On 24 November the European Parliament approved IORP II, a revision of the 2003 Directive on Institutions for Occupational Retirement Provision. A new feature of IORP II is the Directive’s requirement for occupational schemes to carry out investment risk assessments on environment, social and governance (ESG) factors.
The risk assessment must be carried out every 3 years or without delay following any significant change in the risk profile of the scheme and must cover “new or emerging risks” which include “risks related to climate change, use of resources and the environment, social risks and risks related to the depreciation of assets due to regulatory change.” The Directive goes on to define these types of assets as ‘”stranded assets”.
The decision of the European Parliament comes in the same week that environmental law NGO ClientEarth published an opinion from two leading barristers on pensions law which confirmed that there is a legal obligation on pension fund trustees to take risks associated with climate change into account when exercising their investment powers to the extent that those risks carry material financial implications for the performance of the fund. The opinion went further to suggest that a failure by trustees to consider this could form the basis for a successful legal challenge.
These developments may prompt a heightened awareness about ESG factors and the risks that they pose to pension schemes amongst pension trustees and managers, which could in turn lead to their taking greater action on these issues. It remains to be seen how the IORP II requirements, if and when they come into force in the UK, will fit with the current UK legal position on consideration of ESG factors in pension schemes. In particular it is clear that pension scheme trustees must already take into account financial ESG factors, which may well include long term investment risks posed by climate change.
Trustees’ primary duty remains to consider the best financial interests of scheme members, and as such they can only consider non-financial ESG factors (such as purely moral or ethical issues) in very limited circumstances. It is not clear that the IORP II requirements will fundamentally change this position, although they could have a cultural impact in terms of requiring trustees to consider these matters more actively on a regular basis.
The legal opinion obtained by ClientEarth backs up the current position that trustees are under a duty to consider financial ESG factors. There may sometimes be a tendency to dismiss ESG factors generally as something the trustees should not or cannot consider because they will not be in the best financial interests of beneficiaries. However the legal opinion confirms that if the trustees of a fund were to take the view that because they consider climate change to be an ESG factor it simply cannot be taken into account, then this could form the basis of a successful legal challenge on the basis they have not considered whether the climate change risk is financially material.
IORP II must be transposed by Member States within the next 2 years and therefore for UK schemes, implementation may well be affected by Brexit and decisions on the triggering of Article 50. Nevertheless, some commentators have described the changes as securing legal certainty for environmentally responsible investment strategies and a turning point for European investment in this area.
The pensions industry will be no doubt be closely monitoring ClientEarth’s next move following the legal opinion. Fresh from its judicial review success on challenging the UK Government’s air pollution policy, it appears the role of pension schemes, as well the role of corporate directors, on climate change, is an emerging target for a future ClientEarth legal challenge.