Home / UK and Canadian Pension Fund – Impact

UK and Canadian Pension Fund – Impact

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

Previous – Content – Next

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

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).