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Climate considerations for pension schemes – the next phase begins…

Pensions & benefits Investment Responsible investment

Last week, the Department for Work and Pensions launched a consultation on climate risk guidance for pension schemes. Developed by an industry group, the guidance outlines the climate-related challenges that pension scheme trustees must address. Having navigated the document’s 100 or so pages (the length alone indicates that this should be taken seriously!), what immediate takeaways are there for trustees?

It has become increasingly clear that the regulator, government and other high-profile organisations and individuals in the financial world (step forward Mark Carney) feel not enough is being done to combat the risks that climate change poses. As significant asset owners, pension scheme trustees are seen as part of the solution; the government’s positioning on this, including plans to introduce regulatory requirements for some pension schemes to address climate change, reinforces this view.

Whether you agree with this view of the role of trustees or not, I think it is clear that fiduciary duty means they can’t duck the issue, and should work to better protect their schemes from the impact of climate change.

What do trustees need to consider?

Although the guidance is currently a draft, with the final version due to be published in autumn following consultation, regulators and government already expect action from trustees on climate change. The draft guidance will help them to get up to speed, and it covers a lot of ground.

First, trustees need to beef up their knowledge and understanding.

The requirement to update scheme SIPs with ESG policies, including climate change, came into force last year. I imagine though that for many trustees, that’s as far as they’ve got. But the guidance makes clear there’s an expectation that trustees will up their knowledge base. For example, if you don’t know what TCFD stands for, you should find out.

With a firmer understanding of these issues, trustees can then put in place a governance framework – the draft suggests this as a priority for even the smallest of schemes, in order to lay the foundation for considering climate-related risks and opportunities in a more structured way.

Of course, trustees don’t face this journey alone. Investment managers should already be considering climate issues on their behalf, helping trustees build up a picture of how climate risks are being managed for their scheme’s assets. Our manager research covers climate-related risks so we can help trustees assess and question their managers’ approaches. We can also help trustees think through the implications of climate change for their strategic asset allocation.

To have a handle on climate risks, you need to measure them. As the saying goes, what gets measured gets managed. So, the guidance expects even trustees of small schemes to monitor climate change metrics such as carbon footprinting, climate change engagement and investment in climate opportunities. In my view, managers need to improve not just their reporting, but also their climate practices. For example, our survey results indicate that around half of managers don’t have a policy for climate change engagement with companies. As trustees demand more, managers will need to respond.

But there’s more – given the cross-cutting nature of climate change risk, trustees will need to consider its impact on sponsor covenant and consider various climate change scenarios to inform investment strategy and funding decisions. These are areas we are developing further; expect to hear more soon.

Assuming the guidance is adopted largely as it stands, this is a step change – from policy statements last year, to implementation, monitoring, measurement and disclosure this year and beyond.

“So, just why do we have to do this?”

That’s a question I often hear when discussing responsible investment with trustees.

I see it differently. Rather than simply view it as yet more guidance to follow, perhaps we should instead be thankful that we’re starting to move from “let’s talk about it” to “let’s actually do something”.

Climate risk – and let’s not forget opportunity – is real. This guidance can help trustees, asset managers and advisers address it, in time reorienting the allocation of capital to those parts of the economy that are more likely to reduce the problem than contribute to it. Successful change can ultimately lead to better outcomes, not just for pension scheme members, but for the broader base of stakeholders as well. Addressing climate change probably seems like quite a challenge for trustees; it probably is. But we are here to help, with practical steps in knowledge-building, governance, analysis and measurement. The aim of all of this is to improve the resilience of scheme assets in the face of climate change, in a way that is consistent with trustees’ fiduciary duty. While the exact approach will vary from scheme to scheme, the direction of travel is clear. Ask your adviser how they can help make sure you don’t take a wrong turning.

For more detail on the content of the consultation paper, refer to our recent News Alert. The full guidance and the quick start guide can be found on the government website.