Fiduciary duty in a warming world: how trustees balance ESG & member returns
Pension scheme trustees often ask: can we consider environmental social and governance (ESG) issues without breaching fiduciary duty? Increasingly, the answer isn’t just ‘yes’, but rather ‘you must.’ Climate risk is financial risk, making ESG integration a matter of prudence, not preference.
Shouldn’t trustees just follow the actions of policy-makers?
Unfortunately, global commitment to net-zero emissions as a policy goal is variable, shifting with the political beliefs of those in power and in response to world events. But climate risk and investment decisions often need to take a more long-term approach than comparatively short election cycles. The University of Exeter and the Universities Superannuation Scheme’s research suggests that in half of the likely future scenarios it will be industry that leads policy on the move towards a greener future. Clearly then, UK pension schemes and nearly £3 trillion they controlled by the end of 2023 can help to lead in this space and take advantage of sustainable investment opportunities rather than follow behind.
How does climate change and fiduciary duty link?
Trustees should consider climate change in the same way they’d consider any other systemic risk to their scheme and its members. If you accept that there are physical risks from climate change, and accept that we are within the scope of triggering tipping points – what does that actually mean for our investments and, most importantly, our members?
As climate change leads to rising water levels and increased instances of extreme weather, this will affect industries that schemes invest in. Investment in products and crops will suffer if extreme flooding impacts their production or distribution. Investment in fossil fuels may not be prudent for schemes with long horizons as they begin to run out or access to them is restricted. Conversely, investments in technologies that mitigate climate risks and renewable energies may perform well as the move towards them becomes a necessity.
Many well-meaning trustees will argue that fiduciary duty still makes ESG considerations secondary to financial returns. But the good news is that the evidence suggests you don’t have to choose. Research from Morgan Stanley found “no trade-off in the financial performance of sustainable funds compared with their traditional peers” between 2004 and 2018. In fact, the same research shows diversification into ESG funds may even reduce risk, particularly during periods of market volatility.
Is it about more than just money?
Fiduciary duty (especially when considering ESG) should be about more than financial returns. Trustees need to consider the quality of the world that scheme members retire into, as well as how much money they have. Investments that offer high returns but drive climate change and cause retirees to experience food scarcity, energy insecurity or displacement may not do enough to meet the needs of future pensioners. Despite its dismissal, cases like McGaughey & Anor v Universities Superannuation Scheme Ltd & Ors where the claimant alleged that the trustees of the scheme were neglecting their duties by failing to divest from fossil fuels show that trustees have a legal responsibility to consider ESG, as well as a moral one and will be challenged if they don’t.
What can trustees do today?
Issues like climate change can often feel too large for individuals to tackle. However, there are practical steps that trustees can take to help fulfil their duties to scheme members.
Larger schemes will have already had to take a number of steps to consider these points, but even smaller schemes can consider the issues. As a starting point, trustee boards should consider their own views and prepare a document, or a policy outlining these. This document can take into consideration whether they should align with the sponsor’s approach to sustainability and consider any member engagement on the topic. It can then be used to ask investment managers if their investment approach matches the board’s views. This should be evidence based and not simply policy based. If the board is not aligned with the manager further advice can be sought to move towards a more matched approach. By embedding sustainability into governance, risk management, and long-term strategy, trustees can better protect and enhance value for beneficiaries while meeting their fiduciary obligations.
For larger schemes undertaking regular TCFD reporting, sustainability is already embedded within fiduciary duty through formal climate governance, risk management, and disclosure processes. Trustees can build on this by using TCFD outputs (such as scenario analysis, metrics, and transition pathway assessments), to actively inform investment decisions, manager oversight, and stewardship priorities. Investor research highlights that integrating these insights into asset allocation and engagement, rather than treating reporting as a compliance exercise, is key to managing financially material climate risks and protecting long-term value. In this context, the focus shifts from whether to consider sustainability to how effectively these tools are being used to drive better outcomes for beneficiaries.
Whilst managing climate change and sustainability points may not be the responsibility of pension scheme trustees, it is something that they can consider as their investment strategy both in managing their risks and leveraging possible opportunities.
To learn more about how fiduciary duty interacts with ESG, you can talk to Sarah Booth or visit our Sustainability page.
