Episode 4: ESG and Pensions: In conversation with PwC and Clive Mather

Episode 4: Transcript

Raj Mody:

Hello and welcome to this episode of PensionsCast, a podcast where we discuss topical pension issues being faced by companies, pension scheme trustees and pension scheme members. I'm Raj Mody, a partner at PwC, working with our clients here in the UK and around the world on a wide range of pension issues. We recorded the first three episodes of this podcast, PensionsCast, virtually, and today we're all together physically in the studio, which is a welcome change. We should be in for a great discussion today. I'm pleased to be joined by Adam Briggs. Hi Adam.

Adam Briggs:

Hi Raj.

Raj:

Who heads up our pensions ESG investment area and Liz Ramsaran, who is a lawyer. Hi Liz.

Liz Ramsaran:

Hi Raj.

Raj:

You are responsible for what we call, responsible pensions. So, good governance in pension schemes and good decision making. I'm also delighted to welcome to this podcast our first ever guest speaker, Clive Mather. Hi Clive.

Clive Mather:

Good morning, Raj.

Raj:

Clive is chair of the Church of England's pensions board, a job you've been doing for the last three years. Working to deliver pensions, housing, retirement services to all those who work or minister for the church, which is some 41,000 people. So I thought PwC in the UK was a large organisation with a mere 25,000 people. But, that is a lot of people under your remit there. And that's along with other numerous roles you've got Clive, I know in the UK, and overseas. In short, you're someone that's got a wealth of experience and knowledge about environmental and ESG issues, which is what we're going to be talking about today. I'm keen to dive straight in.

So, Clive, can we start with the fundamental subject really, the question of what people call green investments versus grey investments. There's a lot of regulation talk, best practice coming down the track for pension, anyone who runs pension schemes, including pension scheme trustees, what is your take on that fundamental debate: grey versus green?

Clive:

Well, it's certainly very live Raj, and the truth is that it's quite hard to define green and quite hard to define grey. I think what we recognise, however, is that the world is becoming more and more conscious of the risks of climate change primarily through carbon emissions and that, anybody who's looked at the IPCC report that came out in the last few days, I hope is feeling slightly concerned. I'm feeling very worried. I think it's now common when trustees get together this is pretty high on the list of things they want to talk about. So we, the Church of England, are an activist investor. We're somebody who believes that we have a responsibility in stewardship that goes beyond simply financial returns. So, I'm not going to pretend that we're neutral on this subject, we're not, we get engaged. We work hard with companies, with governments and so on, in order to demonstrate the highest standards of ESG - so the wider responsible, ethical issue in all that we do. Now, we do that, because we care, but we also do it because it's in the financial interests of our members. Quite clear, it's in the financial interests of our members. We can demonstrate a higher rate of return as a result of viewing investment opportunities through a green lens, then we can by not doing so. And if I take the last two years, our returns have been excellent.

Of course, our primary investment vehicle; in equities, which is the Transition Pathway Initiative - and anybody, as a corporate pension fund or other can invest in that - has outperformed, for example, the FTSE. So this is a matter of objective record, that you don't lose out by going green, but it is hard work. It is hard work. You have to apply yourself, although TPI can help in that. And there's no doubt that anybody, if they wish, can see in other areas, attractive investment opportunities. So the grey market hasn't gone away, and the grey market will give you, there's no question in some cases, short term returns. We sit today on the 12th of April, in the middle of the most horrendous conflict that we could ever have imagined in my lifetime.

And guess what? We're paying record prices for our gasoline and so on. And that isn't going to end anytime soon alas. It's a challenging debate. I would also argue though, it's not just a question of returns. It's also about risk, real risk. I'm sure we're going to get into the issue of fiduciary responsibility in this conversation. And we know that we owe to our members and we owe to wider society as trustees, responsibility to look ahead. If we look ahead, we can clearly see the climate is warming up, and we can clearly see that it's going to significantly, substantially, and increasingly impact corporates and sovereign states, who will offer us investment opportunities, and we've got to factor that in. Otherwise, we could find as trustees that the portfolio of assets that we have today simply doesn't perform over the medium and long term.

