A Responsible Future. Neil Chapman and Adam Gillett. Life June willistowerswatson.com 2018 Willis Towers Watson. All rights reserved.

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1 A Responsible Future Neil Chapman and Adam Gillett Life June Willis Towers Watson. All rights reserved.

2 Sustainability and ESG considerations are already making the headlines No longer insuring coal companies and will limit its investments in the industry amid mounting pressure from environmental campaigners Allianz Divesting c.$4bn of tobacco stocks AXA, Aviva and SCOR Moved entire 130bn liquid asset portfolio to ESG benchmarks Swiss Re Expanded impact investment portfolio to $5bn in Nov-17 after reaching $2bn in green bonds Zurich Among 9 investors collaborating to implement recommendations from the Taskforce on Climaterelated Financial Disclosures Aviva Under fire for pouring 370m into Polish coal industry - UK insurer accused of undermining international efforts to fight climate change Aviva 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 146

3 and impacting business areas Branding Investment approaches for policyholder funds Staff DB & DC approaches and investment options Customer demand/ product design Corporate and social responsibility 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 147

4 Agenda Evolution of Responsible Investment ( RI ) Supervisory trends RI strategies RI return impact Implementing RI Conclusion 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 148

5 EVOLUTION OF RESPONSIBLE INVESTING Evolution of responsible investment initiatives in the U.K. Hampel Review post Combined Code ISC best Practice Code on Shareholders Rights and Responsibilities Walker Review Corporate Governance UK Banking sector Updated Combined Code, new name UK Corporate Governance Code UK Law Commission Review of Fiduciary Duty in pensions Task Force on Climate-related Financial Disclosures (TCFD) presented Phase I report (scope, high-level objectives and principles of disclosure) to the Financial Stability Board AMNT Red Line Voting initiative Greenbury Report Review director remuneration Cadbury Report Combined Code on Corporate Governance Turnbull Report Review companies internal controls Myners Review UN Principles for Responsible Investment FRC Review of audit committee function Smith Report Independence of auditors UK Stewardship Code for Investors Higgs Report Role and effectiveness of NEDs and audit committee Regulation on Director Remuneration Binding shareholder vote on executive pay Kay Review of UK equity markets and long term decision making UK Investor Forum for collaborative engagement established DWP Consultation on Investment Regulations following Law commission review of fiduciary duty Paris COP21 G195 agreement to reduce carbon emissions and global temperatures to less than +2 C above pre-industrialisation levels Responsible investment goes mainstream: over 1,000 attendees at PRI in Person conference 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 149

6 EVOLUTION OF RESPONSIBLE INVESTING Signing up to UN PRI used to be a good RI credential Background The PRI is a voluntary initiative that was launched in 2006 by a group of 20 of the world s largest institutional investors, coordinated by the UN. The Principles provide a common framework for investors to integrate environmental, social and governance (ESG) considerations into investment decision-making and ownership practices. Principles 1. We will incorporate ESG issues into investment analysis and decision-making processes. 2. We will be active owners and incorporate ESG issues into our ownership policies and practices. 3. We will seek appropriate disclosure on ESG issues by the entities in which we invest. 4. We will promote acceptance and implementation of the Principles within the investment industry. 5. We will work together to enhance our effectiveness in implementing the Principles. 6. We will each report on our activities and progress towards implementing the Principles. ESG integration Stewardship Transparency Promotion Collaboration Reporting 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 150

7 EVOLUTION OF RESPONSIBLE INVESTING but is now the norm for asset managers Asset owners Investment managers Service providers Institutional investors that represent the holders of long term assets e.g. pension funds, endowments and insurance companies Organisations that manage and control investment funds Organisations who have influence over their clients asset holdings e.g. investment consultancies Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr % of signatories are based in the UK 2% are UK asset owners AO AUM ($ US trillion) Assets under management (US$ trillion) Number of AOs Number of Signatories Data as at 10 May 2018; chart as at 30 April Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 151

