a responsible future - willis towers watson
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A Responsible Future
Neil Chapman and Adam Gillett
21 June 2018
Life 2018
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Expanded impact investment portfolio to $5bn in Nov-17 after reaching $2bn in green bonds
Zurich
“Under fire for pouring £370m into Polish coal industry - UK insurer accused of undermining international efforts to fight climate change”
Aviva
Divesting c.$4bn of tobacco stocksAXA, Aviva and SCOR
Among 9 investors collaborating to implement recommendations from the Taskforce on Climate-
related Financial DisclosuresAviva
Moved entire £130bn liquid asset portfolio to ESG benchmarks
Swiss Re
No longer insuring coal companies and will limit its investments in the industry … amid mounting
pressure from environmental campaigners Allianz
Sustainability and ESG considerations are already making the headlines …
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… and impacting business areas
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Staff DB & DC approaches
and investment
options
Customer demand/ product design
Investment approaches
for policyholder
funds
Corporate and social
responsibility
Branding
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Agenda
Evolution of Responsible Investment (‘RI’)Supervisory trendsRI strategiesRI return impactImplementing RIConclusion
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Evolution of responsible investment initiatives in the U.K.
EVOLUTION OF RESPONSIBLE INVESTING
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Greenbury ReportReview director remuneration
Cadbury Report
Combined Code on Corporate Governance
Hampel Review post Combined Code
Turnbull ReportReview companies’
internal controls
Myners Review
ISC best Practice Code on Shareholders Rights and
Responsibilities
UK Stewardship Code for Investors
Kay Review of UK equity markets and long term decision making
UN Principles for Responsible Investment
Walker ReviewCorporate Governance
UK Banking sector
1992 1995 1998 1999 2001 2002 2003 2006 2009 2010 2011 2012 2013 2014 2015 2016
FRCReview of audit committee function
Smith ReportIndependence of auditors
Higgs ReportRole and effectiveness of NEDs and audit committee
Regulation on Director Remuneration
Binding shareholder vote on executive pay
UK Law Commission Review of Fiduciary
Duty in pensions
Updated Combined Code, new name ‘UK Corporate Governance
Code’
UK Investor Forum for
collaborative engagement established
DWP Consultation on Investment Regulations
following Law commission review of fiduciary duty
AMNT Red Line Voting initiative
Paris COP21 – G195 agreement to reduce carbon emissions and global temperatures to less than +2˚C above pre-industrialisation levels
Responsible investment goes mainstream: over 1,000 attendees at PRI in Person conference
Task Force on Climate-related Financial Disclosures (TCFD) presented Phase I report (scope, high-level objectives and principles of
disclosure) to the Financial Stability Board
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Signing up to UN PRI used to be a good RI credential …
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Background
The PRI is a voluntary initiative that was launched in 2006 by a group of 20 of the world’s largest institutional investors, co-ordinated by the UN. The Principles provide a common framework for investors to integrate environmental, social and governance (ESG) considerations into investment decision-making and ownership practices.
