Much pension fund regulation operates on a “disclose if you consider ESG” basis, giving the impression stewardship and ESG integration are optional, according to a report on responsible investment regulation by the Principles for Responsible Investment (PRI).

The organisation responsible for the UN-backed principles said the report found that investors were still sceptical about whether responsible investment regulation was driving “real change”, even though they believed some of it was useful in terms of increasing awareness of environmental, social and governance (ESG) factors.

The report has forewords from high-profile politicians and regulators, such as Valdis Dombrovskis, the financial services European commissioner with responsibility for the EU executive’s Capital Markets Union (CMU) project, and Frank Elderson, executive director of the Dutch pension fund supervisor De Nederlandsche Bank (DNB).

The report is the outcome of an analysis of almost 300 policy instruments covering pension fund and corporate disclosure rules, with the authors also deciding to assess the impact of voluntary stewardship codes.

The PRI also carried out interviews with policymakers, investors and stock exchanges across the world, focusing on investors’ perceptions about the impact of regulation on investment practice.

The report said it was “the first global study to analyse the impact of responsible investment-related public policy initiatives”.

In a statement, the PRI said “the analysis suggests that, while regulation is having an impact, regulatory frameworks aren’t fully aligned with sustainable development. Underpinning this is a belief that governments are failing to clearly signal the importance of ESG issues.”

The authors of the report note that few of the “highest-profile government sustainability commitments […] articulate the role investors are expected to play”, and that they therefore excluded these.

Out of “thousands of individual environmental or social-protection regulations” that exist around the world, their analysis focused on those with an investment component.

The report said “many regulations fail to send a strong enough signal and position responsible investment as a voluntary activity, or conflate financially material ESG issues with beneficiary preferences”.

It examined corporate disclosure regulations and investor regulation.

With respect to the former, it found that government-led mandatory ESG reporting improved corporate risk management and said voluntary disclosures were “a useful stepping stone towards more formal rules”.

Pension fund regulation and stewardship codes are correlated with better ESG risk management by companies, but “we can’t prove that regulation is responsible for the result”, according to the PRI report.

Problematic poor policy design

The report picked out some shortcomings in policy design – for example, stating that much pension fund regulation operates on a “disclose if you consider ESG” basis, and that financially material ESG issues were conflated with the ethical preference of members.

“While it’s right that regulations give flexibility to funds to respond to their members’ ethical preferences, this is separate and distinct from the requirement to consider financially materially ESG issues,” said the report.

The way in which rules are worded can also have an impact by potentially giving investors “easy opt-outs”, according to the PRI.

This could happen if terms are poorly defined or phrases such as “give consideration to” are used without guidance on what this means.

Nathan Fabian, director of policy and research at the PRI, said: “Too often, the drafting of ESG regulation treats ESG as an optional add-on, which investors can ignore if they so choose.”

The PRI also said it found little monitoring of policy with ESG-related clauses, and that, even in those markets where individual investors were held to account, investors “remained extremely sceptical of the impact – they didn’t feel they’d seen their peers and competitors change behaviour”.

The report adds: “Interviewees openly questioned whether ESG issues were a priority for the government, suggesting ESG clauses were introduced just to respond to pressure from civil society – or even debated whether the clause in question existed.”

The PRI is calling on policymakers – which it distinguishes from regulators – to “make the crucial link between sustainable development and the finance industry”.

As part of that, they should “build the evidence base on investor practice” – that is, collect and publish more information about how investors contribute to or undermine sustainable investment objectives. 

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