Trustees are being urged not to overlook ESG considerations when looking at defined benefit endgame strategies.
The advice comes from Isio’s head of sustainable investment Cadi Thomas, amid increasing choice for trustees on future funding options for DB schemes, which include insurance, consolidation and run-on strategies.
Thomas points out that ESG risks are not confined to distant horizons. “While some challenges, such as climate change, unfold gradually, others – including regulatory shifts or sudden market disruptions – can materialise unexpectedly.
“Trustees must act proactively to integrate ESG considerations into their strategies, whether preparing for a near-term insurance transaction or investing over longer time horizons.”
She adds: “As run-on strategies gain popularity, there may be greater scope for trustees to deliver real-world impact through less stringent liquidity constraints, while tackling long-term risks head on.
“At the same time, the narrative that ESG risks will simply be transferred to an insurer is changing. Insurers are increasingly implementing ESG-resilient portfolios, meaning schemes on the journey to insurance should align their investment strategies accordingly to protect against potential pricing disparities.”
Thomas highlighted the potential for ESG risks to crystallise more rapidly, for example following the introduction of stricter carbon taxes, which may lead to rapid repricing of stocks and bonds in carbon-intensive sectors.
“Recent events in the UK water sector provide a further illustration of how environmental risks can quickly translate into financial stress.
“Underinvestment in infrastructure, regulatory scrutiny, pollution fines and rising debt levels contributed to declining investor confidence, credit downgrades and widening spreads.
“What began as environmental and governance weaknesses ultimately eroded asset values and spilled over into broader sector repricing. This highlights how hidden ESG risks can destabilise even critical infrastructure assets.
“Trustees should therefore take a holistic view of ESG risks across all endgame strategies, assessing both short- and long-term exposures regardless of the pathway chosen.”
She adds: ”ESG integration is relevant across all endgame routes through robust asset selection and risk management. Under a run-on strategy, trustees may have greater flexibility to access higher-returning, more illiquid asset classes – such as renewables, natural capital or social housing – where measurable real-world impact can be achieved.
“For schemes targeting insurance, focus should not only be on low-risk assets but also on insurer capabilities and ESG alignment. Assessing how sustainability considerations are embedded within insurer portfolios and stress-testing against climate or transition shocks can help mitigate last-minute pricing mismatches.”