Progress and priorities: reviewing sustainability in key pension systems

Ten priorities for embedding sustainability in pension systems and a review of Australian, UK and US progress on each priority.

Download the report in full or read a summary of the ten priorities outlined in the report

Executive summary

Pension funds are long-term investors and their ability to generate long-term returns relies on the performance of the markets and economies in which they invest. Because sustainability factors such as climate change and biodiversity loss threaten the performance of the markets and economies on which they rely for financial returns, pension funds have a responsibility to consider whether sustainability-related risks will inhibit their ability to protect long-term value and provide an adequate pension to their members or beneficiaries. Accordingly, pension funds are increasingly seeking to mitigate these risks through their investment decisions and stewardship activities.

Research carried out by the PRI in 2020 and 2021 on the Australian, United Kingdom, United States and Japanese pension systems found that there are policy, structural and market barriers to sustainability in these jurisdictions, which impact the ability of pension funds to incorporate ESG factors within their investment decisions and stewardship activities and to take action to pursue sustainability outcomes in keeping with their fiduciary duties. The research also identified intervention areas for policy makers and industry bodies, including the PRI.

Following this research, the PRI, the UNEP Finance Initiative (FI) and the Generation Foundation commissioned A Legal Framework for Impact (LFI), a report authored by Freshfields Bruckhaus Deringer and published in 2021. With a ground-breaking analysis of 11 jurisdictions around the world, the report considered whether the law permits or even requires investors to tackle sustainability challenges by setting and pursuing sustainability objectives. The report found that, under existing laws, pension funds are likely to have a legal obligation to consider investing for sustainability impact where this can help in pursuing their investment purpose and objectives. However, pension funds may face impediments to setting and pursuing positive sustainability objectives. With this in mind, this Legal Framework for Impact briefing suggests a number of recommendations for policy makers to address these barriers.

In 2023, the PRI carried out further industry research and practitioner interviews in Australia, the UK and the US to gather updated perspectives on the barriers to embedding sustainability in pension systems. Drawing on the conclusions of the PRI’s earlier pension reports and the LFI study, this report summarises the findings from this research in 10 priorities that are necessary for a pension system to take sustainability considerations into account. These priorities could enable and incentivise pension funds, their investment managers and consultants to build sustainable investment portfolios and help pension fund members become more informed about the sustainability objectives of their schemes. However, the PRI acknowledges that they are not exhaustive and further nuance and context is necessary when introducing them to different markets and pension schemes. The priorities are summarised in a policy, market structure and investment practice framework (see the summary of the 10 priorities below).

This report also analyses the extent to which the Australian, UK and US pension systems have made progress on each priority. We use the analysis to highlight good practice and key gaps within each jurisdiction. We find that, while there has been some progress since the PRI’s earlier reports – especially in relation to policy and regulation, with significant developments across all three jurisdictions – there are many elements across their policy, market structure and investment practice frameworks that still need to be addressed. Our aim with this research is to offer policy makers, investors and other interested stakeholders a view on the current state of the policy, market structure and investment practice environment for pension funds in these jurisdictions and to spur discussion on the priority areas for change.

Alongside this research, the PRI has been collaborating with its signatories to design Progression Pathways, which seek to better distinguish different approaches investors take to addressing sustainability-related risks, and set out what best practice looks like with respect to each approach. This may improve alignment on responsible investment objectives between actors along the investment chain. Policy and regulation may also seek to clarify how such approaches align with pension fund duties, and whether particular approaches are required.

For further queries about this report, or to discuss its findings, please email: [email protected].

Summary of the 10 priorities outlined in the report

The policy framework is comprehensive and consistent

Policy makers develop a comprehensive, consistent and supportive policy framework that provides clarity for pension funds as they seek to address sustainability risks and opportunities, including system-level risks, when they pose a threat to achieving their financial objectives. Policy and regulatory frameworks ensure that:
1. There is clarity regarding the duties and obligations of pension funds to incorporate ESG factors into investment decisions and stewardship activity, and to consider taking action to pursue sustainability outcomes that are instrumental to fulfilling financial objectives in line with members’ and beneficiaries’ preferences.
2. The long-term investment horizon and fiduciary duties of pension funds are recognised, incentivised and protected through appropriate parameters in investment decision-making, product choice and the tenure of pension fund trustees and senior executives, leading to decision-making that prioritises long-term goals.
Policy and regulation distinguish between addressing exposure to sustainability-related risks, tackling underlying drivers of such risks and pursuing sustainability outcomes in parallel with financial objectives

Pension funds are enabled to move beyond ESG integration at a risk-return level and pursue sustainability outcomes. Standards and guidance should clarify when pension funds may be required to consider addressing system-level risks relevant to financial objectives, as well as when and how they might pursue sustainability objectives in the best interest of members and beneficiaries.
Pension funds, investment managers and intermediaries produce standardised reporting on sustainability objectives

Standardised reporting provides information about the extent to which pension funds have met stated sustainability objectives and taken action to achieve those objectives. Similarly, investment managers and relevant intermediaries in the investment value chain align their reporting to support pension funds. Reporting by pension funds is in a format that is accessible to members and beneficiaries.
There is appropriate guidance on the sustainability claims of pension funds

Regulators provide guidance to pension funds on how to demonstrate the sustainability claims of their offerings and ensure that their disclosures indicate the types of strategies that facilitate these claims. This is a key factor in ensuring that members and beneficiaries have confidence in the sustainability characteristics of their products. Such guidance should not create unnecessary restrictions on the types of strategy that can be considered sustainable, providing adequate incentives to innovate.

Market structure

Pension funds have scale or can otherwise access the benefits of scale

Policy makers and regulators encourage fund consolidation where there are benefits to the market within which the funds are operating. However, the impacts of consolidation on sustainability objectives and strategies should be properly considered. In the absence of consolidation, policy makers and regulators encourage pooling of investments or resources, including encouraging sharing of resources on stewardship activities.
Suitable, sustainable investment products are available and accessible

Pension funds can access investment products with their desired sustainability characteristics, at appropriate cost and scale, to achieve their sustainable investment objectives.

Investment practices

Members and beneficiaries are educated about and engaged with regarding their sustainability objectives

Pension fund members and beneficiaries are appropriately educated about and regularly and systematically engaged with regarding their sustainability objectives. Where appropriate, the views of members and beneficiaries are reflected in pension fund sustainability strategies.
Trustees and fiduciaries are capable and skilled, with sustainability knowledge

Trustees and fiduciaries are equipped to meet high professional standards and receive sustainability-related training.
Trustees and fiduciaries are willing to move beyond traditional pension fund investment strategies and identify, implement and support the development of appropriate benchmarks to take action to pursue sustainability outcomes in keeping with their fiduciary duties

This includes provision of adequate incentives and market settings for moving, where appropriate, from traditional benchmarks focused on short-term, portfolio-level risks, towards benchmarks that allow the measurement of a scheme’s impact on system-level risks and the impacts of system-level risks on funds over longer time frames.
Service providers are adequately incentivised to support the pursuit of pension funds’ sustainability objectives

Service providers (notably investment managers and consultants) are adequately incentivised, able and willing to provide products and services that support pension funds’ sustainability objectives. This includes protecting against the adverse impacts of market concentration, such as the potential for conflicts of interest or impacts on the principal-agent relationship due to the size of intermediaries relative to the pension fund clients they serve.