Pension plan managers and administrators face complexity when they manage and govern pension assets. Amongst their concerns is the greater focus on environmental, social, and governance (ESG) factors and the broader subject of sustainability. ESG and sustainability in the context of investment aren’t new topics, but their prevalence is rising and fiduciaries are paying attention.

ESG as a framework

Whilst the primary purpose of pension plans is to provide pension income security, there is increasing recognition that non-financial and pre-financial risks and factors could be material to decisions and outcomes related to financial risk and return.

ESG is a framework that emerged to categorize these factors, which may include:

• climate change, biodiversity loss, pollution, deforestation, and extreme weather events;
• diversity, equity and inclusion, Indigenous rights, employee safety and fair wages, child labour, forced labour, and ethical supply chains; and
• board independence, diversity and expertise, executive compensation, financial controls and risk oversight.

Based on Mercer’s ESG fund ratings, we have seen a rise in ESG integration in fund strategies over the last ten years (more than 80% of rated asset managers are integrating ESG in some form, up from 50% in 2013.) Pension plan administrators should stay up-to-date on these issues, discuss and decide how important, relevant, and material these factors are to their plan, and document the process, principles, and decisions related to taking ESG factors into consideration. ESG and sustainability factors could be relevant to decisions throughout the investment approach including governance, investment strategy, asset mix, due diligence, portfolio monitoring, and stewardship or active engagement. 

ESG and sustainability factors are also present across all asset classes and styles. There may be growth or value opportunities with a sustainability lens. Although the implementation or approach may differ, ESG integration or sustainability themes are increasingly available in public equity, fixed income, alternatives including real estate, infrastructure, and private equity, and emerging markets. Faced with increasing complexity and wondering what to prioritize, pension plan managers and administrators must evaluate the risks and opportunities, including ESG.

What pension plans are doing

In Mercer’s 2023, Shaping the Future survey of defined benefit (DB) plan sponsors, we found that all DB pension plans faced the same drivers and motivations in terms of ESG and sustainability. There are three key observations:

• All DB pension plans faced the same drivers and pressures. 51% of all respondents cited alignment to corporate mission as the reason to integrate ESG factors. The second most cited driver was the documentation of ESG approaches in statements of investment principles and policies, followed by stakeholder demand. 
• Engagement with external managers is prevalent. Whereas most plans engage with investment managers directly on ESG factors, large pension plans use a variety of engagement methods including collaborative efforts.
• Shifts from passive asset management strategies to active strategies in relation to sustainability-themed public markets opportunities.

Whereas 46% of large plans cited established sustainable investment beliefs and policies as guiding their actions, only 19% of small and mid-sized plan cited beliefs and policy.

For small and mid-sized pensions, clearly they face the same drivers and pressures to consider ESG and there is the opportunity to modernize their governance and monitoring frameworks to take steps forward with ESG integration. 

Larger pension plans are clearly leading and not slowing down. They are taking more action in all respects: more engagement, thematic investing, tracking progress against benchmarks and reporting. 

What pension plan managers and administrators could do to future-proof and modernize their pension portfolios

Whilst sustainability-focused regulation exists in other markets globally, in Canada, guidance for pension plans is principles-based rather than prescriptive, leaving plan administrators scrambling for clarity. Ontario-registered plans are required to disclose if and how ESG is being considered within their plans. 

At the time of writing, draft CAPSA pension risk management guidelines were open for the next round of consultation and directionally, we can see where ESG guidelines are headed. In summary:

1. Pension plan administrators should consider whether and how ESG information may be important, relevant, and material to financial risk and return of their funds. 
2. Plan administrators should ensure that their plan governance, risk management and investment decision-making practices are designed to identify and respond to material ESG risks and opportunities in a manner appropriate for their plan circumstances and investment beliefs. 
3. Plan administrators should describe whether and how material ESG information is considered or not and make reference to that information in the Statement of Investment Policies and Procedures (SIP&P) and plan member statements or other sources of plan member information.

With the development of international and local sustainability standards setting boards, corporate and investment fund reporting is anticipated to reflect sustainability disclosures. Pension plan administrators in Canada are becoming prepared and some of the first or next steps they can take include:

• Review their governance framework and documents and consider whether and how ESG information may be important, relevant, and material to financial risk and return of their funds. 
• Stress test the resilience of their portfolio for climate scenarios and climate-related risks.
• Consider ESG information in the manager selection and due diligence process.
• Understand the exposures to ESG and sustainability risks and opportunities within their portfolio through an ESG assessment or monitoring.
• Engage with managers on the ESG factors that have been determined to be important, relevant, and material to their plan.

For pension plans that are further along on their sustainability journey and where they have determined the importance, relevance, and materiality of ESG risks, particularly climate change, a next step could be to determine their baseline position in terms of carbon footprint and design a climate transition strategy.

Wherever you are on your sustainability journey, one thing appears to be increasingly clear: all pension plans are planning to do more as it relates to taking ESG and sustainability into consideration. ESG leaders continue to inspire, pension plans progressing on this path are integrating, and at a minimum, pension plan administrators are staying informed about the new developments.