3A.1 The limitations of “engagement”

Most local authority pension funds say that they address environmental, social and governance (ESG) issues through “engagement” with the companies that they invest in. Fund managers claim that engagement is more effective than divestment at changing company behaviour.

However, it is important to understand the limitations of this approach. The engagement undertaken by the local authority pension funds that we have looked at does not, nor is it intended to, address fundamental concerns about the ethics of investing in harmful industries. Rather, it is only concerned with managing the financial risks related to ESG issues.

For example, Lothian Pension Fund’s Statement of Responsible Investment Principles emphasises that the fund is a “responsible”, not an ethical, investor. It states that “the management of ESG issues is a question of identifying and mitigating material financial risks, not a question of ethics”.

While nuclear weapons investments do, in fact, present a financial risk to pension funds (see section 1.3), we contend that divestment from nuclear weapons can (see section 3A.2) and should be carried out for ethical reasons. It is simply wrong for local authority pension funds to profit, through their investments, from the production of indiscriminate, inhumane weapons of mass destruction.

What is engagement?

Investor engagement takes various forms, including correspondence and meetings with company managers, filing shareholder resolutions and voting at shareholder meetings. Correspondence between Don’t Bank on the Bomb Scotland, Nuclear Free Local Authorities and Strathclyde Pension Fund has shed more light on the nature of this engagement.

Strathclyde Pension Fund employs a company called Sustainalytics to carry out engagement on its behalf. The overall purpose of this engagement is to “manage financially-material reputational risk and increase corporate accountability”, according to a letter from Strathclyde Pension Fund.

Sustainalytics monitors company activity to identify risks and rates the risk on a scale of 1 to 5. Where a risk is identified, Sustainalytics may engage with the company concerned. This engagement may have a “specific change objective” or it may “take the form of a dialogue on risk”, Strathclyde Pension Fund says.

The engagement process is “controversy based”, that is it is largely triggered by news flow about the company’s activities, “including reports of new contracts, products or lawsuits”. This suggests that a company’s ongoing involvement in a harmful activity will not necessarily trigger engagement by Sustainalytics.

Strathclyde Pension Fund told us that “association with the provision of key products or services for nuclear weapons” has been listed as a controversy since 2012 and engagement regarding nuclear weapons is currently in the category of a dialogue on risk. However, the fund did not provide us with any examples of Sustainalytics’ engagement in this area. The fund did note that no recent engagement has been reported in relation to Boeing’s nuclear weapons work.

We also asked Lothian Pension Fund whether, in the last five years, it has carried out engagement with any of the nuclear weapons producers that it invests in regarding the involvement of those companies with nuclear weapons. The response stated: “There has been no such engagement with any of the named companies in this period.”

It is clear that engagement is limited in both scope and aim and, as currently approached, is unlikely to result in the cessation of nuclear weapons work by any of the companies listed in section 2. The example of cluster munitions discussed in section 1.5.2 suggests that divestment is a more effective way to curb the production of controversial weapons.