Raj:

There is so much to go for in that Clive. We'll definitely come back to the neutrality point and how that squares up against how trustees have to make objective decisions. And of course, you raise quite rightly that ESG and - just to spell that out - environmental, social and governance; there is more in ESG than just climate change. We will come back to that too. But let me just focus particularly on that financial returns point and Adam, I'd like to bring you in. As Clive said, we sit here in April 2022 in the middle of one of the most shocking, sad crises that you could have imagined going on around the world, that has, though, had an unusual impact in the short term on the grey versus green debate; the returns of so-called grey investments. Now that is just a short term point, but where are you at on that issue, Adam, of financial returns in green versus grey.

Adam:

Thanks, Raj. I think what you're alluding to there is the high returns that energy companies have had in 2022, as commodity prices have risen as a result of the global instability that we've seen. And I've seen a lot of market participants out there, who are taking this as some kind of argument against ESG investing and saying that actually, these great assets still can generate a lot of returns. I think this is quite risky, there's two key risks really. First of all, there's the transmission risk. So if you're holding fossil fuel investments, at some point, these are going to be regulated out of existence and no longer socially acceptable to hold. So, eventually your investment value is going to go to zero, and that could happen very suddenly.

Secondly, there's the physical risks. As we produce more carbon emissions, there's more likelihood of extreme weather events and global warming, and this has an impact on a wide range of companies and industries. As a simple example, the property sector will be severely impacted by hurricanes as a result of global warming. By continuing to fund fossil fuels, you are harming your returns in the long term. And Raj as you mentioned, we have focused a bit on climate here, but actually there are social and governance factors as well. An example of this could be social media, there's a lot of disinformation being spread on these social media platforms that could also bring about significant global instability, which is also a systemic risk for investment returns in the long term.

Raj:

Okay, so Liz, why don't we try putting some of that all together against the legal and governance considerations. So Clive talked about having an activist mindset and there's a deliberate opinion and point of view in the way that he's going about things. Adam’s talked about some of the financial factors we need to consider. Where does that leave us? I want to just want to personalise it. What are the considerations that trustees need to be going through, what is their thought process and maybe start with what are the legal parameters that affect their thought process?

Liz:

Yeah, sure. It's definitely not straightforward, that's for sure. And as Clive mentioned, fiduciary duties do need to be at the heart of everything trustees do. So, just to be clear, that means that trustees need to be thinking, acting in the best interests of members and by that we generally mean financial interests of members. They also need to be applying a test called a prudent man test. So, really all their decision making needs to be in the basis that a prudent man would make a decision. It's generally now accepted as we've said, that there are climate risks look to be financial risks, and there's a lot of data to support that. And with big schemes such as the Church of England scheme, we're now actually seeing a lot more data to support impact investing on more of a social level as well. And, in many ways, we need the larger institutions to keep impact investing and generating returns and evidence to support the positive financial impact of impact investing, in order to give trustees the data to be able to make those decisions in line with their fiduciary duties.

So really, it is incumbent on the whole financial services sector to be showing how impact investing works. Which then creates financial data that trustees can rely on, so that they can make their decisions in line with their fiduciary duties, which are always going to be couched in financial factors. But it's not only the short term returns, Raj, we also need to be thinking about the risks and the potential financial risks of longer term investment. So as Adam says, if we know certain categories of investment are going to get regulated out of existence, trustees need to bear that in mind and factor that into their decision making, because they're looking at the risks throughout the whole time horizon, not just the short term.

Raj:

Well, let me bring Clive back in there. Turning back to you Clive, because Liz, Adam, and I sit here and we advise clients and organisations on these issues, but you're on the ground, implementing it. We're talking about making these judgments as if it's possible to have perfect foresight about what the future course of some of these different types of assets will be, but I'm not sure that is possible, and I'm not sure it's even possible today to know exactly how you can categorise something as green versus grey or different shades of green. How do you go about that? How do you tackle the data challenge, if you like or the analysis challenge? How do you know what's green and what's grey?

