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Understanding ESG Investment - The Legal Considerations for Pension Scheme Trustees

Services: Employment, Pensions and Benefits DATE: 02/04/2019

Pensions Senior Associate Jane McKeever writes for the Spring edition of IAPF Magazine on the legal considerations for pensions scheme trustees of integrating Environmental, Social and Corporate Governance investment factors.


The integration of environmental, social and corporate governance (“ESG”) factors into occupational pension scheme investment has become a more significant consideration for trustees in recent times.

Once the EU Directive on the activities and supervision of institutions for occupational retirement provision (the “IORP II Directive”) has been transposed into Irish law, the trustees of many occupational pension schemes in Ireland will be obliged to publically disclose where ESG factors are considered in their investment decisions and how they form part of their risk management system.  Despite this, there remains a high level of uncertainty about what exactly constitutes ESG investment and to what extent it is appropriate for trustees to take ESG factors into account when making investment decisions.  This article seeks to clarify what is meant by ESG investment and how ESG integration interacts with trustees’ fiduciary duties to members.

What is ESG investment?

A good place to start when looking at what constitutes ESG investment is appreciating, in the first instance, what ESG investment is not.  The conversation around ESG investing often includes references to distinct concepts such as impact investing, socially responsible investing and ethical investing, which tend to be driven by non-financial factors, such as disapproval of certain industries.  This has contributed to the misapprehension amongst some trustee groups that ESG investment involves seeking to impose the trustees’ own moral principles or ethical considerations on the scheme’s investment policy.  A failure to understand what is meant by ESG investment means that trustees can be inclined to treat ESG factors as non-financial considerations that do not merit attention.  This is not the case.

In fact, ESG investing relates to environmental, social and corporate governance issues (including those outlined in the table below) and, crucially, how these factors may affect the investment performance of a company.  The value of ESG factors when setting investment policy lies in identifying ESG risks and then assessing the likelihood of these factors influencing the financial return on investments.  In this respect, it has been shown that there is a positive correlation between a company’s track record in respect of ESG and its financial performance, particularly with respect to mitigating risk and reducing volatility.

ESG Factors

Environmental Social Governance
Climate Change Employment SafetyDiversity
PollutionHealth and SafetyBribery and Corruption
Natural Resources Supply ChainEthics
Energy UseHuman RightsAuditing

Discharging fiduciary duties

A question that regularly arises in the context of ESG investing is whether trustees’ fiduciary duties to members restrict their ability to take ESG factors into account when investment decisions relating to members’ benefits are being made.

The law in relation to the investment duties of trustees arises from three separate strands; the governing trust documents of the scheme, common law duties established under case law and relevant statutory provisions.

Trust documents

It is generally the case that the trust documents of pension schemes established in Ireland provide for very wide investment powers in favour of the scheme trustees.   While it has not yet become practise for trust documents to make specific reference to consideration of ESG factors, typically, trustees are permitted to make any investment that would be possible if they were absolutely and beneficially entitled to the scheme assets.  It would be unusual for a scheme to contain a provision that could be read as preventing trustees from taking ESG factors into account.

Common law duties

Turning then to common law duties in relation to investment, the UK case of Cowan v Scargill (1) sets out the generally accepted formulation in relation to trustees duties as regards exercising their investment powers.  The Court in that case required trustees, when making investment decisions, to “take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide”.  The Court also found that “when the purpose of the trust is to provide financial benefits for the beneficiaries, as is usually the case, the best interests of the beneficiaries are normally their best financial interests”.  The case is regularly quoted as authority for trustees basing investments on financial criteria as opposed to moral or ethical principles, with Robert Megarry V-C outlining that “in considering what investments to make trustees must put aside their own personal interests and views.”

The Cowan v Scargill case was used for some years to support an argument that the sole obligation of trustees with respect to investments was to maximise returns.  The thinking in relation to this case has since developed and the more commonly held view now is that, aside from the requirement to invest in accordance with the “prudent person” principle (which is legislated for in the IORP II Directive), trustees should exercise their power of investment for the purpose for which it was provided.  As the purpose of a pension scheme trust is to provide the beneficiaries with the benefits provided for under the trust, investment powers should therefore be exercised with a view to maximising the chances of being able to deliver those benefits in full.

It is now established that ESG factors may impact on a company’s financial performance and long term sustainability.  Clearly, risks to financial performance that are material, whether those risks are connected to ESG or otherwise, may impact on the ability of trustees to provide scheme benefits.  Trustees are expected to balance returns against risk, recognising the long term nature of pension scheme investment.  It follows that ESG factors should be taken into account to the extent that they can reasonably be expected to impact on investment returns.

Statutory provisions

In terms of statutory provisions, section 59(1)(b) of the Pensions Act 1990 (as amended) requires trustees to provide for the proper investment of the resources of the scheme in accordance with regulations and, subject to those regulations, in accordance with the rules of the scheme.   The Occupational Pension Schemes (Investment) Regulations 2006 require the assets of a scheme to be invested in a manner designed to ensure the security, quality, liquidity and profitability of the portfolio as a whole, in so far as is appropriate having regard to the nature and duration of the expected liabilities of the scheme.  From a legal perspective, consideration of risks posed by ESG factors to financial returns is entirely consistent with these requirements.

There are also a number of provisions of the IORP II Directive which touch on ESG investing.  Under the IORP II Directive, ESG factors are recognised as being necessary elements to both the investment policy and risk management systems of pension funds.   At a high level, the IORP II Directive requires schemes to invest in accordance with the prudent person rule (which allows for consideration of ESG factors) and to provide information to members in relation to the relevance and materiality of ESG factors to the scheme’s investments and how such factors are taken into account. It should be noted that the IORP II Directive specifies that the ESG information requirements set out in the Directive may be satisfied by stating that ESG factors are not considered in the scheme’s investment policy or by stating that the costs of a system to monitor the relevance and materiality of such factors and how they are taken into account are disproportionate to the size, nature, scale and complexity of the scheme’s activities.

The requirements of the IORP II Directive with respect to ESG have yet to be transposed into Irish law however all occupational pension schemes with 15 or more members will have to comply with at least some of the requirements and, unless the Irish Government avails of derogations provided under the IORP II Directive (with the most recent indications being that this is not proposed), the requirements will apply to all schemes.


Having considered all three strands, it is clear that, provided that trustees appreciate the requirement to consider ESG factors primarily from the perspective of their impact on financial performance, there are no legal barriers to trustees taking ESG factors into account when making investments or setting investment strategy.  Indeed, where trustees are considering an investment and are aware of an ESG factor that gives rise to a material financial risk then it is arguable that not only are they entitled to give that factor appropriate weight, they are obliged to do so.  

Practical steps for trustees

The following are some practical steps that trustees may wish to consider taking in light of the new ESG related obligations on trustees set out under the IORP II Directive:

  • take advice in relation to legal and regulatory responsibilities in respect of ESG investing;
  • evaluate the potential costs or benefits of incorporating ESG factors as part of the scheme’s investment strategy;
  • establish an ESG policy and include ESG as a topic of discussion at trustee meetings, particularly where those meetings relate to investment decisions;
  • assess whether the scheme’s statement of investment policy principles should be updated to include reference to ESG factors;
  • request updates from the scheme’s investment advisors in relation to developments in ESG related topics


[1].            Cowan v Scargill [1985] Ch 270