Matti Leppälä on how pensions funds are looking to address long-term sustainability

Question 1: As pension funds look to address long-term sustainability, what are the top priorities in terms of integrating ESG factors into investment decisions?

As pension funds address long-term sustainability, integrating ESG factors into investment decisions has become a key priority.

By nature, pension funds are long-term investors that have as their main objective the delivery of adequate pensions to their members and beneficiaries. This means they should naturally take the long-term view and are required to consider the long-term risks that may affect their portfolios. ESG risks, and climate change risks, in particular, play an increasingly significant role in risk management. In order to mitigate these risks, some pension funds have put in place carbon reduction plans or fossil fuel divestment policies.

Moreover, many pension funds are based on collective agreements and managed by the social partners, pension funds’ responsible investment policies often place equivalent importance on social and governance issues.

There is a long tradition of pension funds aligning investment practices with the values of their members and beneficiaries and the needs of the society at large. Members are becoming more vocal about their sustainability preferences and pension funds are increasingly responding by increasing the level of ambition of their responsible investment policies.

Lastly, regulatory alignment and transparency are important priorities. Pension funds must ensure compliance with evolving EU regulations, especially the Sustainable Finance Disclosure Regulation (SFDR).

Question 2: How are pension funds approaching the challenge of balancing fiduciary duties with the need for sustainable investments?

The debate on whether sustainable investments are compatible with the fiduciary duties of pension funds has largely been resolved in the EU. In Europe, Article 19(1)b of the IORP II Directive explicitly allows Institutions for Occupational Retirement Provision (IORPs) to take ESG factors into account when making investment decisions.

More and more pension funds also consider the negative impact of investments on the environment and societies (inside-out perspective), in line with the OECD Guidelines. This means that they implement due diligence policies to identify and mitigate negative impacts. Also, impact investments, which are specifically targeted to achieve non-financial outcomes next to financial returns, are becoming increasingly popular investments amongst pension funds.

The way the prudent person principle is currently being applied in many EU countries has not constrained pension funds in their ambition to make impact investments or get out of profitable sectors that are thought to pose ESG risks.

Question 3: What role should pension funds play in the transition to a carbon-neutral economy, and how can they support climate-related initiatives through their investment strategies?

The transition to a carbon-neutral economy is one of the most pressing challenges of our time, and pension funds, as long-term investors play an important role in tackling this challenge.

Pension funds implement diverse investment strategies to support climate-related initiatives. One widely used strategy is stewardship and proxy voting to influence ESG advancements within investee companies.

Impact investing is another approach, targeting long-term growth trends in sectors undergoing climate and energy transitions. Additionally, investors may focus on companies with strong or improving ESG scores and integrate ESG factors throughout the investment process.

Pension funds can either adopt exclusionary screening involves avoiding sectors like coal, fossil fuels, or inclusionary screening selects assets that meet ESG thresholds, often favouring sector leaders through a "best-in-class" approach.

Thematic strategies are gaining traction, targeting sustainability goals through investments in green and social bonds, which are particularly appealing because they are targeting specific projects that can be monitored.

Institutional investors may also form a coalition, joining with other investors to increase their power and influence and encourage the companies they invest in to improve sustainability practices.

Question 4: Can you share any best practices or case studies from pension funds that have successfully aligned their portfolios with the EU’s sustainability goals?

Several European pension funds have successfully aligned their investment strategies with the EU's sustainability goals, demonstrating leadership in responsible and climate-conscious investing.

A prominent example is ABP, the largest pension fund in the Netherlands. ABP has set ambitious sustainability targets, aiming to halve its carbon footprint by 2030 and achieve a climate-neutral portfolio by 2050. To meet these objectives, the fund divests from companies that fail to meet its sustainability criteria and actively invests in green projects, renewable energy, and green bonds. In 2021, ABP made the decision to stop investing fossil fuel’s investments. Additionally, the fund engages in active dialogue with major energy consumers and companies with a significant climate impact. The fund also uses its voting rights to influence corporate behaviour and drive meaningful changes. ABP's approach extends beyond climate to include policies on biodiversity, human rights, and good corporate governance.

Nordic pension funds have also been pioneers in sustainable investing, with ESG considerations deeply embedded in their investment strategies. Nordic countries and pension funds have been involved in sustainable investing well ahead of European legislation on the matter. For instance, the Swedish pension fund AP7 is strongly committed to the Paris Agreement and prioritises the climate transition. Additionally, according to a survey by Cerulli, 50% of Nordic asset owners target clean technology and renewable energy when allocating capital to responsible investments, which illustrates the region's focus on climate-related investing.