Clive:

Raj. This is an excellent question, and it demands our attention. Now, when I joined the Pension Board of the Church of England three years ago, the Transition Pathway Initiative was that, it was an initiative, and it's moved on a lot now and it's now become a centre, a well-funded, and of course, heavily reliant upon the Grantham Institute in the London School of Economics, which provides this extraordinarily rigorous objective review of corporates and indeed beyond that now. Not just in terms of equities, but in bonds and then over time into sovereign risk. So we are beginning to build a world database that is free, it is being offered for the good of the world. It's been funded, generally speaking by those like us, and many others across the world, who care, in terms of the start-up. But it's now being taken over by a significant charitable investment on a world scale. So this institute is really digging in now sector after sector after sector, hundreds and thousands of corporates to analyse their understanding of climate risk, to analyse their plans and report on their performance. Now, it's not perfect, but it's immensely better than it was a few years ago. I am certain that in a couple of years’ time, this is going to become the go-to objective test as to how you measure green in terms of ESG.

Raj:

Can I ask you a follow up question on that? Let's just take a specific example, something like electric cars versus petrol cars. There's a mantra that suggests that electric cars are better. But I think when you start looking at how they're manufactured, the whole end-to-end process from the mining of the minerals and the manufacturing ingredients that are required to put together an electric car. That's a really complex assessment to make, will this initiative you're talking about, handle and tackle that kind of complexity of assessment?

Clive:

It is highly complex. You're right. And I think the electric car is a really good example. But of course, it goes way beyond carbon emissions. So we're now talking the wider environmental impact. We're looking at rare metals. We're looking at recycling, we're looking at safe disposal. There's an immense spectrum of issues as to how this whole process from design, manufacture, use, end-of-use impacts our environment. I'm not going to pretend that's easy and in fact, bluntly, the electric car is bathed in a green tinge because it's electric. If you look beyond that, if you go under the bonnet, as it were, it's not as green as it would seem by any means. Of course, other major sectors fall into the same category, not least the whole digital world.

When I started with information technology many years ago, memory was the key resource. My word, we almost had zero memory, now memory is free. We think I've got more memory on my mobile phone than I could ever have imagined a decade ago. However, that memory isn't free. There are vast technologies out there sitting in deserts and beautiful places, which support something, which is being paid for by the consumer generally, and we know the subtle economic models that the digital networks have to attract our purchases and so on, but we're not aware of it. So yeah, I'm not going to pretend this is easy. What I am going to pretend is, we can't shy away just because it's hard. We've got to get stuck in. Please don't think this is just the Church of England. We are in fact a very small player.

Our total invested assets are about £3.7 billion, which sounds a lot. But of course, across the universe, it is very small. It's in coalition with like-minded people through the Climate Action 100+, and so on and so on, that we can attract that trillions of dollars of assets under management, which gives us the leverage to get into the CEOs of Microsoft, BP, and so on. We've got to stick with it. We're going to stick with it, because it matters. And I have to say, can I just give a plug to PwC on this, I walked in this morning to your offices, and I was very struck by your advertising to clients as they come in, which said something like: human ingenuity combined with the right technology delivers real results, okay.

I buy that, that's exactly what I'm doing. You know that I spend a lot of my time developing and promoting new technologies, because I'm clear that this has to be the way forward. But let's not pretend it all rests on whether people want to do it. Whether you want to do it, whether I want to do it, whether pension fund trustees want to do it and so on. And that's the bit that bothers me. Because we live a wonderful lifestyle, and we don't want to change it for all sorts of good reasons.

