How pension schemes will need to help tackle climate change

By Gareth Jones, Associate Partner

Last Wednesday, the government tabled new legislation that would require pension trustees to take climate change into account when managing their pension schemes assets and investments. This proposed legislation was inserted into the current Pension Schemes Bill (which is currently being debated in Parliament and is expected to become law later this year) and includes a requirement for pension schemes to take the government’s net zero targets into account in their governance arrangements, as well as the Paris Agreement goals of limiting the rise of average global temperatures.

The Pensions Minister, Guy Opperman, has said that trustees will be required to report against the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) – an international framework, originally established by Mark Carney and Michael Bloomberg, which has been designed to establish the metrics by which companies calculate their exposure to climate risk and disclose it to investors. The government has already indicated that listed companies and major asset managers will be required to disclose information in line with TCFD standards by 2022. This new proposed legislation will require pension schemes to incorporate those standards in its governance, with precise details of how they do this due to be set out in guidance published later this year. 

For those following recent developments on ESG investing and green finance, these new legislative requirements are unlikely to be a surprise. Climate change issues have risen up the agenda across the financial services sector over the past few years, given the widespread recognition that it is likely to affect all parts of the economy, especially energy, manufacturing, construction, transport and agriculture. And TCFD standards are increasingly seen as the global standard for measuring climate risks among investors, with major figures such as BlackRock’s CEO Larry Fink committing to these standards and calling for all companies to do the same. 

In addition, pension funds are increasingly viewed as a crucial component in managing the financial risks associated with climate change, given the size and timescale of their investments. Pension funds, naturally, need to consider investments in the long-term and on that timescale, the threat posed by climate change is substantial. All pension schemes are exposed to climate-related risks in one way or another through their assets and investments. These risks can arise from the direct impact of climate change, where rising temperatures, rising sea levels and greater instances of extreme weather is likely to have a devastating impact on certain parts of the world and their economies – or through the transition to a low-carbon economy, which has the potential to make some assets worthless in future, for example, fossil fuel assets such as oil fields or coal power stations (conversely, the transition to a low carbon economy presents a number of opportunities for pension schemes to invest in the technologies of the future). A failure by a pensions scheme to manage these risks would ultimately impact their members’ future retirement income and, in some cases, could result in the scheme’s insolvency.

Such concerns are now part of mainstream debate in financial services, but it is also fair to say that not all pension trustees, especially those managing smaller schemes, currently have the long-term impact of climate change at the front of their minds. In the short term, pension trustees are likely to be more focused on managing the short-term pressures associated with their pension schemes (not least the disruption caused by Covid-19 and the impact of the economic downturn is having on their sponsors, as well as managing the impact of current ultra-low interest rates). These new requirements represent another set of responsibilities placed on pension trustees, who already operate within a highly regulated environment and with a fiduciary duty to deliver the best outcomes for their members. In practical terms, they will mean that pension trustees may have to adapt their investment strategies, how they work with consultants and asset managers and how they report and communicate with their members. 

While this may represent a headache in the short term, in the long term these new requirements – along with new guidance and consistent reporting standards that will accompany them – should help pension trustees better manage the major financial risks associated with climate change and should mean better outcomes for the scheme members. This is also another development that will help make ESG investing and green finance more mainstream and speed up the adoption of TCFD standards across the sector. Asset managers and listed companies, for instance, will now need to demonstrate their climate change credentials to market themselves to pension funds. Importantly, the impact of the measures should extend far beyond pensions and financial services, particularly as they coincide with those looking to ‘build back better' following the pandemic – with the ultimate objective of these measures being to help finance and deliver the green recovery as well as assist in managing the impacts of climate change.