Principles
1. We will incorporate ESG issues into investment analysis and decision-making processes.
2. We will be active owners and incorporate ESG issues into our ownership policies and practices.
3. We will seek appropriate disclosure on ESG issues by the entities in which we invest.
4. We will promote acceptance and implementation of the Principles within the investment industry.
5. We will work together to enhance our effectiveness in implementing the Principles.
6. We will each report on our activities and progress towards implementing the Principles.
ESG integration
Stewardship
Transparency
Promotion
Collaboration
Reporting
EVOLUTION OF RESPONSIBLE INVESTING
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… but is now the norm for asset managers
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Asset owners Investment managers Service providers
372 1351 240Institutional investors that represent the holders of long term assets e.g. pension funds, endowments
and insurance companies
Organisations that manage and control investment funds
Organisations who have influence over their clients asset holdings e.g. investment consultancies
14% of signatories are based
in the UK
2% are UK asset owners
Data as at 10 May 2018; chart as at 30 April 2017
0
200
400
600
800
1000
1200
1400
1600
1800
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17
AO AUM ($ US trillion) Assets under management (US$ trillion) Number of AOs Number of Signatories
EVOLUTION OF RESPONSIBLE INVESTING
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However, there is a confusing proliferation of terms and approaches used in the market
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Target competitive risk-adjusted financial returns
Impact goals
Financial goals
Approach TRADITIONAL RESPONSIBLE SUSTAINABLE IMPACT DRIVEN PHILANTHROPY
Avoid harm and mitigate ESG risks
Benefit all stakeholders
Contribute to solutions
Unchartered returns
Below-market returns
Partial capital preservation
Complete capital loss
Description
‘Finance first’ ‘Impact first’
Global Equity Fund SIB FundGlobal Equity Fund Social bond fund Social growth fundExamples
Sustainable Development Goal investing
EVOLUTION OF RESPONSIBLE INVESTING
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ESG issues that investors might take account of
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Remuneration
Governance Social
Board structure
Climate change
Sustainability
Gre
en e
nerg
y
Biodiversity
Bribery & corruptionLong termism
Responsible management
Local communityengagement
Business Ethics
Extreme weather
Car
bon
emis
sion
s
Waste managementIn
equa
lity
Financial crime
Supply chain management
Div
ersi
ty
Environmental
EVOLUTION OF RESPONSIBLE INVESTING
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Supervisory bodies are increasingly focusing on ESG issues and responsibilities
FRC are seeking to improve the effectiveness of Section 172 and encourage ESG related disclosure and focus on long term sustainable success and contribution to wider society
Pensions Regulator requires DB schemes’ investment principles to explain the role of ESG in investment decisions
FCA & Law Commission are considering what oversight requirements should apply for workplace personal pension schemes including stewardship and sustainability
European Commission Action Plan: Financing Sustainable Growth
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SUPERVISORY TRENDS
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Clarify duties in relation to sustainability with aim of explicitly requiring institutions to
integrate sustainability considerations into decision making process and increase
transparency
6. Clarify Institutional Investors’ and Asset Managers Duties
The Commission will explore the merits of amending Credit Rating Agency Regulation to
mandate explicitly integrating sustainability factors
7. Better Integrate Sustainability in Credit Ratings
EIOPA will be invited to provide an opinion on the impact of prudential rules for insurers on
sustainable investment with a focus on climate change mitigation
8. Incorporate Sustainability in Prudential Requirements
• Revision of disclosure guidelines including the Non-Financial Information Directive
• Asset impact of new or revised IFRSs on sustainable investment including the impact of IFRS 9
9. Strengthen Sustainability Disclosure & Accounting Rules
Assess the possible need to require corporate boards to develop and disclose a
sustainability strategy; and investigate evidence of short term pressure from capital
markets on decisions
10. Foster Sustainable Corporate Governance
Adoption of Delegated Acts on transparency of methodologies and features of benchmarks
allowing users to assess quality of sustainability benchmarks; harmonisation of
low-carbon benchmarks
5. Sustainable Benchmarks
The Commission will amend MIFID II and IDD delegated acts to ensure sustainability
preferences are taken into account
4. Incorporate Sustainability in Financial Advice
Legislative proposal for EU classification system for sustainable activities including
taxonomy and tools to allow such classification
1. Classification System for Sustainable Activities
The Commission will specify content of the prospectus for green bond issuance; and explore the use of the Ecolabel framework
2. Standards and Labels for Green Products
Actions 4,5,6,8 and 9 have the potential to have a direct impact on insurers and on the shaping of its future products Actions 5 and 6 will potentially impact asset managers
3. F
oste
r In
vest
men
t in
Sus
tain
able
Pro
ject
s
2018
2019
REGULATORY TRENDS
European legislation could be a significant driver of change
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RI strategy needs to take account of multiple interconnected considerations
RI STRATEGY
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Customer demand
New entrants/product
design
Regulatory requirements
Brand/product strategy
Actions of existing
competitors
Corporate and social
responsibility policy
Delivering the “best” returns for
customers
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The scope to implement RI varies
RI STRATEGY
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Scope for integrating ESG into investment processes
WP and actively managed UL
funds
UL investment options actively
chosen by policyholders
Passively managed UL
funds
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Surveys suggest increasing customer interest
RI STRATEGY
