21 June 2022
News Alert 2022/04
At a glance
On 17 June 2022, the DWP published its first Guidance on Reporting on Stewardship. The guidance takes effect for trustees preparing Implementation Statements for scheme years ending on or after 1 October 2022.
The guidance comes after the consultation on draft guidance closed in January 2022 and sets out new expectations of trustees. The message from the DWP is clear: trustees are expected to be more proactive in their stewardship activities and improve their disclosures. Whilst the guidance extends beyond stewardship, this commentary is focused on the stewardship elements as these form the bulk of the guidance. This News Alert highlights some of the key areas from the new guidance and some practical steps for trustees.
Key Actions for trustees
- Training on the contents and implications of the guidance. Training on stewardship specifically to better understand the options available is likely to be helpful for most trustees
- Identify stewardship priorities or themes for engagement with managers and as a basis for the “most significant” votes recorded in Implementation Statements
- Review the voting and engagement policies of trustees’ managers (or other third parties acting on their behalf). Assess whether current stewardship policies are adequate and consider developing more specific stewardship policies (ie voting and engagement policies) where necessary
- Engage with managers on stewardship priorities and ahead of any “most significant votes” taking place where possible
- Monitor managers’ stewardship. Trustees need to decide: how often and when to review managers’ stewardship policies and performance against these; how aligned they are to the trustees’ policies; the circumstances that warrant escalation; and how that would take place.
The guidance covers stewardship and some other topics, including alignment with the Stewardship Code, consideration of the legal “best interests” of the members, and operates by reference to the existing statutory requirements for trustees to prepare a Statement of Investment Principles (SIP) and an Implementation Statement (IS).
The guidance is split into non-statutory guidance applicable to SIPs and statutory guidance applicable to ISs. Trustees are legally obliged to have regard to statutory guidance and the content of the IS will inform any judgments (including by the Pensions Regulator) about whether the statutory guidance has been properly considered. In the worst case it could result in the IS being deemed non-compliant and a civil penalty issued to the trustees. Non-statutory guidance is intended to indicate best practice and trustees are encouraged to follow it where possible.
The statutory guidance is effective for ISs being drafted for scheme year ends on or after 1 October 2022 while the DWP encourages trustees to consider the non-statutory guidance from now.
The DWP is working within some legal constraints in issuing this guidance. The chosen mechanism is the existing legal provision for SIPs and ISs. However, while the IS legislation contains a power for the DWP to issue statutory guidance, the SIP legislation does not. As much of the substance of the guidance is under the SIP heading this makes for a somewhat unsatisfactory framework for the introduction of new stewardship requirements and something of a challenge to apply.
“Stewardship Priorities” and/or “Themes”
The introduction of the concepts of stewardship priorities and themes is one of the key innovations of the guidance. The guidance includes the examples of climate change, biodiversity, board remuneration and modern slavery as suitable stewardship priorities.
The non-statutory element of the guidance suggests that trustees’ stewardship priorities or themes relevant to their scheme are summarised in the SIP. These priorities or themes will vary from scheme to scheme depending on several factors such as the trustees’ investment beliefs, their assessment of the risks to which the scheme is exposed, members’ and beneficiaries’ best interests, the scheme’s culture, values and business model, trustees’ analysis of their membership demographic and their scheme’s investment horizon, or the distribution of holdings invested across particular sectors or asset classes.
The statutory guidance makes reference to stewardship priorities through information that trustees need to include in their IS. In particular, trustees are expected to consider the extent to which their stewardship priorities are aligned with their “most” significant votes and voting policies (see sections on Voting and Engagement policies and drafting of the IS and SIP below). The DWP has clarified that trustees may include examples of “significant votes” which do not relate to a particular priority and/or theme.
The DWP wants trustees to move away from boilerplate wording in respect of voting and engagement policies in their SIP. Encouraging trustees to identify stewardship priorities or themes aims to draw out a more tailored approach and focus for trustee stewardship actions.
Whilst we believe that asking trustees to identify stewardship priorities is a good idea to help focus stewardship efforts most relevant to their scheme, it will probably be challenging in practice. It is likely that trustees will need to allocate considerably more resources to identifying the priorities and make good use of them.
Voting and Engagement policies
The guidance states that a good stewardship policy should cover voting and engagement as a minimum, noting that stewardship encompasses a much broader range of activities than these alone.
Trustees are expected to either set their own voting policy or explain in their SIP how they will monitor their asset managers’ voting policies. In addition, trustees must include their policy in relation to undertaking engagement activities, including the circumstances under which trustees monitor and engage with managers.
Where trustees use the voting policy of their asset manager, they should briefly summarise in the IS whether the asset manager’s voting behaviour was aligned with the scheme’s stewardship priorities.
The “most significant votes” (for inclusion in the IS) are expected to be linked to the scheme’s stewardship priorities or themes. In addition, the DWP now expects trustees to explain whether, and how, they made clear to their manager what they consider to be the most significant votes in advance of those votes being taken. The DWP encourages trustees to engage with their managers at least annually to discuss voting policies and set out their viewpoints and issues of interest ahead of each voting season.
