A Responsible Future - Willis Towers Watson

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A Responsible Future

Neil Chapman and Adam Gillett

21 June 2018

Life 2018

© 2018 Will is Towers Watson. All rights reserved.

willistowerswatson.com© 2018 Will is Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only.

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 …

146


… and impacting business areas

© 2018 Will is Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 147

Staff DB & DC approaches

and investment

options

Customer demand/ product design

Investment approaches

for policyholder

funds

Corporate and social

responsibility

Branding


Agenda

Evolution of Responsible Investment (‘RI’)Supervisory trendsRI strategiesRI return impactImplementing RIConclusion



Evolution of responsible investment initiatives in the U.K.

EVOLUTION OF RESPONSIBLE INVESTING


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


Signing up to UN PRI used to be a good RI credential …


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



… but is now the norm for asset managers


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



However, there is a confusing proliferation of terms and approaches used in the market

152

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


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ESG issues that investors might take account of


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



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


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

155


RI strategy needs to take account of multiple interconnected considerations

RI STRATEGY


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


The scope to implement RI varies

RI STRATEGY


Scope for integrating ESG into investment processes

WP and actively managed UL

funds

UL investment options actively

chosen by policyholders

Passively managed UL

funds


Surveys suggest increasing customer interest

RI STRATEGY


§ 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


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



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


1, 2, 3, 4, 5, 6, 7, 8, 9, 10 see slides in supporting material section


Empirical evidence can be supportive but not definitive

RI RETURN IMPACT


Source: Bloomberg


How to integrate sustainability into the investment process

IMPLEMENTING RI


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


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


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


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


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.


NEST Case study

IMPLEMENTING RI


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


HSBC Case study

IMPLEMENTING RI


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


What ‘good’ might look like externally

IMPLEMENTING RI


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.

https://unfriendcoal.com/wp-content/uploads/2017/11/UnfriendCoal-Insurance-Scorecard.pdf

http://aodproject.net/insurance-index


Drivers for future development…

CONCLUSION


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

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A Responsible Future - Willis Towers Watson