that they do consider SEE issues rather than that they do not. Environmental Resources Management (ERM) conducted a study in June 2000 (just prior to legislation of the requirement) that found that 21 of the largest 25 pension funds (representing 35 to 40 percent of total pension assets) intended to include SRI principles in their SIP (ERM, 2000). Upon implementation of the requirement, major pension funds such as BT and USS 24responded by publishing their policy on social issues and recruiting staff to engage companies in their portfolio on social responsibility issues (UKSIF Newsletter Spring 2000). UKSIF conducted a survey of pension fund SIPs in October 2000 (following legislation of the requirement) that reinforced ERM’s projections for a high uptake of SEE considerations in U.K. SIPs; UKSIF found that only 14 percent of the funds participating in the survey clearly stated that they will not take SEE issues into account (Mathieu, 2000). Following up two years later, EIRIS (2003a) carried out a study of the largest 250 U.K. pension funds and 25found that:
  • 90 percent of pension funds state in their SIPs that they consider SEE issues in their investment strategy;
  • 59 percent of funds consider SRI experience and performance when appointing or reappointing investment managers;
  • 74 percent of public sector funds disclose voting practices compared with 47 percent in the private sector; and
  • 73 percent of pension funds engage with companies and, of these, 46 percent have written guidelines, 80 percent ask for regular reports on engagement activities and 87 percent exercise voting rights on SEE grounds.
The U.K. Institutional Shareholders Committee (ISC)—which includes the National Association of Pension Funds (NAPF), the Association of British Insurers (ABI) and the Investment Management Association (IMA)—has set out best-practice principles for institutional investors and their agents, which include: “monitoring the performance of and establishing a regular dialogue with investee companies; intervening where necessary; evaluating the impact of their activism; and reporting back to clients/beneficial owner” (ISC, 2002). It goes on to include concerns about corporate social responsibility (among other relevant items) as cause for intervention. This development is notable given NAPF’s earlier opposition to the requirement, and it demonstrates that they have indeed changed their public position. However, it is unclear whether this principle is actively pursued or advocated within NAPF’s membership (Pryce, see App. A). In our research, we detected no discussions about increased costs associated with the requirement. This is taken to indicate that it is not an issue.

General Sentiment among Investment Managers and Research Firms

A number of mainstream investment management firms such as ISIS (formerly Friends Ivory & Sime), Insight Investment, Henderson and Aviva/Morley, as well as SRI research specialists such as Innovest and EIRIS, saw the requirement as a business opportunity. The requirement has indeed generated interest in SRI among fund managers, and many have come out with new products and services. The interest of fund managers is also reflected in their recruitment of project teams in SRI.
There is a significant number of fund managers who have built significant expertise in this area and part of that is done in anticipation of demand from the pension funds. (Mansley, see App. A)
However, fund managers and SRI commentators concur that the demand has not been as great as expected following the requirement (Robins, see App. A; Gamble, see App. A; Lankester, see App. A). Some attribute lack of demand to trustees’ lack of knowledge and confidence about SRI and heavy reliance on conventional consultants for advice. Others cited the three-year bear market along with an increased emphasis on trustee responsibilities following the Myners Report—factors that focused trustee attention on short-term recovery of fund positions and prompted a preference for low-risk responsible investment strategies (such as engagement) (Robins, see App. A). The impact of the requirement was also described to us as somewhat paradoxical for SRI, as it has increased engagement-based approaches and created myths around screening.
In particular, the assumption has grown up that active SRI inherently involves extensive negative exclusions (e.g., of tobacco, military stocks), whereas the reality of segregated SRI mandates for pensions is that they can have no exclusions and take a pure best-in-class approach. (Robins, see App. A)