In respect of engagement, the statutory guidance states that trustees could include the following detail in the IS:
- Details of the engagement objectives that have been set
- Examples of engagement with asset managers and companies or other issuers, including the circumstances in which engagement took place, the process followed and the outcome of the engagement
- Examples of collaborative engagement
- How engagement has differed for funds, assets, or geographies
- Whether engagement has been escalated, and how, if it has not been initially effective
- Any use of fintech solutions to facilitate engagement
Following the consultation, the DWP has softened the requirement to show as much detail in the IS on engagement as listed above by changing the wording from “should” to “could”, acknowledging some of the challenges around the items listed, for example setting engagement objectives or collaboration with other investors.
In practice we expect most trustees to be reliant on their investment managers’ stewardship policies including voting and engagement. However, the DWP has encouraged trustees to take more ownership. In particular, trustees need to understand what managers are doing on their behalf and consider how it relates to their stewardship priorities. Trustees should monitor managers, engage and where necessary intervene on matters that may impact investment performance.
The DWP has set out some helpful examples of how trustees may seek to influence managers through good stewardship, even where they invest in pooled funds. Getting trustees to better understand the range of stewardship tools available to them is a positive. However, this work is likely to be non-trivial.
Drafting the IS
The IS must state the extent to which, in the opinion of the trustees, the policy covered in the SIP regarding exercise of the rights (including voting rights) attached to the scheme’s investments and the undertaking of engagement activities in respect of the investments have been followed and how action has followed intent. Trustees also need to include a description of voting behaviour by, or on behalf of, the trustees (including most significant votes).
Trustees have been following this requirement for a few years now; however, the guidance has introduced material changes to how trustees are meant to prepare these documents.
The guidance introduces some new content in the IS and encourages trustees to consider preparing summary versions of their IS and SIP for members with links to the full documents.
Trustees must report all “most significant votes” in the IS and should include a narrative explaining why each vote is significant, the vote outcome, and why the scheme voted the way it did. When reporting, trustees should include:
- The company name
- Why the trustees consider it to be “most significant”, if it relates to the trustees’ stewardship priorities or themes, and if so, which one
- Approximate size of scheme/mandate holding as at date of vote
- Summary of the resolution
- How the trustees (or asset manager/service provider acting on behalf of the trustees) voted
- If the vote was against management, whether the intention was communicated to the company ahead of the vote
- Rationale for the voting decision, particularly where there was a vote against the board, votes against shareholder resolutions, a vote was withheld, or the vote was not in line with the voting policy
- Outcome of the vote
- Next steps, including whether the trustees (or asset manager/service provider acting on behalf of the trustees) intend to escalate stewardship efforts
Alignment with the UK Stewardship Code 2020
The statutory guidance states that when preparing the IS, trustees may wish to consider whether there is any alignment with the UK Stewardship Code, in particular:
- Principle 6: which asks signatories to take account of client and beneficiary needs and communicate the activities and outcomes of their stewardship and investment to them
- Principle 12: which asks signatories to actively exercise their rights and responsibilities
- Principle 5: which asks signatories to explain how they have reviewed their policies to ensure they enable effective stewardship
Drafting the SIP
The SIP must cover the trustees’ policy in respect of the exercise of voting rights attaching to investments. Where trustees invest in pooled funds, the DWP notes that there are still potential options for trustees to direct voting. For example, with “split voting”, despite the challenges, the DWP quotes the Taskforce on Pension Scheme Voting Implementation (TPSVI) conclusion that these problems do not appear material or insuperable. In addition, the guidance provides a range of examples of stewardship activities that may be considered and covered in the SIP, including:
- Selecting and appointing asset and fiduciary managers
- Setting an expression of wish for how managers vote on their behalf
- Collective voting policies
- Asset manager engagement and monitoring
- Collaborative investor initiatives
Alignment with the UK Stewardship Code 2020
When preparing the IS, trustees may wish to consider whether there is any alignment with the UK Stewardship Code, in particular:
- Principle 4: which asks signatories to identify and respond to market-wide and systemic risks to promote a well-functioning financial system
- Principle 7: which asks signatories to systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities
- Principle 8: which asks signatories to monitor and hold to account managers and/or service providers
The DWP has recognised that stewardship is an area where trustees’ existing policies appear weak, and its guidance aims to improve standards and disclosures. Much of this guidance is consistent with our current view of best practice, including in relation to manager selection, monitoring and engagement.
However, the guidance goes far beyond what most trustees are currently doing in the stewardship space, potentially changing their status from passive onlookers and moving towards being proactive in setting the stewardship agenda for consultants and managers. Meeting the DWP’s expectations is likely to require significant initial extra focus from trustees over the next year or two.
Given the ever-increasing governance burden on trustees (and we expect more on stewardship from the Pensions Regulator later this year in its single code of practice), we understand that they may be reluctant to embrace another piece of guidance, especially where more resources are required to comply. However, we believe that stewardship can be an effective way for trustees to improve investment outcomes and therefore that raising stewardship standards is in members’ best interests.