The thing is, it is going to change. And if you love skiing, you probably already know that the ski that you enjoy in the alps and so on nowadays is generally manufactured rather than delivered from the skies. And as this sort of thing starts to permeate the world, I hope people will realise this is going to hit them personally. And that's going to be painful, and they will react to that. But we need more of that to drive the incentive into those of us who invest, that this is for real and it's scary. Now you Adam, used the expression, the risks are gathering pace, and that of course is at the heart of the IPCC report. I always like the Ernest Hemingway example: how would you go bankrupt, gradually, then suddenly? And I would say to you, all we're in the gradual process. We think we've got time, we talk about 2050, that sounds a very long time away. I don't think this is going to get way beyond the next five years before we start to see massive change across society. This is happening much quicker than we think, and frankly, we've got to get into it no matter how difficult it is.

Raj:

So Adam, that's a good segue to turn to what trustees of pension schemes or anyone involved in managing them should do now and the practical challenges they're facing. So Clive talked about representing nearly £4 billion of an asset portfolio, obviously the entire UK pension universe is in excess of £2 trillion of assets and you and Liz are heavily involved in advising a good chunk of that. Let me just come back to that question. What is it that trustees are facing all; sorts of regulatory and disclosure requirements coming down the track? What should they be doing right now? How do they tackle this impossibility of complexity of analysis?

Adam:

Yeah, I think that this is the key question really the trustees need to answer, and I agree with what Clive has said that there's no easy answers in ESG. And I think Trustees shouldn't try and reduce it to a set of simple metrics. Me and Liz had an interesting debate yesterday about exclusions and there are various controversial sectors such as nuclear, where there's pension schemes that would completely exclude these assets. But at the same time, they could be a key contributor to reaching net zero and reducing carbon emissions. So I think it's unhelpful to just reduce these discussions to black and white framework.

I think also, trustees rely a lot on ESG ratings provided by third parties, and these ESG ratings can be quite subjective. They can be quite opaque. You don't really know how the rating has been formulated and different ratings agencies can have different ratings for individual companies. So, I would be hesitant to just rely on these simple metrics alone and you really have to roll up your sleeves and get underneath what is going on in your portfolio.
Just to sum up, trustees should set out some clear, measurable beliefs and make sure they clearly communicate these to their advisors and their investment managers and hold these parties to account for their performance by diving deeply under the bonnet of the portfolio, rather than relying on simplistic metrics.

Raj:

Liz, I saw you nodding when Adam was talking about getting into that detail. What are you thinking?

Liz:

Yeah, they're really fair points, and I completely agree with everything Clive said. But I do also recognise things like nuclear. It's not straightforward because the by-products of nuclear plants are in fact used towards nuclear weapons in some cases. And so it's not as straightforward as one answer is actually the complete answer. Listening to both Raj and Clive talking then, it really struck me that this is a journey. For example, we know electric cars aren't the answer but they're definitely better than petrol. And everything is an evolution, we are on an evolutionary journey with all of ESG.

The bar will keep rising, science will improve, our outlook on the world will improve, and what trustees need to be doing is actually putting in place a good infrastructure of governance. To think about how they're going to incorporate these considerations into their day-to-day life, into every decision, how they're going to keep up with developments, try and be on the right side of the line there. But recognising that this is not simply a tick box exercise, it’s not about one year's worth of metrics, it's not about a single TCFD report, it's about changing our way of being and really constantly challenging ourselves to think about the bigger ESG risks and opportunities in every decision that we take.

Clive:

Can I just come in on that Liz? I very much agree. It is a journey. You're right. One thing we haven't specifically mentioned, which plays directly into trustee responsibility is membership. So what do the members think? I'm always curious to ask my colleagues, do you consult your members on for example, the views you might take as a trustee board that tilts the beliefs that you have? Most people say, well, you know what the only thing members are worried about is whether their pensions are paid or whether their pensions promise is safe. I don't believe that's true. Apart from the reward in terms of returns, and in terms of risk mitigation, there's also the issue of reputation. And this is where I think talking to your members is a good idea.