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§ General interest in sustainable investing with Millennial investors twice as likely to invest in companies that target social or environmental outcomes
§ However, the majority of Millennials (63%) expect this to result in lower returns§ 90% of Millennials would be interested in pursuing sustainable investments if they were an option in
their pension plan compared to 72% for the general population § Women continue to express a greater interest in sustainable investing 84% compared to 67% for men
Source: Morgan Stanley Sustainable Signals Whitepaper 7 Aug 2017
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RI strategies need to reflect RI ambitions and beliefs
Brand and product strategy built around being an RI leader
Being seen as a RI thought leader and
champion
Cutting edge investment
approaches and products
Leader with high conviction on
stewardship and co. engagement
Enhanced RI capability and credentials
Strong stewardship and company engagement
RI monitoring and planning to be able to
respond to developments
Just implementing RI within investment processes
Embed ESG in active investment approaches
Passive ESG tilted funds where justified
Specialist RI investment options where there is
customer demand
RI STRATEGY
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Empirical evidence for ESG
§ While data history is limited and results vary, evidence tends to point towards either a neutral impact or moderate long-term risk adjusted return advantage for approaches which integrate consideration of ESG risks § As part of sensible risk management it seems appropriate to implement strategies which consider ESG risks especially if the fee/cost
drag is not much higher than alternative approaches§ While difficult to measure, there is increasing empirical evidence to support the value of stewardship§ Effective stewardship by asset owners should be encouraged
1. Lower ESG scoring companies tend to provide moderately better risk-adjusted returns over the long term and some evidence for lower credit spreads (fixed income)
2. Governance (‘G’) is often found to be the most influential factor3. Company engagement appears to have a positive impact
RI RETURN IMPACT
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1, 2, 3, 4, 5, 6, 7, 8, 9, 10 see slides in supporting material section
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Empirical evidence can be supportive but not definitive
RI RETURN IMPACT
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Source: Bloomberg
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How to integrate sustainability into the investment process
IMPLEMENTING RI
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5. MonitoringMonitoring – to ensure activities are mission consistent and meeting expectations. Communicate progress to stakeholders.
1. Mission and beliefsSelect fund positioning – articulate mission
and beliefs and document in a policy
2. Risk managementDevelop a risk management process –
link sustainability themes to long-term risk-return expectations and stress tests4. Implementation
Implementation – through active ownership and alignment of financial interests towards the long term 3. Portfolio construction
Portfolio construction – accounts for material sustainable risks and opportunities.
Identify strategies across asset classes/alpha and beta spectrum
4
51
2
3
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What makes a good RI asset manager
A key differentiator is how well RI is integrated into existing processes with successful managers having a clear competitiveposition, including for the stages of adoption, differentiation and organisational context.
IMPLEMENTING RI
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Aligned to objectives, beliefs and context of asset owner
Tailored to investment mandate, asset class and
strategy
Conscious of evolving market standards, applicable best practices, regulation and
industry guidance
Leadership from senior company personnel (at group and asset manager level) and key decision makers within a
strategy
Key pillars of ESG integration and stewardship:
Resources including team structures and reporting lines
Integrated into investment
process, involving investment team
Documented policies
Voting, including track record and
statistics
Engagement, including track
record and statistics
Transparency
AlignmentTwo-way
engagement to improve practices
over time
Promotion of good practices within the
organisation and the financial
industry
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Inde
x Pr
ovid
ers
MSCI§ MSCI Global ex-Controversial Weapons (CW)§ MSCI Global ex-Fossil Fuels§ MSCI SRI§ MSCI Global Sustainability§ MSCI Global Low Carbon§ MSCI Global Governance Quality§ MSCI Global Environment§ MSCI Sustainable Impact§ Barclays MSCI SRI§ Barclays MSCI Sustainability§ Barclays MSCI ESG Weighted§ Barclays MSCI Green Bonds
S&P§ Global Low Carbon§ Faith-based§ Global 1200 ESG§ Global Clean Energy§ Global 1200 Carbon Efficient§ Global 1200 Fossil Fuel Free§ Long-Term Value Creation Global§ ESG Sovereign Bond
STOXX§ Global ESG Leaders§ Global ESG Environmental Leaders§ Global ESG Governance Leaders§ Global ESG Social Leaders§ Global ESG Impact§ Global Climate Change Leaders
FTSE Russell§ FTSE 4Good§ FTSE Green Revenues § FTSE Environmental Markets§ FTSE All World ex-Fossil Fuels§ FTSE All World ex-CW Climate Balanced Factor§ Divest-Invest Developed 200
If using an external manager there is already a wide range of products and providers
IMPLEMENTING RI
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Inde
xatio
nM
anag
ers
BlackRock§ Exclusionary Screens§ Clean Energy Weighted§ Low Carbon§ Sustainability§ Broad Public Equity Impact§ Renewable Power§ Green Bonds
UBS Climate Aware fund
LGIM Future World Fund
SSgA§ REITs ESG§ World Custom ESG Funds
Trad
ition
al A
ctiv
e M
anag
ers
Mor
e fo
cuss
ed o
n a
sing
le t
opic
or
issu
e Jupiter§ Ecology
Wellington§ Global Impact
Impax§ Environmental Leaders
Schroders§ Climate Change Equity § QEP Global ESG
Lansdowne§ Clean Energy S
trate
gies
with
a s
trong
focu
s on
RI
and
ES
G in
the
inve
stm
ent
proc
ess
Comgest§ Europe
Stewart Investors§ Worldwide Sustainability§ Global Emerging Markets§ Asia Pacific
First State Stewart Asia§ Asia Pacific§ China
The wide range of funds may indicate product proliferation rather than high conviction innovative solutions. Partly, this mirrors patchy investor demand (often with a relative mind-set constraints) in an evolving subject area. It also reflects a weak taxonomy system, and competing or emerging standards.