Trade Unions

Trade unions emerged as generally supportive of the requirement and in recent years have adopted a more proactive response, recognizing that SRI can be harnessed in support of broader union policy goals. The General Secretary of the TUC, Brendan Barber, has been most active:
…trade unions will try and play our part in developing a responsible investment culture. We will endeavour to use our financial assets actively to ensure that companies are well-run and responsive to questions of social responsibility. (Barber, 2003)
The TUC’s Pension Investment Officer, Tom Powdrill, reinforces this view:
We’d obviously like to see pension funds invest in a more responsible way and make sure that they put CSR issues further up the agenda. (Powdrill, see App. A)
Indeed, the U.K. trade unions have become quite active on CR issues via capital markets, and this can largely be attributed to the requirement. The TUC has initiated a number of activities—including creating a position of Pension Investment Officer—to focus on leveraging union pension funds to achieve social objectives. They encourage union trustees to engage in shareholder activism and SRI and provide training on investment issues (Powdrill, see App. A; Insight Investment, 2003).

Growth of SRI Since the Requirement

It has undoubtedly had an impact and it has undoubtedly galvanised change quite substantially for the investment industry. (Mansley, see App. A) Following the changes to the pension fund legislation, demand for this type of service has increased significantly. (Lankester, see App. A)
The U.K. SRI market has expanded rapidly since the requirement came into effect in 2000. This is reflected in Figure 1, where the total value of U.K. pension fund investments using SRI criteria increased from virtually zero in 1997 to £80 billion in 2001 (Sparkes, 2002). However, it is not possible to observe or claim a causal relationship. Figure 1: Total value of U.K. pension fund investments using SRI criteria (Source: Sparkes, 2002). Today, more than £80 billion of U.K. equities out of £250 billion held by U.K. occupational pension funds are subject to pension funds’ SIP/SEE policies (Eurosif, 2003). As noted above, pension funds still largely favour corporate engagement over active screening or a combination of the two, as the perception is that engagement does not challenge their fiduciary duties (and it is still felt in many quarters that screening may). Thus it is widely believed that the trend toward increased shareholder activism and corporate engagement is likely to continue (Eurosif, 2003). Table 2: U.K. occupational pension funds – Demand for SRI
SRI Activity: U.K. equities holdings subject to SRI approaches £ billion
Negative screening only 0.2
Positive and negative screening 1.4
Positive screening only 0.2
Engagement 84.2
Source: Eurosif, 2003.
Another important impact is companies increasing transparency in response to demand from the investors:
The SIPs have led to an increase in engagement activities and companies in the UK are becoming accustomed to dialogue on these issues with shareholders. (Wildsmith, see App. A)

Consideration of SEE Issues as Stated in SIPs

In 2003, Patricia Hewitt, Secretary of State at the Department of Trade and Industry, made a speech in which she hinted that the voluntary approach is not working and not enough pension funds and asset managers are taking activism seriously (Insight Investment, 2003). There is evidence to suggest that the consideration of SEE issues in U.K. pension fund investments does not match the degree of inclusion in SIPs (Coles and Green, 2002; Gribben and Faruk, 2004).
The number of pension funds that have actually done something really substantive in this is disappointingly small…it is perhaps going slowly and the real change in pension funds is small. (Mansley, see App. A)
There are various reasons for this lack of implementation. Most pension funds seem reluctant or not equipped to monitor the activities of their fund managers on these issues. Therefore, it is common to see a lack of reporting from fund managers on how they integrate SEE issues into the investments—even when it is clearly stated in the SIPs.
Unless people like us are required to report to trustees and the trustees are required to report their own members...there is just not enough transparency for moving this agenda forward. (Lankester, see App. A)
Similar sentiment was voiced in other interviews, and many think that unless pension funds address this issue of implementation urgently, the case for regulatory action by government will become stronger.