Now, I'm not suggesting that they will have a complete grasp of this and necessarily very significant, profound views that the trustee board doesn't have, but they may encourage the trustee board to take these issues more seriously. And that in turn, can enhance the reputation of the fund and the sponsor. And in that, I always point as well to the issue of recruitment, because in my experience, young people are taking this issue very seriously. I've just walked through London, and I meet lots of people protesting. Now some of them are my age, I have to say most of them are not. I am quite pleased about that, because it is their world that's a stake, not especially mine.

I think sponsors and boards will find that if they get into this, if they start to formulate their views and develop their strategies and plans, that will attract talent into their organisations. And that is all part, to me, of the engagement that begins with your own membership.

Raj:

Liz, from a governance point of view. Have you got any views about the voice of the membership, the role of the voice of the members?

Liz:

So I think your points are really well made Clive. I think Trustees just need to be very careful when gauging member views and how they use those views. Because taking into account members’ view of the world alone isn't acceptable from a fiduciary perspective. And it will always, all decisions will need to be linked back to financial factors. But I do think it's right that when you're considering, particularly, more on the ‘S’ side of the spectrum, the societal elements, which are far from straightforward, actually gauging member views to help direct the conversation, direct the strategy, is something that more schemes should do.

And just finally, on the diversity point, I absolutely agree with you from a recruitment perspective we need to be looking at ensuring different voices are coming into the mix. I also think that's true of the advisor community; trustees have traditionally used their stable of advisors from the pensions industry, and we are going into a new world which is a completely different discipline. And I think Trustees really need to reconsider how they use advisors to be able to actually bring in a much deeper knowledge of ESG factors into their advisory cohort and that can involve actual sustainability professionals that work alongside traditional scheme actuaries and scheme lawyers, because it's a different discipline and it's a different skill. I don't think enough trustees are approaching this issue from that diversity lens.

Clive:

I was very struck, Liz, at the pressure we are under to offer more ethical environmental funds in our DC offerings. This is consultation in the sense that we are picking up very clear signals from across our DC community that they're no longer interested in simply growth stocks or equity stocks or the various asset allocations. They are very interested in the extent to which these firms reflect their views on responsibility and stewardship. And that is an objective example, which I think we can take. I entirely accept your other points, but I think reputationally as we look forward, we have to be mindful, and it was interesting- two years ago, or nearly two years ago, we used our investment managers to develop some climate scenarios against which we could test the resilience of our various funds. They're a matter of public record. So we took one degree warming, two degrees, three degrees, four degrees, and we said to our members well, here are the results. You know what, four degrees, we're in trouble. I'm not going to pretend we've cracked this, because I think four degrees, a perfectly viable scenario looking ahead 20 years, alas, which we'll see. We do very well at one, good at two; three, we're fine; four, we're out. I just think those sorts of advisor objectivity is vital in this equation.

Raj:

Well, I'm glad in a way that we turned to the subject of what members are the ultimate point of all of these assets and all of these pension scheme entities, what they think, what their concerns might be, and even though it's not a clear-cut list to some extent, how we take account of their viewpoints. It's probably a fitting point to end on but it sounds like we not only need to come back to this topic again at some point, but we'll come back and maybe dive more deeply into the member viewpoint. It's really quite rare, isn't it to come across a topic that has such an existential impact over the long term. Yet, it has short term urgency, but it's also so complicated to try and get your head around all the different angles and therefore the action you need to take.

Thank you all, Liz, Adam and Clive for joining me today to talk that through. If you have any questions as a listener, or would like us to focus in on particular topics in future episodes, please drop us a note, our contact details are in the episode notes for this show. Of course, if you'd like to find out when future episodes are released, you can subscribe on Apple podcasts or Spotify. The link again to that is in the show notes. You've been listening to Pensions Cast. Bye bye for now.

Participants

• Raj Mody
• Clive Mather
• Liz Ramsaran
  
• Adam Briggs