Covenant analysis still missing
on schemes’ ESG strategies

Data crunch: Only 19 per cent of schemes are analysing the risk posed by environmental, social and governance factors to their sponsor’s covenant

At a time when defined benefit scheme trustees will soon be asked to include employer covenants in their climate risk analysis, fewer than two in 10 are doing so, new research has revealed.

The analysis from EY, which questioned 85 trustees from schemes ranging from smaller plans with less than £1bn in assets to giant schemes with more than £10bn, concluded that only 19 per cent are accounting for environmental, social and governance risk in the assessment of their sponsor’s covenant.

In a consultation published in January, the Department for Work and Pensions proposed broadening the scope of climate risk analysis to cover not just the environmental impact of pension schemes’ portfolios, but also sponsor covenants and actuarial valuations.

The new rules state that schemes with assets of £5bn or more will have to meet the new governance requirements from October 2021, and their trustees must publish a Task Force on Climate-related Financial Disclosures report within seven months of the end of the scheme year.

“A lot of trustees are already factoring ESG from an investment perspective, but the bit they have missing — and the government has now confirmed it will expect it will be part of it — is sponsor covenant”
Karina Brookes, EY-Parthenon

This means that trustees will need to report on the progress of their ESG covenant assessment, which, according to EY’s research, 29 per cent of schemes have not yet addressed.

The analysis showed that 12 per cent of trustees are implementing this assessment, and in 41 per cent of schemes the discussion has started but has not been resolved.

Karina Brookes, UK pensions covenant advisory leader at EY-Parthenon, explained that a “lot of trustees are already factoring ESG from an investment perspective, but the bit they have missing — and the government has now confirmed it will expect it will be part of it — is sponsor covenant”. 

She explained that in most cases, covenant is responsible not only for contributions but also for any buffer gap that trustees might need, so they must bring ESG into their thinking. 

“In many cases, the sponsor is already doing work on ESG — it’s a very collaborative piece of work where trustees and sponsors need to understand the ESG risks for the sponsor — but then the trustee needs to take those risks and see how they correlate with their investment risk,” Brookes said. 

“Sometimes you will find that you’re doubling your risk in a particular area. It’s a new dimension to the integrated risk agenda.”

Pixabay

Pixabay

Trustees prioritise reporting requirements

The research showed that while almost all (94 per cent) of trustees surveyed agree or strongly agree that addressing ESG factors is consistent with their fiduciary duty to act in members’ best interests, only 12 per cent have started to implement their policies for addressing and reporting on climate-change risk.

Marc Hommel, senior pensions adviser at EY-Parthenon, is not surprised by this result. The survey was conducted in December, and “it wasn’t until the Pension Schemes Act was passed that there was certainty that the government would push ahead with the October 1 2021 date for pension funds with more than £5bn of assets to comply”.

He noted that schemes between £1bn and £5bn in assets have another year to comply with the requirements.

“It wasn’t until the Pension Schemes Act was passed that there was certainty that the government would push ahead with the October 1 2021 date for pension funds with more than £5bn of assets to comply”
Marc Hommel, EY-Parthenon

“Only recently this issue has come on to the regulatory agenda, and it’s the regulation that is forcing an acceleration in the number of schemes looking both at what they want to do to understand how climate risk should impact their investment strategy, how they discharge that strategy and how they are going to comply with the reporting, because that is the actual legal requirement,” he said.

Hommel explained that “there is a rather large number of schemes for which this issue has suddenly become high on their priority list for 2021, having not being in that list at all before”.

EY’s research showed that to date, trustees have predominantly focused their ESG deliberations on investment risk and return. 

Nearly two-thirds (64 per cent) have an agreed ESG strategy, with 29 per cent currently implementing it into their asset management processes. A further 35 per cent are at a strategy discussion stage. 

The analysis also revealed that the majority (76 per cent) of trustees have implemented the changes required to update their scheme’s statement of investment principles in relation to ESG factors, with the remainder having agreed their strategy for doing so. 

The remaining actions are still a work in progress, with initiatives on compliance with the stewardship code being implemented by a third of trustees.

AP Photo

AP Photo