Interview: Mark Thompson
Mark Thompson, Chief Investment Officer at the HSBC UK Pension Scheme, helps to oversee over US$38bn of assets under management in both defined-benefit and defined-contribution pension schemes.
An early proponent of a responsible investment approach, Mark explained to insight the rationale behind the approach adopted by the HSBC UK schemes and what this has meant in practice.
Insight: How would you describe your approach to responsible investment?
The term responsible investment can be misunderstood. I like to describe our approach as being about the management of ESG risks – it’s about value, not values. This means it is all about the effect ESG risks could have on the value of our members’ investments.
Insight: How did you establish your approach?
Eight years ago, I worked with the pension scheme’s trustees to decide on our investment beliefs. These were not very long, and one of them states that ESG risks, including climate change, are a material factor in investment decision-making.
Having settled on our beliefs, we developed our policy, and this included a statement on corporate governance and socially responsible investing. This says the trustees expect investment managers to ensure ESG factors are incorporated within investment processes.
Insight: Your approach has been in place for a long time. How have you refined it?
When we began discussing this with investment managers, most fund managers were not taking these risks explicitly into account. A big part of our efforts over the years has been pushing our fund managers to consider these risks more, and to communicate how they are doing that.
The most significant development since we established our responsible investment approach was probably to establish an ESG steering group of Trustees to ensure we spent enough time considering the issues. This committee was set up to answer three questions: how to get better evidence from our fund managers that they were in fact acting on their promises; whether we should adopt a climate change policy; and how we might incorporate ESG risk management into our investments more.
Insight: How does climate change feature in your thinking?
On climate change, our approach has changed somewhat over time. We did analysis on our portfolios to assess how we might alter our asset allocations in response to different climate scenarios. This highlighted just how bad things could get – not least for our members. This led the trustees to decide that lobbying on broader climate change policy was consistent with their fiduciary duty.
We also decided to establish our own climate change policy, which we adopted in 2015. We then wrote to each of our fund managers and asked them what they were doing. When the TCFD (Task Force on Climate-related Financial Disclosures) issued its recommendations in 2017, we again wrote to our fund managers to understand how they are incorporating the TCFD framework.
Insight: Can you explain some of the practical results of your approach?
We worked with an investment manager to create an equity fund based on a customised index that has tilts away from companies with higher carbon emissions and reserves, and towards companies with greener revenues. The manager committed to a proactive engagement policy on ESG issues including climate change.
This included writing to 84 companies across the six sectors most susceptible to climate change and asking what they were doing about it. If there was no progress after a year, the manager would vote against the re-election of the chairmen at the next annual general meeting and divest the stock from our fund. In June last year, we divested from eight companies as a result of this – and all eight are putting the work in to improve their processes as a result.
Insight: How about for fixed income strategies?
In fixed income markets, the credit rating is a big factor. The big credit ratings agencies are getting better at incorporating ESG factors into their research. As in equity markets, engagement is relevant, but the approach is necessarily different. Equity investors can vote and have a direct say in matters that affect long-term performance. That said, companies need finance, which means they will listen to bond investors.
Insight: What challenges have you faced in adopting and implementing a responsible approach?
It helped that the trustees were in the right mindset from the beginning. I think the biggest problem around responsible investing can be a lack of clarity, so we have always been clear it’s about risk management.
It is necessary to actively question and challenge how the approach is implemented. When appointing new managers, we ask a lot of questions around what they do in this area. We expect them to be able to articulate their approach and to show how they’re responding to major new initiatives like the TCFD. I’ve questioned why our investment managers voted on their shareholdings in a particular way. My questions led the managers to change their voting policy.
Insight: What role does ESG data play?
I believe a company that governs itself well and manages ESG risks effectively will do well over time. But judging this purely on ESG data is questionable. You can’t be sure how accurate or up-to-date the data is.
A lot of companies can improve their ESG ratings simply through better communication of what they are doing. One of our smaller equity managers invested in an Asian online gambling company, for which an ESG data provider had two red flags over labour and energy. The flags were driven by assumptions about labour rights in the company’s home country and typical energy usage by the online gambling sector. It turned out the company’s workforce was mostly well-paid accountants and the company had taken extensive measures to minimise the impact of its energy use, so the ESG red flags were simply a result of lack of communication with the ESG data provider.
This shows why transparency is crucial: more disclosures can only result in more accurate analysis. I asked an index provider to analyse the carbon emissions of our equity portfolio relative to the index, and the provider was only able to find real data for about half of the companies: the remainder had to be modelled. This is why we support the broader push, in line with the TCFD, to get more companies to disclose information like this.
Insight: What progress would you like to see in how investors and investment managers approach responsible investment?
Ultimately, there needs to be more engagement at both the policy level and through investment managers. Asset owners can be more assertive and ask their managers exactly what they have done, and how. I want to see that our investment managers do more than incorporate ESG ratings – I want to see that they have the right mindset when it comes to investment.