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“Be prepared to fix it or pay for it”

Managing Director Michael Bushnell explains that the role of Cardano Advisory, as employer covenant and related services advisor, is to look for the potential issues that might arise in a sponsor company, so that the pension fund trustee is prepared for them. “Climate change and ESG factors give trustees a chance to positively influence the employer covenant in a way that is not generally possible. Trustees are uniquely placed to discuss these factors with the sponsor. And they’re likely to be the stakeholder truly interested in the long-term prospects of their sponsor, because they are going to be together for a very long time.”

Michael feels that ESG has to date been overlooked in the employer covenant space: “Very little has been explicitly done. Trustees have yet to consider in any detail the way that ESG might impact their sponsors rather than their investment portfolios.


There are three reasons for this lack of action:

  • There are three reasons for this lack of action:The first is that people don’t know where to start.
  • The second is that the information that is available to allow the kind of proper ESG assessment on sponsors is very patchy.
  • And thirdly, people think it is something they can come back to when there is more clarity.

I believe that all of those three points can be met quite easily and solved. The third one in particular is quite pernicious. I don’t think there is time to wait. We need to get on with it now.”

But why this sense of urgency?

“There are two ways to look at climate change and ESG problems in general. One is as a chronic problem that builds up over time and can be modelled; this change is smooth, so that you can see into the future. That’s how we’re used to thinking of these big problems: we hear about them as a long, smooth trajectory. In that reading, I can see, particularly with a diversified investment portfolio, that a lot of the volatility gets smoothed out and you do have time. But the strength of a sponsor’s business is different. A single company is much more exposed to the second manifestation of climate and ESG risks: the up and down spikes, the acute changes and risks that underly the smooth modelling and arise as part of sharp swings in both social and climate trends.”

The problem is that there’s very little room for manoeuvre. You can’t simply diversify a single sponsor. So if you’re underfunded, you have a big credit risk exposure to one single company. Does that make ESG factors different when you look at the sponsoring company, than when you look, for example, at a broad portfolio?

Nowhere else to go

Michael: “It raises similar questions to the questions that should be asked for an investment portfolio, but the answers are going to be very different. You can’t hedge your exposure to the credit risk of a sponsor in the way that you could a bond portfolio. You can’t make a plan to transfer out of your sponsor to somewhere else. There isn’t anywhere else (unless you have sufficiently strong funding, in which case your reliance was already low). So your response to climate change has to be more like the response you would make to a sponsor that is highly exposed to M&A, for example, if there is a high chance that it’s going to sell off its crown jewels or be bought by an acquisitive, highly leveraged vehicle. You would plan for that. You would protect the scheme as best you can. The same is true for ESG factors. That’s the response that you should have.”

As Michael sees it, the trustee is the stakeholder with the longest time horizon in any business. “Shareholders, management, debt providers and staff all might be happy with a company thriving for 10 years before it ultimately runs out of gas. Trustees need that sponsor to be strong into the very long-term. Therefore, you can’t as a trustee only be concerned with near-term risks and maximising income. You must have a view to the very long spread. So not only do you have to worry about that chronic problem I talked about, and encourage management to think through and meet that chronic change, you also need to protect yourself from those short-term acute risks.”

I don’t think there is time to wait. We need to get on with it now.

Short-term risk v. longer term positive

“Let’s take an example. Say you are a pension scheme trustee and your sponsor company makes almond milk. All the almonds grow in southern California. As we all know, right now, southern California is going through a lot of wildfires, heat waves and disruption. There are two risks that you need to think about in terms of climate. One is that your sponsor has a short-term cash drain from having to meet those risks right now: those wildfires, sorting out production, sourcing new supplies of almonds, finding staff who are willing to work in those locations. That’s all the short-term cost. But longer term, there is a trend for alternative drinks such as almond milk – because they’re lower carbon, better for the environment – to be taken up more. So there’s a longer term positive in your sponsor’s business, but short-term risks because of the source of those almonds.”

What would that mean for trustees in practice? Let’s say that you buy into this. You really want to deal with it. So you sit down and talk to the sponsor. What actions would you then take as a trustee in this particular scheme?

Working towards low reliance

“The first step is investigate how the overall business supports your covenant. For example, your almond milk producer is part of a larger group that also produces dairy products, but your covenant is not currently backed by those dairy products since they are in another side of the group. Well, first thing you can do is think whether you can diversify your protection by making sure that you have access to both sides of the sponsoring group. So thinking through, can you somehow use the financial strength of the  wider organisation to help you get through any short-term disruption?”

“Step two is to think about when cash, in terms of sponsor profitability, is available and how you can model the scheme into that cash flow. Another example, for an oil producer, cash might be strong today, but not be so strong in the future. In other words, the long-term prospects are not looking good for this industry. As a trustee,  you’d be thinking: how do I get that cash now? Plan for your journey to a low reliance position, of your sponsor, to be as short as possible. Because over the longer term, your end state needs to reflect the long-term financial prospects of that industry, which are not particularly strong.”

But how do you convince the management of a sponsor like an oil company, which is rich today and poor tomorrow, to actually start contributing today rather than to invest their money in something else?

Interests and levers

“There are two factors at work here. First, it’s in everybody’s interest. Take the oil producer. They have cash now. They may not in the future. That’s not something that only the trustees know. Management know that, too. It’s in their interest to get rid of the volatility and risk in the scheme now, while they have the ability to do it, so that in future they can focus on the business.”

“The second factor is that the trustees have their own levers. They can adjust the risk profile of their investments to match the long-term financial situation of their sponsor.”

Michael believes that there is definitely an increased appetite to understand the ESG risk inherent to employer covenants. “There’s a long journey to go on, trustees have started thinking about ESG in their investments, and the language and concepts used in investing around ESG are not the same as those you would use for employer covenants. But I think we’ll get there. It’ll take a bit of time before we, as an industry, understand the problem and how to fix it, and for sponsors’ management teams to come to work with the trustees on fixing it.”

“The point is that trustees are the only stakeholder that can turn to the management of a company and say: you’re not doing enough to deal with your ESG and climate change exposure. That’s a risk to us. We need you to pay us now (through less risk in the scheme and increased contributions), unless you fix it. Fix it or pay us. As perpetual creditors, trustees are the only ones who can do that. No other stakeholder can.”


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