Financially material considerations

From October this year, trustees of occupational schemes will be required to amend their statement of investment principles (SIP). Amongst other requirements, the revised SIP must state trustees' policies on taking financially material considerations and non-financially matters into account when making investment decisions and on stewardship. 

In the first of our two-part blog on the new statutory requirements, we focus on the requirement for trustees to formulate a policy on taking financially material considerations into account. 

What are "financially material considerations"? 

The regulations provide that "financially material considerations" includes environmental, social and governance (ESG) considerations which the trustees of the trust scheme consider financially material, though the definition is not limited to such factors so would include any factor having a material impact on a company's financial performance. 

Examples of ESG considerations which are capable of being financially material include environmental practices that could result in a company being penalised by future regulation or litigation, unlawful or immoral practices which could ruin a company's reputation and business, or poor governance practices which may prevent problems within the company from being managed properly as they arise. The regulations make specific reference to climate change. 

The regulations state that financially material considerations are to be considered over the appropriate time horizon, meaning the length of time that is needed for the funding of future benefits by the scheme investments. A scheme that is planning to buy out benefits in the near future can take a more short-term approach to investment than a scheme that is open to active members and therefore has a long-term investment horizon. In practice, the funding level of the scheme should also be considered. 

What is the law on taking into account financially material considerations? 

When exercising their powers, including their power of investment, trustees should take into account all relevant factors and disregard all irrelevant factors. Trustees are therefore under a legal obligation to take into account all financially material considerations when exercising their powers of investment.  

Why are the regulations being changed? 

The Law Commission noted that the current law, which requires trustees to state their policy on "social, environmental and ethical" matters, was causing confusion. The Law Commission's recommendation was that the regulations simply refer to "financial" and "non-financial" matters, in order to avoid financially relevant matters (such as the impact of climate change on the value of investments) being confused with other matters (such as the ethical views of the members on climate change). 

From a practical perspective, what do trustees need to do to comply with the new requirements? 

In practice, trustees should already be taking such factors into account.  However, the new regulations may require statement of investment principles to be updated to reflect the new emphasis. 

Trustees should review their current policies on exercising their investment decision-making power. What this involves will differ from scheme to scheme, depending on the size of the scheme, the asset allocation and the extent to which investment decisions are delegated to investment managers. Trustees of small schemes which are largely invested in pooled funds should focus on the process for selecting and monitoring funds. Trustees of larger schemes are likely to be able to take a more active role in directing the manner in which their investment managers manage the schemes' assets. 

The trustees should consider which (if any) environmental, social and governance considerations they consider to be likely to impact the value of their investments. It would be prudent to make specific reference to climate change, even if the trustees do not consider this to be financially material, and state why the trustees do (or do not) consider it important. The policy should also make specific reference to the maturity of the scheme and the time horizon over which benefits should be paid. 

However, trustees are not expected to be scientists or investment professionals. It is enough for trustees to demonstrate that, having taken investment advice in accordance with their statutory duties, when exercising their power of investment they have regard to relevant factors. 

Further information 

For our complete summary of the new regulations please see here.

For further information on how to comply with the new requirements, please contact Judith Donnelly or your usual AG contact.