8 EVOLUTION OF RESPONSIBLE INVESTING However, there is a confusing proliferation of terms and approaches used in the market Approach TRADITIONAL RESPONSIBLE SUSTAINABLE IMPACT DRIVEN PHILANTHROPY Financial goals Finance first Target competitive risk-adjusted financial returns Unchartered returns Impact first Below-market returns Partial capital preservation Complete capital loss Avoid harm and mitigate ESG risks Impact goals Benefit all stakeholders Contribute to solutions Description Examples Global Equity Fund Global Equity Fund Social bond fund SIB Fund Social growth fund Sustainable Development Goal investing 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 152

9 EVOLUTION OF RESPONSIBLE INVESTING ESG issues that investors might take account of Environmental Social Governance Biodiversity Supply chain management Business Ethics Sustainability Board structure Carbon emissions Waste management Extreme weather Local community engagement Inequality Diversity Remuneration Long termism Responsible management Financial crime Climate change Bribery & corruption Green energy 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 153

10 SUPERVISORY TRENDS Supervisory bodies are increasingly focusing on ESG issues and responsibilities FRC are seeking to improve the effectiveness of Section 172 and encourage ESG related disclosure and focus on long term sustainable success and contribution to wider society Pensions Regulator requires DB schemes investment principles to explain the role of ESG in investment decisions FCA & Law Commission are considering what oversight requirements should apply for workplace personal pension schemes including stewardship and sustainability European Commission Action Plan: Financing Sustainable Growth 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 154

11 REGULATORY TRENDS European legislation could be a significant driver of change Classification System for Sustainable Activities Legislative proposal for EU classification system for sustainable activities including taxonomy and tools to allow such classification 6. Clarify Institutional Investors and Asset Managers Duties Clarify duties in relation to sustainability with aim of explicitly requiring institutions to integrate sustainability considerations into decision making process and increase transparency 8. Incorporate Sustainability in Prudential Requirements EIOPA will be invited to provide an opinion on the impact of prudential rules for insurers on sustainable investment with a focus on climate change mitigation 4. Incorporate Sustainability in Financial Advice The Commission will amend MIFID II and IDD delegated acts to ensure sustainability preferences are taken into account 7. Better Integrate Sustainability in Credit Ratings The Commission will explore the merits of amending Credit Rating Agency Regulation to mandate explicitly integrating sustainability factors 10. Foster Sustainable Corporate Governance Assess the possible need to require corporate boards to develop and disclose a sustainability strategy; and investigate evidence of short term pressure from capital markets on decisions 5. Sustainable Benchmarks Adoption of Delegated Acts on transparency of methodologies and features of benchmarks allowing users to assess quality of sustainability benchmarks; harmonisation of low-carbon benchmarks 9. Strengthen Sustainability Disclosure & Accounting Rules Revision of disclosure guidelines including the Non-Financial Information Directive Asset impact of new or revised IFRSs on sustainable investment including the impact of IFRS 9 2. Standards and Labels for Green Products The Commission will specify content of the prospectus for green bond issuance; and explore the use of the Ecolabel framework 3. Foster Investment in Sustainable Projects Actions 4,5,6,8 and 9 have the potential to have a direct impact on insurers and on the shaping of its future products Actions 5 and 6 will potentially impact asset managers Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 155

12 RI STRATEGY RI strategy needs to take account of multiple interconnected considerations Customer demand Actions of existing competitors New entrants/product design Brand/product strategy Delivering the best returns for customers Regulatory requirements Corporate and social responsibility policy 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 156

13 RI STRATEGY The scope to implement RI varies UL investment options actively chosen by policyholders WP and actively managed UL funds Passively managed UL funds Scope for integrating ESG into investment processes 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 157

14 RI STRATEGY Surveys suggest increasing customer interest Source: Morgan Stanley Sustainable Signals Whitepaper 7 Aug 2017 General interest in sustainable investing with Millennial investors twice as likely to invest in companies that target social or environmental outcomes However, the majority of Millennials (63%) expect this to result in lower returns 90% of Millennials would be interested in pursuing sustainable investments if they were an option in their pension plan compared to 72% for the general population Women continue to express a greater interest in sustainable investing 84% compared to 67% for men 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 158