Other Developments

Gribben and Faruk (2004) conducted a study of pension trustees that identified the main barriers to consideration of SEE issues in the investment process: 1. Lack of tools to evaluate the financial impact of SEE issues on portfolio companies. 2. Lack of tools to evaluate the competence of fund managers in considering SEE issues in the investment process. 3. Concerns raised by legal or investment advice. 4. Uncertainty surrounding financial benefits and additional costs generated. The same study reported that many trustees felt additional regulation was needed, including requirements for:
  • pension funds to report on the implementation of their SIP in their report and accounts;
  • defined contribution schemes in the U.K. to offer an “ethical” option; and
  • all pension fund trustees to receive investment training incorporating SEE issues.
  • a longer-term perspective in equity investment.26
  • a formal code of best practice for pension funds in dealing with SEE issues.
Our interviews also suggested action to mitigate the barriers outlined above:
A couple of easy things would be mandatory reporting on CSR issues in company reports. That is where the OFR bit within the Company Law review was all about, is what companies would have to report and it got tied into this issue of materiality; what really is material for shareholders and we argue that human capital is an important issue, environmental stuff is important. We’d like to see mandatory reporting on this….Making it mandatory for fund managers to publish their voting and engagement records. (Powdrill, see App. A) The new regulations emerged in the context of regulation of pension funds. And, of course, capital market investments are much broader than just pension funds, although obviously they constitute a large slug of that money. I would have preferred to see a more fundamental review of fiduciary responsibility—to redefine it to include sustainability and governance, too. Such a review would apply to all those acting in a fiduciary capacity, whether it be mutual funds, investment trusts (we have here), bank investments, financial products for the retail market, or collective investment schemes like insurance companies or pension fund products and services. I would have preferred to see a broadening of the application of enablement. This would have avoided some pension funds saying “why single us out.” It’s not so much saying that you are not acting in the best interests of your beneficiaries if you don’t take it into account, but what you do need to do is be aware of it. And in that way it would have to be part of a culture of fiduciary responsibility. (MacDougall, see App. A)
In response, the U.K. government is taking action or giving consideration to:
  • Further regulation to encourage pension funds to put policies into practice. There is strong demand for pension funds (and therefore fund managers) to produce reports detailing the actions they have taken on SEE issues as outlined in their SIP (Colman, see App. A; Waygood, see App. A; Webster, see App. A).  
  • Regulation to extend the disclosure requirement that applies to occupational pension funds to all retail investment products (Insight Investment, 2003).  
  • Similar regulation for U.K. registered charities with an annual income of over £1 million (Green, 2003). Moreover, following the Myners Review of Institutional Investment, the government is also showing an interest in legislating on shareholder activism (Eurosif, 2003).  
  • A new statutory Operating and Financial Review currently has draft regulations out for consultation. These include increased transparency for company reporting including on SEE issues 27(DTI, 2004).

Summary

According to Alan MacDougall, the Managing Director of PIRC:
We have developed a positive culture in the U.K. in which sustainability is no longer a dirty word either in the investment world or the corporate world, and many companies have begun to manage expectations and negotiate with stakeholder interests, whether they are NGOs, employees, investors or regulators and government. The regulations have been a very healthy development, and we’ve seen little “witch hunting” of companies or investors. What we’ve seen is a dialogue, sometimes hostile, but broadly speaking positive…. Few company directors publicly say that… these activities have no effect on their ability to create wealth...on the other hand, very few investors would deny that these issues do not have legitimacy in the investment process. (MacDougall, see App. A)
It seems the requirement has indeed raised awareness and created space for trustees to consider SEE issues in pension fund investments. The requirement has certainly been a driver in the growth of SRI in the U.K., albeit mostly through increased shareholder activism and corporate engagement. However, it has not been a panacea for CR, and the degree of real impact is still unclear. There was no feedback to suggest that the requirement has had any negative impact on the U.K. pension fund industry or the companies in which they invest. The criticisms expressed by civil society and allied organizations typically stemmed from lack of “real” implementation and a possible lack of impact of the voluntary approach. However, the SIP/SEE requirement is likely to stay and is unlikely to be discarded by future governments. It has been widely touted as successful, and it has generated a great deal of interest internationally with a number of other countries implementing the same or very similar policies (Australia, Belgium, France, Germany and Sweden). Many others are looking to it as best practice (Napier, see App. A).