Social considerations
 

Trustees must act fast to draw up a policy on socially responsible investment in time for 1 July 2000. Liam Kennedy asks what they should be doing.
 

The free-market economics guru Milton Friedman said that the social responsibility of business was to increase its profits. But this is not precisely the view that the current government takes. From 1 July next year, all occupational pension schemes will have to add a policy on social, environmental and ethical concerns to their Statement of Investment Principles, as well as a policy on shareholder voting.

General hostility to the measure abated last June when a smart turnaround on the part of the NAPF prior to the formal tabling of the final regulation last summer, allayed the concerns of many pensions professionals, who look to the body for advice. However, a large number of trustees remain unclear about how, exactly, they should word their policy.

The government's view

John Denham, then pensions minister, first announced the requirement last year, when he said the government was minded to "require trustees to state the extent, if any, to which they take account of ethical and social considerations in their investment strategy".

Similar statements followed prior to the publication of the green paper in December 1998, which stated that trustees should be "free" to consider moral and social issues in relation to investments, within trust law.

Denham's original statement led to fears, however unfounded, that the government was going to penalise schemes that did not adopt ethical investment strategies. Trustees were also concerned that the measure would add to their often onerous fiduciary duties, for which they receive no remuneration and little reward. The requirement was considered an unwelcome addition to the duties of the 1995 Act.

However, the government is presumably convinced of the merits of SRI, otherwise it would not have devised the policy in the first place. "We believe that SRI offers an opportunity to improve the chances of making the right investment and thereby securing good returns for beneficiaries," the new pensions minister Jeff Rooker said last month.

Rooker also reiterated the government's current stance on SRI: "The government has always accepted the view expressed by vice chancellor Megarry that trustees are under a duty to make investments in the best interests of the scheme's beneficiaries, and that in the context of occupational pension schemes that will normally be the beneficiaries' financial interests."

The industry view

Eric Hunt, BAA's pension scheme manager, says BAA is a firm which takes its corporate responsibilities seriously and is currently drawing up its response to the new requirement. Hunt speaks for many when he says: "Eight or nine months ago I think we were all jumping up and down with severe agitation about what we saw as stupid and naive." In general, trustees were concerned that schemes would be expected to become the moral guardians of the corporate world when their duties were to maximise investments on behalf of scheme members.

Undoubtedly, there is still a good deal of hostility to the concept of SRI. The Railway Pension Trust chief executive and former NAPF chairman Peter Murray has expressed some pretty firm views on ethical investment. At the NAPF's international conference in October, he voiced the opinions of many in the industry: "In my view, trustees are not there to run the world, or members' lives. They are quite simply there to provide pensions and other benefits."

But BAA's Hunt feels that a consensus has now been forged on the issue. He says that the recognition that this is only a disclosure measure also stressed by the DSS - has reassured the pensions industry: "I think that has made it more comfortable for people to make what they see as a sensible decision without thinking that they may be forced into something else less comfortable two or three years down the line," he says.

SRI: The current situation

The government and SRI proponents are Keen to stress that there is more to the concept than simply the negative screening of portfolios - which would in most cases not be permissible.

Schemes are therefore not expected to engage in widespread disinvestment, or to adopt negative screening, although charities' and voluntary organisations' schemes may do this in order to ensure that they do not invest in firms which conflict with the aims of the organisation.

Various court cases in the last 15 years concerning investments and trust law have cemented the view in many trustees' minds that ethical investment per se is illegal. This impression has been reinforced and perpetuated in many trustee training seminars. In fact, there are various approaches which trustees can safely adopt.

Alistair Collett, a partner at Wilde Sapte, points out that while it is generally thought to be acceptable to evaluate investments to take account of environmental considerations, other ethical considerations, such as on alcohol or tobacco, are not likely to be in members' interests. "The more extensive your restrictions, the less likely you are to be able to justify what you are doing" he comments.

There are also further complications. It may just be that a person taking an ethical stance on a company would end up making the same decision if they were looking at issues from a pure investment stance. Tobacco stocks are a prime example. "It's pretty certain that tobacco companies are going to have to shell out large sums of money in the future," says BAA's Hunt.

"That's a financial implication that any investor should take on board in determining whether or not to put money in that company We would expect the managers already to have considered that," he continues. From an ethical standpoint such a decision would probably be against the law. But from an investment stance, which took into account the financial implications of risk, the decision would be safe.

Indeed, avoiding investments that are prone to risk could be regarded as a fiduciary duty and a prudent investment decision at that. Companies that needlessly pollute the environment could become subject to legislative penalties that could affect market performance.

Murray of the Railway Pensions Trust agrees that the environment is one area where adopting a socially responsible investment policy could work for the benefit of pension schemes.

"Environmentally responsible investment is a good thing and can be carried out without detriment to pension fund beneficiaries. There is a perfectly respectable argument that trustees should include environmental considerations in their investment policies," he told the NAPF conference.

What will the regulation mean in practice?

Trustees' options are widely agreed to be as follows:

To state that they will not take social, environmental or ethical factors into account

Engagement through a specific third-party service, such as the recently launched Friends Ivory & Sime's Responsible Engagement Overlay

Instruct fund managers to take account of any criteria they might specify. Again, this is unlikely to be in areas other than the environment, although this could conceivably be in any area of social responsibility where trustees believe a company was prone to investment risk which would damage members' interests

Ethical AVCs or investment options for DC schemes. This confers the advantage that investment risk is divested on to the member But there are caveats - pension schemes are unlikely to be able to give advice to members.

In any situation, changes to a scheme's SIP must always be made in consultation with the sponsoring employer.

What should my scheme do next?

The government does not expect smaller schemes - which it considers to be those with around 50 active members - to adopt any large-scale measures. In particular, it accepts that pro-active engagement with firms is only going to be the preserve of larger schemes.

As regards schemes' next move, the government is pragmatic: "Trustees should take advice from professional advisers and they must consult the sponsoring employer before they can change investment policy," a senior DSS policy official says.

"They should then decide if they think this is something that will benefit their scheme members. We respect all trustees' decisions in this area," he continues. In any case, the issue needs to be brought up in trustee meetings as soon as possible in order for an amendment to be drafted in time for next July.

Liam Kennedy, Pensions Age
December, 1999

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