15 RI STRATEGY RI strategies need to reflect RI ambitions and beliefs Brand and product strategy built around being an RI leader Being seen as a RI thought leader and champion Enhanced RI capability and credentials Cutting edge investment approaches and products Strong stewardship and company engagement Just implementing RI within investment processes Leader with high conviction on stewardship and co. engagement RI monitoring and planning to be able to respond to developments Embed ESG in active investment approaches Passive ESG tilted funds where justified Specialist RI investment options where there is customer demand 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 159

16 RI RETURN IMPACT Empirical evidence for ESG While data history is limited and results vary, evidence tends to point towards either a neutral impact or moderate long-term risk adjusted return advantage for approaches which integrate consideration of ESG risks As part of sensible risk management it seems appropriate to implement strategies which consider ESG risks especially if the fee/cost drag is not much higher than alternative approaches While difficult to measure, there is increasing empirical evidence to support the value of stewardship Effective stewardship by asset owners should be encouraged 1. Lower ESG scoring companies tend to provide moderately better risk-adjusted returns over the long term and some evidence for lower credit spreads (fixed income) 2. Governance ( G ) is often found to be the most influential factor 3. Company engagement appears to have a positive impact 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 see slides in supporting material section 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 160

17 RI RETURN IMPACT Empirical evidence can be supportive but not definitive Source: Bloomberg 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 161

18 IMPLEMENTING RI How to integrate sustainability into the investment process 5. Monitoring Monitoring to ensure activities are mission consistent and meeting expectations. Communicate progress to stakeholders Mission and beliefs Select fund positioning articulate mission and beliefs and document in a policy 2. Risk management 4. Implementation 4 2 Develop a risk management process link sustainability themes to long-term risk-return expectations and stress tests Implementation through active ownership and alignment of financial interests towards the long term 3 3. Portfolio construction Portfolio construction accounts for material sustainable risks and opportunities. Identify strategies across asset classes/alpha and beta spectrum 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 162

19 IMPLEMENTING RI What makes a good RI asset manager A key differentiator is how well RI is integrated into existing processes with successful managers having a clear competitive position, including for the stages of adoption, differentiation and organisational context. Aligned to objectives, beliefs and context of asset owner Tailored to investment mandate, asset class and strategy Conscious of evolving market standards, applicable best practices, regulation and industry guidance Leadership from senior company personnel (at group and asset manager level) and key decision makers within a strategy Key pillars of ESG integration and stewardship: Resources including team structures and reporting lines Integrated into investment process, involving investment team Documented policies Voting, including track record and statistics Engagement, including track record and statistics Transparency Alignment Two-way engagement to improve practices over time Promotion of good practices within the organisation and the financial industry 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 163

20 IMPLEMENTING RI If using an external manager there is already a wide range of products and providers Index Providers MSCI MSCI Global ex-controversial Weapons (CW) MSCI Global ex-fossil Fuels MSCI SRI MSCI Global Sustainability MSCI Global Low Carbon MSCI Global Governance Quality MSCI Global Environment MSCI Sustainable Impact Barclays MSCI SRI Barclays MSCI Sustainability Barclays MSCI ESG Weighted Barclays MSCI Green Bonds S&P Global Low Carbon Faith-based Global 1200 ESG Global Clean Energy Global 1200 Carbon Efficient Global 1200 Fossil Fuel Free Long-Term Value Creation Global ESG Sovereign Bond The wide range of funds may indicate product proliferation rather than high conviction innovative solutions. Partly, this mirrors patchy investor demand (often with a relative mindset constraints) in an evolving subject area. It also reflects a weak taxonomy system, and competing or emerging standards. STOXX Global ESG Leaders Global ESG Environmental Leaders Global ESG Governance Leaders Global ESG Social Leaders Global ESG Impact Global Climate Change Leaders FTSE Russell FTSE 4Good FTSE Green Revenues FTSE Environmental Markets FTSE All World ex-fossil Fuels FTSE All World ex-cw Climate Balanced Factor Divest-Invest Developed 200 Traditional Active Managers More focussed on a single topic or issue Jupiter Ecology Wellington Global Impact Impax Environmental Leaders Schroders Climate Change Equity QEP Global ESG Lansdowne Clean Energy Indexation Managers BlackRock Exclusionary Screens Clean Energy Weighted Low Carbon Sustainability Broad Public Equity Impact Renewable Power Green Bonds UBS Climate Aware fund LGIM Future World Fund SSgA REITs ESG World Custom ESG Funds Strategies with a strong focus on RI and ESG in the investment process Comgest Europe Stewart Investors Worldwide Sustainability Global Emerging Markets Asia Pacific First State Stewart Asia Asia Pacific China 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 164

