Board and executive-level efforts to integrate environmental, social and governance issues into pension plans’ investment strategies are frequently thwarted by unclear guidance from plan sponsors and uncertainty about fiduciary duties, according to a new working paper by the University of Pennsylvania.

The paper concluded that efforts to implement ESG criteria in investment decision-making are frequently hamstrung by the structure of pension plans. It was commissioned by the Wharton Pension Research Council and co-authored by Judith Strole, a senior research fellow at the University of Oxford, and Stéphanie Lachance, managing director of responsible investment at the Public Sector Pension Investment Board.

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The barriers to implementing ESG criteria are particularly difficult for defined contribution plans to overcome. According to the paper, just 2.8 per cent of DC plans in the U.S. offer ESG fund options to plan members. “This is likely due to concerns about fiduciary duty and conflicting regulatory policy, both of which led to confusion about the legality of pension products incorporating ESG.”

Strole and Lachance also contend that, while uncertainty about fiduciary duties have largely prevented DC plans from implementing ESG criteria and hampered similar efforts at defined benefit plans in the U.S., the situation is somewhat different in Canada. They point to a recent change to the Canada Business Corporations Act as an example of legislation freeing the hands of pension executives and boards to incorporate ESG criteria into pension plans’ investments.

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“Recently, for example, the [act] was amended to codify the longstanding common law principle that directors and officers of CBCA corporations are not required to consider only the interests of shareholders when acting in the best interest of the corporation,” said the paper. “Instead, they may also consider, among other factors, the interests of employees, the environment and the long-term interests of the corporation.”

The paper also suggested that pensions, both DB and DC, work together in order to overcome some of the barriers to the market-wide integration of ESG factors at the institutional, organizational and portfolio levels. “Possible targets of such coordination, like disclosure standards and standard mandates for external managers, can help facilitate a deeper integration of ESG in the entire investment chain.”

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