By Nikolaj Halkjaer Pedersen (@NikolajHalkjaer), Senior Specialist, Responsible Investment, and Morgan Slebos, Director of Sustainable Markets, both at the PRI
Retirement plans are at the top of the food chain in our financial and economic system. Almost $50 trillion are held in workplace and personal pension plans, leaving workers and savers with significant, mostly untapped, influence to affect real world outcomes through a range of financial intermediaries. However, the design of private retirement systems often undermines the ability of plan boards and managers, acting on our behalf, to be responsible investors, active stewards and allocators of capital to economic activities with desirable social and environmental outcomes.
The primary objective of a retirement system is to provide financial security for savers in retirement. It’s easy to succumb to a narrow understanding of how to fulfil this mandate, but we also ought to consider the wider social, environmental and economic implications of the pension and retirement policies and structures that we put in place. This is important because of immediate financial reasons, as so-called ESG products seem to outperform conventional benchmarks, also during the Covid-19 crisis as markets show increased volatility. The collective consequences of a retirement system that turns a blind eye to the climate crisis, human rights infringements and rampant economic inequality – which are already at our doorstep - are simply too severe.
As outlined by the leading pensions authority Keith Ambachtsheer, financial individualism - where people are left to develop and execute their own retirement savings strategy – rarely leads to good financial outcomes. The PRI’s latest research on sustainable retirement systems reveals that the same holds true for sustainability objectives. This is even more pronounced in light of the COVID-19 pandemic, which has exposed the fragility of global systems and our subsequent powerlessness as individuals.
In our research, we have examined the private retirement systems of Australia, the UK and the US and identified major challenges to the ability of organisations and individuals charged with overseeing the management of our retirement pots to fulfil this function in a sustainable way. A combination of structures and regulation leave retirement plans – such as US 401(k) plans – poorly equipped to understand and drive environmental and social considerations through a complicated investment chain ripe with principal-agent problems.
Asset managers, investment consultants and other service providers operate in relatively concentrated markets and have extensive resources and knowledge. While their market power and resources mean that, in theory, they are often better placed than retirement plans to drive responsible investment and stewardship, their lack of incentives leads to limited execution in practice. This is a key structural challenge.
In April, US academics Leo E. Strine Jr. and Dorothy S. Lund wrote in the New York Times that the American corporate governance model has increasingly favoured stock markets and shareholders over other stakeholders thereby hindering financial soundness, sustainable wealth creation and the fair treatment of workers. They go on to explain how powerful institutional investors have led this charge through the pressure they put on companies. We would add that the current structure of the US retirement system and the lack of influence of savers and workers represented through 401(k) plans relative to financial intermediaries - due to structural, regulatory and legal constraints - contribute to this story.
To promote sustainability objectives, policymakers should pay closer attention to retirement system structure and policy and adopt measures – including fund consolidation – and encourage retirement plans that are well-governed and active when it comes to sustainability issues. Large retirement plans – with a universal ownership outlook - can play a key role in influencing how systemic sustainability issues are addressed by other actors. The presence of such organisations and their relative weight in the system is vital for the general functioning of the financial industry.
To address these themes, the PRI is building a knowledge base for policymakers, industry and academics to foster further debate about how we can best design our retirement systems to deliver financial security for participants while not undermining healthy social and environmental outcomes.
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