The DWP’s Call for Evidence was to seek views on how pension scheme trustees understand social factors and how they are included in their Environmental, Social and Governance (ESG) policies. Our securities litigation team responded and their response is summarised below.

The reporting regime relating to Statements of Investment Principles (SIPs) and implementation statements, as well as the UK Stewardship Code (the Code) encourage UK pension scheme trustees and signatories of the Code respectively to report on investee companies, to conduct their stewardship responsibilities with a view to preserving long-term value in scheme assets and investing in the best interests of scheme members. These requirements are to be applauded, as they align with trustees’ duties to act with care, skill and diligence, in accordance with the “prudent person” test and in the best long-term interests of beneficiaries as a whole. Given that ESG is an increasing focus of UK pensions legislation and UK investor stewardship norms, a prudent investor should now routinely consider such ESG factors and their financial impact before making investment decisions on behalf of scheme members; and continue to do so during the lifecycle of their investment.

References to ‘ESG’ in both the SIP requirements and the Code refer to environmental, social and governance matters in equal measure, however, as stated in the DWP’s call for evidence, occupational pension scheme trustees’ reporting on social issues is relatively high-level when compared to their reporting on governance and environmental issues. This is likely to reflect the relatively comprehensive regulatory frameworks or benchmarks relating to environmental and governance matters which, in turn, support reporting and stewardship in these areas.

Meanwhile, there are multiple overlapping standards on social matters which may result in trustees finding their integration into stewardship activity and SIP reporting, challenging. For instance, the BNP Paribas 2019 ESG Global Survey, which covers the views of the wider investment community, concluded that:

‘[w]hile experts are getting to grips with the ‘E’ in ESG, the ‘S’ remains elusive. This year’s survey found the ‘S’ the most difficult element to incorporate into investment analysis. Nearly half (46%) of respondents feel that this is the case (versus 41% in 2017 for both the S and the E). Investors are grappling with the complexity of integrating social factors into their investment analysis and decision-making. A lack of consensus in the industry surrounding what constitutes the ‘S’ makes it harder to incorporate into investment strategies compared to both the ‘E’ and ‘G’… The range of issues sitting under the ‘S’ umbrella, along with the qualitative nature of social metrics, further contributes to the difficulty of incorporating the ‘S’ into ESG analysis. A lack of social reporting from companies adds another layer of complexity.’

This lack of consensus on what constitutes the ‘S’ in ‘ESG’ and the absence of comprehensive guidance or legislation on the expected standards and parameters of reporting in this area (for investee companies and trustees alike), can limit the extent and quality of trustee stewardship on such issues. It also risks inhibiting trustees (and other institutional investors) from seeking to fully utilise other means to maximise the value of assets (or mitigate potential losses) on behalf of scheme members. This includes possible divestment and/or seeking compensation from current or former investee companies which have caused trustees (and, in turn, scheme members) to suffer losses as a result of their concealment of failures to comply with social standards.

Divestment from the investee company and/or seeking to recover losses suffered by filing a claim against the investee company under ss.90 and 90A of FSMA9 are both ways in which trustees can mitigate further losses (or recover existing losses) of their holdings in investee companies. Sections 90 and 90A of FSMA entitle trustees (and other investors) to bring claims against investee companies in the UK for, amongst other things, their untrue or misleading statements or dishonest omissions in information they publish to the market. This published information is wide in scope and can include environmental, governance and social matters to which investors and their advisors typically refer (or want to refer) when making informed decisions about the prospects of the issuer.

Divestment and litigation need not be regarded as mutually exclusive or sequential; trustees may retain their holdings in the investee company while seeking to recover damages from the company via securities litigation or they may divest partially or fully, and then subsequently, partake in litigation. The appropriate course for a trustee to take will often be dictated by the interests and policies associated with the pension scheme itself and the relationship with and conduct of the investee company in question. Several UK pension scheme trustees already consider their participation in securities litigation as a key component of their stewardship activities.

This recognition is to be both applauded and encouraged across the industry. The role of litigation is also reflected in the International Corporate Governance Network’s (ICGN’s) Global Stewardship Principles which state that ‘investors should clarify how engagement might be escalated when company dialogue is failing including…(g) seeking governance improvements and/or damages through legal remedies or arbitration’. We consider this reference to litigation to properly reflect the full scope of institutional investors’ stewardship obligations as they understand it. We recommended to the FRC that a similar provision be included in the Code (during the consultation period before the recent update to the Code) and continue to do so to encourage other UK signatories to reflect on this alternative way to engage with investee companies with a view to preserving the value of scheme members’ assets.

However, where reporting on social matters is not forthcoming at the investee company-level and the understanding of which social matters should be prioritised by trustees is unclear, this may inhibit trustees from taking advantage of their entitlement to bring a ss.90/90A FSMA claim against an investee company. This would ultimately prevent pension scheme members from recouping losses which the pension fund would have otherwise received and could arguably result in trustees failing to meet their duties to scheme members.

A clear, Government-backed regulatory framework for investee company and trustee reporting is required to address the current confusion and lack of rigorous reporting by the investor community on ‘S’ factors. UK Government guidance on how such social factors should be accurately measured is also urgently required to support trustee engagement, voting, and escalation of such issues, via securities litigation if necessary, thereby supplementing and assisting the work of public regulators. Even so, it is important for trustees to bear in mind that securities litigation is an option already available to them, if what issuers say in their published information about social factors turns out not to be true, and if the revelation of this truth has a negative impact (as we would hope) on the issuer’s share price.


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