On 1 October this year, the law governing a pension scheme's statement of investment principles (SIP) will change, with new requirements regarding how the SIP addresses environmental, social and governance (ESG) factors and trustee engagement with investment. Further requirements must then be incorporated in 2020.  In this bulletin, we look at the key steps scheme trustees need to take.

SIP policy on "financially material considerations"

Currently, the law requires a SIP to state the extent (if at all) to which social, environmental or ethical considerations are taken into account in the scheme's investment strategy.  However, there were concerns that this wording did not distinguish between financial considerations and non-financial (ethical) considerations.

From 1 October 2019, a SIP will be required to cover the trustees' policy on "financially material considerations" and how these are taken into account in the scheme's investment strategy.  Financially material considerations include (but are not limited to) "environmental, social and governance considerations (including but not limited to climate change)".

Non-financial matters

Also from 1 October 2019, the SIP will be required to cover the trustees' policy in relation to the extent (if at all) to which non-financial matters are taken into account.  There are three key points to note here:

• there is no legal requirement for the trustees to take non-financial matters into account in their investment strategy at all, but what they are required to do is spell out whether or not they do.  If non-financial matters are taken into account, the SIP needs to explain how; 
• "non-financial matters" has a specific meaning under the legislation.  It means the views of the scheme's members and beneficiaries including (but not limited to) their ethical views and their views in relation to social and environmental impact and present and future quality of life of the scheme's members and beneficiaries; and 
• if trustees are minded to take non-financial matters into account, this should be approached with care and advice taken on the extent to which trust law allows trustees to follow their chosen policy.  

Policy on voting rights

From 1 October 2019, the SIP will have to cover the trustees' policy in relation to the exercise of the rights (including voting rights) attaching to the investments.  The current law says that the SIP must state the trustees' policy "if any" on the exercise of such rights, but the words "if any" are deleted from 1 October.

Policy on engagement activities

From 1 October 2019, the SIP will have to cover the trustees' policy in relation to undertaking "engagement activities" in respect of the scheme's investments, eg engaging with investee companies and/or investment managers on such matters as their performance, strategy and risks, as well as social and environmental impact.

Additional requirements for schemes providing money purchase benefits

The following additional requirements will apply from 1 October 2019 for schemes that provide money purchase benefits (other than money purchase benefits from AVCs):

• the SIP will have to be published on a website and benefit statements will have to signpost that this is the case; and
• the changes to the requirements for SIP policies will also apply to the scheme's SIP for its default investment arrangement(s).

Further changes from October 2020 and October 2021

Additional related changes will take effect from October 2020 and October 2021.  These include:

• the inclusion in the SIP of the trustees' policy regarding their arrangement with any fund manager;
• requiring trustees of defined benefit schemes to publish their SIP on a website;
• additional reporting requirements, for example a requirement that the annual report must detail voting behaviour by or on behalf of the trustees and the extent to which the SIP policy on voting rights has been followed;
• expanding the information that schemes are required to publish on a website.  For example, from 1 October 2020, money purchase schemes will be required to publish on a website their opinion on how, and the extent to which, the SIP has been followed during the year.

Our scheme is invested in pooled funds.  How can we comply with the new requirements?

For many schemes, the reality is that trustee investment decisions will be made at a high level, with the detail of the underlying investments being delegated to a fund manager, particularly where the trustees are invested in pooled funds.  The wording of the regulations sometimes appears not to sit particularly well with this reality.  However, the Pensions Regulator's recently updated guidance on investment governance for DC schemes acknowledges that for many pension schemes, engagement activities are likely to be undertaken by investment managers on the trustees' behalf, and that where a pooled fund is chosen, the trustees' approach regarding environmental social and governance (ESG) issues may be constrained by the fund options available.  

The guidance says that the Regulator encourages trustees to become familiar with their managers' stewardship policies, and that where trustees "consider it appropriate", they should seek to influence such policies and use stewardship as a criterion when shortlisting and selecting managers.  For pooled funds, the guidance says that the trustees should take care to understand the ESG approach of the available funds, including the selection criteria for new funds and monitoring how managers take account of ESG factors in practice.

Our thoughts

The Pensions Regulator's new compliance regime makes it important for Trustees to ensure that they are on track to comply by 1 October, or risk a fine.  Active engagement with the SIP has not been common to date, but Trustees should make sure that they decide how they will monitor ongoing compliance with their revised SIP, bearing in mind the requirements to report on compliance in future years.