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NEST Case study
IMPLEMENTING RI
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NEST DC Default Fund
Passive World Equity Fund
UBS Climate Aware Fund
Other asset classes
Other asset classes…
£130m transfer
Fund pursues a very active climate aware voting and engagement policy with companies
Negative tilt to reduce exposure to heavy greenhouse gas emission and fossil fuels
Positive tilt to increase exposure to renewable energy firms meeting 2oC climate change goals
Fund aims to deliver returns broadly in line with FTSE Developed Index with TE +/- 0.5%
Represents 20% of Developed World Equities and 10% of total holdings
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HSBC Case study
IMPLEMENTING RI
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HSBC DC Default Fund
LGIM Passive Global Equities
LGIM Future World Equity Factors
Index Fund
Other asset classes
Other asset classes…
c. £1.9bn transfer
Targets better risk adjusted returns using a rules based factor approach that reduces climate change risk
Overarching LGIM pledge ‘to engage with world’s largest companies that are required to adapt their business models and drive innovation in order to meet the global climate change goals … to accelerate a low carbon
economy’
Value Quality Low volatility Size
Negative tilt to worse than average carbon
emissions & fossil fuel
Traditional market cap tilted using four factors
Positive tilt to revenue generation from the
green transition
Traditional market cap tilted using 4 factors
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What ‘good’ might look like externally
IMPLEMENTING RI
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Published strategy setting out the company’s approach for acting on climate-related investment risk over 2015-2020
ESG Integration Active Ownership Shaping Markets§ Global Responsible Investment Team ensures
that ESG factors are considered when determining the firm-wide macro outlook
§ ESG heat map supplemented by additional fund manager and analyst briefings
§ Development of bespoke ESG strategies from real estate and infrastructure to structured finance and private corporate debt
§ Voted in 4,259 shareholder meetings and withheld support on 26% management proposals in 2016
§ Member of the Investment Association Remuneration and Share Schemes Committee responsible for the continuous review of executive remuneration
§ Undertook 1,222 company engagements with 872 individual companies in 2016
§ Published policy document as input into UNFCCC policy discussions at the climate conference COP22
§ Founding member of a group collaborating to establish the World Benchmarking Alliance, a publically funded, global institution that funds, houses and safeguards the quality of Sustainable Development Goals-related corporate benchmarks
Investment target of £500m annually in low-carbon infrastructure 2015-2020. £450m green
investments signed 2016
Focused engagement with 40 companies with >30% business derived from coal mining
Invited to join the EU expert group to develop a ‘comprehensive sustainable finance strategy’
Unfriend Coal rating
AODP rating AA
The Asset Owner Disclosure Project Index assesses 500 of the world’s largest asset owners –rating them from AAA to X – on how well they are managing climate risk.
Unfriend Coal: https://unfriendcoal.com/wp-content/uploads/2017/11/UnfriendCoal-Insurance-Scorecard.pdfAODP: http://aodproject.net/insurance-index/?wdt_column_filter%5B5%5D=Insurance
This case study was developed based on publicly available information.
One of the first firms to integrate ESG issues into their decision making across all asset classes. Advocate policy measures that support longer-term, more sustainable capital markets.
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Drivers for future development…
CONCLUSION
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Risk and returns
RegulationIndustry
expectations
Licence to operate
Brand and profile
Socially conscious consumer
Evolving asset owner
practices
…in an expanding domestic and global regulatory frameworkWhilst there is arguably little in the way of innovation, strategies including Resilience
Bonds have been known to engage interest. Private markets also offers the opportunity to
pursue more niche or targeted strategies.These drivers should be used to frame management response with key steps being:
1. Self-understanding2. Meta-understanding3. Deliberate and proactive positioning