Climate change and pension schemes – where will you start?
Responsible investment
We recently hosted a webinar discussing why and how DB and DC pension schemes should start tackling climate change. Our guest speaker, David Farrar from the Department of Work and Pensions, provided the Government’s perspective, including the background and thinking behind recent proposals.
These include a requirement for pension schemes with over £5bn in assets to monitor and disclose their approach to managing climate risk by 2022 (or those with over £1bn in assets by 2023). David made it clear that this doesn’t come from an expectation that trustees should come to the Government’s rescue and take on the challenge of solving climate change - the aim of the proposals is to ensure trustees manage the financial risks associated with climate change.
Although the new requirements would initially apply to larger schemes, DWP has said they may be extended to smaller schemes in the future. In the meantime, trustees of smaller schemes should also be developing an approach to managing climate risk, in an effort to protect outcomes for members.
Given that climate change is a huge risk (I could say much larger than the risks associated with another issue that’s top of mind, but I’ll leave you to fill in the blank – it starts with “C”), we were interested to see where trustees thought their scheme was in terms of managing this financial risk. So we asked webinar attendees the question…
I was a bit surprised that as many as 10% of respondents hadn’t discussed climate change at all. Trustees of almost all schemes will have needed to consider their stance on financially material considerations in order to include them in their Statement of Investment Principles, and the regulations make it clear that ESG considerations, and climate change in particular, are expected to be included here.
The rest of the poll results were broadly as I expected. As the level of engagement with climate change issues goes up (with lower engagement at the bottom of the chart and higher engagement at the top), the proportion of schemes that it applies to goes down. Although very few schemes appear to have a well-developed approach to climate risk, over 40% said that they have started implementing a plan of action. Not too bad you say… but there are still almost half of schemes where trustees, having discussed climate change, have taken little or no action.
I think it’s unlikely that the trustees have concluded that climate change is not financially material to their scheme in all of these cases. So why is there a mismatch between discussing this risk, and taking action to reduce it?
My sense is that there are a couple of key factors at play here for trustees.
- We’ve got a lot of other urgent actions to consider.
Yes, there is a lot to think about for trustees, and there always seem to be more pressing issues to deal with. But this is a pretty major financial risk that is already starting to materialise, as the effects of climate change seem to be approaching more rapidly than previously expected (amongst other indicators, climate scientists point to the recent wildfires in Australia and the US).
There is also a very human inclination to deal with the “easier” (I use the term loosely in this context) actions first, which brings me to my second point… - This is really difficult. We’ve never had to think about climate risks in this way before. I don’t know where to start.
In the past, this has been the trickier to address, but there is now more guidance and tools available to monitor climate risk, and there are more concrete actions that schemes can take to reduce risk. All of this means that it is now much easier for both larger and smaller schemes to address climate risks in some way.
We have organised the actions that trustees can take into nine key areas, listed in the graph below. We asked the webinar attendees which three of the nine areas they would prioritise in the next six months…
I expected training to be the leader, given this is relatively new for most trustees, and more than half picked this action.
Disclosure (which includes member communication more generally) was last, which may be at least partly due to the fact that this is seen a later action and might not fit within a six-month timeframe.
Climate-aware investments was also relatively low at around 25% - perhaps this is also seen as a later action, although there may also be a perception that this is quite a bold step. I don’t think this is necessarily true, and there are options available that could significantly reduce climate change impact without seeming like a plunge into the unknown, but that’s a topic for another blog (here’s one we made earlier).
For the other actions, there is a more even spread – this may reflect the fact that the immediate actions a scheme takes will depend on the specific considerations of that scheme and where the greatest risk lies. For example, a scheme with a sponsor in the oil industry might prioritise sponsor dialogue more than other schemes that have sponsors that are less directly impacted by climate change.
Time to act
The effects of climate change are already being felt years before they had previously predicted to be. The transition to a lower carbon economy is also happening, and possibly faster than we thought - it’s a question of how, how far and how fast. How this unfolds will impact the magnitude and timing of the associated financial risks, but there is little doubt that they are expected to be hugely significant. I believe we’re overdue bringing this to the top of the to-do list (or at least much further up than it has been).
Which brings us back to my original question - where will you start?
To get some inspiration for how you might answer this question, please see our action plans for trustees of DB and DC schemes and for pension scheme sponsors which provide more detail on the nine action areas above.
And of course, please contact us if you would like to discuss this further.
Action plans:
Download our action plans which outline how schemes and sponsors can address climate change: