SPP calls for tighter monitoring of ESG risks

It is essential that trustees of UK defined benefit pension schemes and their advisers assess and monitor Environmental, Social and Governance (ESG) risks in relation to the employer covenant and whether such risks have the potential to disrupt a scheme’s funding journey, the Society of Pensions Professionals (SPP) Covenant Committee has advised.

In its report, Evaluating the impact of Environmental, Social and Governance risks in the Employer Covenant, the SPP revealed that ESG risks and opportunities can impact both the employer’s financial capacity (its ability to underwrite the needs of the pension scheme over time) and its sponsor longevity (the time horizon over which the employer may be required/available to underwrite the pension scheme).

The report also acknowledged that, whilst it is important to understand climate change and ESG opportunity, from a covenant perspective, downside risk is a far more important consideration.

The SPP called for trustees and advisers to assess the scope of ESG risk for their scheme’s sponsor proportionately as, according to the society, ESG factors should be evaluated within the context of the scheme’s current and future need for support.

A scheme moving to buy-out within five years will have very different considerations from a scheme that remains open, or one that places reliance on the sponsor long into the future.

Tools exist to help refine the range of potential ESG factors to those most likely to be material to covenant, and trustees should also take into account (with appropriate critical scrutiny) any work already done in this area by the sponsor, the report also said.

Whilst ESG ratings are available for some (typically larger and/or publicly listed) sponsors, these are a useful input but not a substitute for proper understanding of the relevant risks.

ESG ratings are produced for a different purpose and with a different lens to the trustee covenant.

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