21 IMPLEMENTING RI NEST Case study NEST DC Default Fund Passive World Equity Fund 130m transfer UBS Climate Aware Fund Other asset classes Other asset classes Represents 20% of Developed World Equities and 10% of total holdings Fund aims to deliver returns broadly in line with FTSE Developed Index with TE +/- 0.5% Negative tilt to reduce exposure to heavy greenhouse gas emission and fossil fuels Positive tilt to increase exposure to renewable energy firms meeting 2oC climate change goals Fund pursues a very active climate aware voting and engagement policy with companies 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 165

22 IMPLEMENTING RI HSBC Case study HSBC DC Default Fund LGIM Passive Global Equities c. 1.9bn transfer LGIM Future World Equity Factors Index Fund Other asset classes Other asset classes Targets better risk adjusted returns using a rules based factor approach that reduces climate change risk Traditional market cap tilted using four factors Traditional market cap tilted using 4 factors Value Quality Low volatility Size Negative tilt to worse than average carbon emissions & fossil fuel Positive tilt to revenue generation from the green transition Overarching LGIM pledge to engage with world s largest companies that are required to adapt their business models and drive innovation in order to meet the global climate change goals to accelerate a low carbon economy 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 166

23 IMPLEMENTING RI What good might look like externally This case study was developed based on publicly available information. Unfriend Coal rating AODP rating AA One of the first firms to integrate ESG issues into their decision making across all asset classes. Advocate policy measures that support longer-term, more sustainable capital markets. Published strategy setting out the company s approach for acting on climate-related investment risk over ESG Integration Active Ownership Shaping Markets Global Responsible Investment Team ensures that ESG factors are considered when determining the firm-wide macro outlook ESG heat map supplemented by additional fund manager and analyst briefings Development of bespoke ESG strategies from real estate and infrastructure to structured finance and private corporate debt Investment target of 500m annually in lowcarbon infrastructure m green investments signed 2016 Voted in 4,259 shareholder meetings and withheld support on 26% management proposals in 2016 Member of the Investment Association Remuneration and Share Schemes Committee responsible for the continuous review of executive remuneration Undertook 1,222 company engagements with 872 individual companies in 2016 Focused engagement with 40 companies with >30% business derived from coal mining Published policy document as input into UNFCCC policy discussions at the climate conference COP22 Founding member of a group collaborating to establish the World Benchmarking Alliance, a publically funded, global institution that funds, houses and safeguards the quality of Sustainable Development Goals-related corporate benchmarks Invited to join the EU expert group to develop a comprehensive sustainable finance strategy Unfriend Coal: AODP: The Asset Owner Disclosure Project Index assesses 500 of the world s largest asset owners rating them from AAA to X on how well they are managing climate risk Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 167

24 CONCLUSION Drivers for future development Evolving asset owner practices Brand and profile Industry expectations Risk and returns Licence to operate Regulation Socially conscious consumer management response with key steps being: drivers strategies.these should be used to frame Private markets also offers the opportunity to pursue more niche or targeted Whilst there is arguably little in the way of innovation, strategies including Resilience Bonds have been known to engage interest. 1. Self-understanding 2. Meta-understanding 3. Deliberate and proactive positioning in an expanding domestic and global regulatory framework 2018 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 168