Levelling the playing field: DC and ESG
23 Apr 2019
Anyone who had the opportunity to watch Edinburgh’s Hibernian football club play in the last century will appreciate that you don’t always get a level playing field! At the end of the 1999-00 season, a slope of 6 feet between the north and south ends of the pitch was removed, allowing a flat pitch to be restored. Whether or not this improved the quality of football at the Easter Road stadium is a moot point!
Levelling the playing field in DC pensions is an important job too – and a “Work in Progress” at the present time. The FCA’s recent consultation on requiring Independent Governance Committees to report on their provider’s policies on Environmental, Social and Governance issues, including climate change is, arguably, a “late to the party” response to the increased focus within the pensions industry on ESG issues. From October this year, trust-based DB and DC schemes must include a detailed account of their ESG policies in their Statement of Investment Principles, including details of what they are doing to engage with their managers and understand their stewardship and engagement policies as well as agreeing how, if at all, they will implement strategies relating to ESG and climate change in their portfolios. So why wouldn’t the same requirements apply to contract-based arrangements?
At present, none of the major contract-based players has a clear positive tilt to ESG factors in their default arrangement, although many would argue that they do actively deal with the G in ESG. Some providers are actively considering ESG more formally at present and if the FCA’s proposals are adopted, we are likely to see more moving down this route.
Within the Master Trust universe, only NEST actively incorporates ESG into its default investment strategies; others offer ESG solutions within their self-select or alternative lifestyle ranges. Master Trust trustee boards are spending increasing amount of time (as they are now required to do) in setting investment beliefs and developing investment strategies that reflect those beliefs as well as gaining a deep understanding of how well their managers stack up in this area. If we are to level the playing field between these two types of arrangements, it’s a no brainer to introduce similar requirements in relation to IGCs.
However, we should not under-estimate the challenge that this could bring if the new regulations require IGCs to understand in detail in the ESG policies in relation to all of the funds offered on the platform. Whilst Master Trusts might offer a choice of up to around 20 funds to members - many from the same investment manager - contract-based providers often offer several hundred funds from multiple managers. Any change in the regulations could therefore potentially lead to a significant reduction in the number of funds offered to members – whether this is a good or a bad thing may be a point for debate…
And perhaps more controversially, there could be a commercial angle to this as well. Most default strategies are simple passive solutions which maximise profit. Introducing additional governance, ESG tilts and active oversight will increase the cost of the investment solution and reduce the profit margin as well as, in more extreme circumstances, potentially creating issues with the charge cap. We may find over time that these issues could create potential conflicts between trustees/ IGCs and the providers? Time will tell.
ESG regulations are only one of a number of areas where trust and contract-based regulations differ. The issue of lower earners and net pay/relief at source is another one where members could be losing out, simply because of the type of arrangement they are in. And through our investigations in the Working Party on the Security of DC Assets, we know that the levels of protection currently afforded to contract-based arrangements can be different to those in trust-based arrangements.
In my view, all DC members should be treated equally. In other words, there should be a level playing field for everyone, regardless of the contract they are invested through. The sooner this happens, the better.