ESG Becoming the New Normal for European Pensions

The vast majority of European pension funds now consider environmental, social, and governance (ESG) risks to their investments, a significant leap from just two years ago when less than half took ESG into consideration, according to Mercer’s most recent European Asset Allocation Survey.

Results from the consulting firm’s survey found that 89% of respondents said they consider ESG risks, a sharp rise from 55% last year, and more than double the 40% of respondents who said so in 2018.

But the most notable change from 2019 was the strong rebound in climate change consideration. Last year’s survey surprised Mercer when the number of pensions considering climate change dropped to 14% of respondents from 17% the previous year. At the time, Mercer said that while the decline was “disappointing to see,” it expected the number of pensions considering climate change would bounce back this year, and it did with a vengeance as 54% of pension funds say they now consider climate change risk.

“In a year that saw activist Greta Thunberg, with others, organizing global school strikes to raise climate change awareness and witnessed vast swaths of the world on fire,” said the report, “it is not surprising that a growing number of investors are considering the investment risk of climate change.”

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Mercer said the rising consideration of ESG risks continues to be driven by the European regulatory environment. As an example, the report cited the 2017 European Pensions Directive, IORP II, and the UK’s Department for Work and Pensions’ introduction of regulations in 2018 on how trustees should consider financially material ESG risks in their investment decisions, particularly those regarding climate change.

And in May, an amendment was added to the UK’s Pension Schemes Bill that imposes requirements on trustees and managers of certain occupational pension plans to take into account the effects of climate change and to publish information relating to those effects.

But financial materiality is also playing a much more significant role in driving ESG considerations in 2020 as 51% of respondents said that was spurring their interest in ESG, up from 29% in last year.

Stewardship issues, such as voting and engagement, are also growing in importance among asset managers, according to Mercer, as they are encouraged or even pressured to disclose how they undertake these activities.

“For the first time, our survey reported over 50% of participants consider the voting and engagement aspects of investments at both the manger-selection and manager-monitoring stages of the investment process,” the report said.

However, the survey also found that, despite this milestone, only 14% have a standalone ESG/responsible investment policy, and only 5% have a responsible investment committee. At the same time, Mercer noted an “encouraging increase” in the number of investors saying they have a public commitment outlining an explicit approach to voting and engagement to 27% from 10% last year.

“It is encouraging to see such a strong increase in ESG risk awareness, including the potential impact of climate change, on the part of institutional investors,” Jo Holden, Mercer’s European director of strategic research, said in a statement. “We can see this awareness emerging as more schemes and company sponsors witness how ESG risks in their portfolios may impact investment returns and how the company and scheme is perceived by the public.”