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Defined Contribution

European plans ramping up on ESG for default options

Mark Thompson said HSBC now is seeing a wider array of ESG options available to plan sponsors.

Execs getting a jump on implementing mandate anticipated in new regs expand

European defined contribution plans are gearing up to incorporate ESG elements into their default funds ahead of anticipated changes to retirement rules.

Sources said plan executives are working to get ahead of expected requirements under the next iteration of the Institutions for Occupational Retirement Provision Directive II, set for publication this year.

Environmental, social and governance-focused funds already are investment options in many DC plans in Europe, helping to attract younger plan participants and catering to those looking for more ethical fund choices. Participants are less likely to opt out of auto escalation provisions if their savings support a cause they care about, industry sources said.

The IORP II directive requires plans to adopt an ESG focus by mid-January 2019. Executives will need to disclose the ways in which they incorporate ESG in the overall portfolio and explain their methodologies.

In addition, the European Commission could go as far as getting national regulators to allow occupational DC plans to reduce investment limits on some illiquid asset classes or to enter long-term social investments, such as housing.

But sources said that with the modification of the IORP II directive, expected to be published as soon as in May, the EC might ask retirement plan sponsors to implement some form of an ESG strategy into their default funds.

In the U.K. — even as officials are wrestling with issues related to the nation's exit from the European Union — an ESG requirement, in line with the EU rules, is expected to make its way into the national ​ regulation in the second half of 2018 as a fiduciary requirement, sources said.

But with little clarity or guidelines available on implementation of ESG as a default option, some plan executives said they are looking to their peers for inspiration.

The HSBC Bank U.K. Pension Scheme, with 3.5 billion ($4.8 billion) in DC assets, London, for example, implemented an ESG strategy about a year ago, becoming one of the first to make an ESG fund its default option.

The global bank's plan created an investment fund that combined ESG factors such as board accountability and diversity or sustainability, and climate-change tilts in an index-based approach, rather than working with a manager to select 'best-in-class' companies, as rated on an ESG scale, for investment.

One U.K.-based plan, TPT Retirement Solutions, Leeds, is working with its target-date fund provider, AllianceBernstein (AB), on incorporating ESG into the target-date funds of its 1.1 billion defined contribution plan later this year.

Jennifer Anderson, investment manager at the multiemployer master trust, said the plan intends to follow in the footsteps of HSBC. "Realistically, we would be implementing factors or a passive tilt. At the moment we are exploring ways and data in which we can do that, incorporating a carbon footprint," Ms. Anderson said.

Money managers have stepped up their game in terms of DC-compatible ESG offerings, sources said.

According to Mark Thompson, chief investment officer at the HSBC plan: "The good thing is that there are many more established options out there compared to when we decided to design our benchmark with Legal and General (Investment Management) and FTSE Russell.

"Back then there wasn't an index that incorporated factors and climate tilt available in the market," he said. "Now plans are offered more variants including the one that we seeded (the Future World Fund) or the one that NEST worked with UBS on," he said.

The 2 billion National Employment Savings Trust developed the UBS Life Climate Aware World Equity fund together with UBS Asset Management and adopted it as its default option in early 2017.

However, in continental Europe a best-in class approach continues to be valued by some plans.

Luc van Briel, CIO of the €400 million ($493 million) DC section of Pensioenfonds KBC, Brussels, which restructured its default to include an ESG strategy in January, said the plan is sector neutral and scores its investments according to an internal scale, rather than focusing on climate change tilts.

Despite the ESG market being more developed, some sources said asset owners still might be challenged to fully embrace ESG, particularly when it comes to passive investments' limited engagement opportunities with the corporations in which they invest vs. the way active managers engage.

But HSBC's Mr. Thompson disagreed: "Even though those companies are part of an index (they could be) divested by the fund."

"Our manager engages with these companies by writing letters to the board chairman. If the company hasn't satisfied sustainability requirements in the given time period, we vote through our manager to remove the chairman," he said.

However, some sources noted that implementation of ESG strategies in default options beyond equities might pose a challenge for plans. This is particularly true "when it comes to fixed income or illiquids," which DC plans might want to expand into at some point, Ms. Anderson noted.