A report by Pinsent Masons calls on trustees to be more proactive on the risks posed by climate change, warning it is no longer a 'nice to have'. Stephanie Baxter considers the action points
Climate change risk is a buzzword in pensions right now. Asset managers and service providers have jumped on the bandwagon while MPs are probing the UK's 25 largest schemes on how they deal with such risks.
Last week, Pinsent Masons published a report on how the developing understanding of climate change affects trustees' legal and fiduciary responsibilities.
Managing climate risk in a changing environment also looks at 16 pension funds across the globe that already consider climate change to varying degrees.
Call to action
The law firm's head of pensions and long-term savings Carolyn Saunders says this is a "call to action" as this is "absolutely a trustee issue" and not just a "nice to have".
While there is no explicit legal requirement for trustees to consider climate change, it is part of their fiduciary duty if it poses a material risk to financial performance.
"Trustees have an obligation to assess if climate change is a material risk. There is lots of awareness of it as an issue but less so specifically on what trustees should actually do," she says.
The Department for Work and Pensions (DWP) has pledged to clarify legislation around consideration of these long-term financial risks, and schemes' abilities to consider members' non-financial or ethical concerns, citing "outright misunderstanding" and "confusion" about trustee duties.
The starting point is getting trustees to engage, says Saunders.
"However, it is quite difficult to know how to because there is no easy set of tools to help trustees measure the impact of climate change. The big issue is getting trustees to understand this is something they need to think about because it's no longer an excuse to say 'we haven't thought about it at all'.
"From a legal point of view, it's about the process they go through in taking their decisions. At the moment there's no process as most trustees aren't thinking about this at all."
Trustees should worry not about getting it wrong, but about not doing anything. She warns if trustees do nothing and there is an issue down the road and big loss of value in the investments, they are much more exposed than if they had done something or thought about climate risk exposure.
"Even if trustees ended up in the same investments, and had the same loss of value, the fact they had gone through a process and been advised on it, and thought about the issues, you can't blame them for the decisions they make. You blame trustees for failing to think about the right things when they're taking decisions. We're getting to the point where you increase the risk by being passive," says Saunders.
However, there is a lack of guidance on what taking account of climate change risks actually means in practice. While last year's updated defined benefit (DB) guidance from The Pensions Regulator (TPR) includes a specific reference to climate change as a potential risk for a pension fund, it is just a short statement.
Saunders believes this is why most trustees have not engaged, and would like to see more detailed guidance from TPR.
"The 'how' is still developing undoubtedly, but there are still 'hows' you can do that aren't dependent on tools yet to be developed."
The report helpfully suggests questions for trustees to ask themselves and their investment managers and consultants.
"That's not difficult to do - it's at least a start," says Saunders.
For Church Commissioners for England head of responsible investment Edward Mason, engagement is vital. Scheme looking at this for the first time should first quiz their advisers about it, he says, adding: "Increasingly, we're seeing investment consultants able to give quite sophisticated advice and support on environmental, social and governance (ESG) issues and climate change."
Schemes could look to engage with shareholder initiatives such as the Institutional Investors Group on Climate Change (IIGCC), the report suggests. Merseyside Pension Fund, one of the 16 schemes studied, uses the IIGCC is its primary engagement partner having just started grappling with climate change in meetings.
"Looking at the resources on the IIGCC website is a very easy first port of call," says Mason.
"Membership of the group is an extremely helpful thing for asset owners because it plugs them into the community of European investors that are concerned about climate change as an investment issue. It's a huge repository of resources and good practice, shows how climate change impacts on different asset classes like property and private equity, and what investors can do on collaborative engagement."
Schemes can be involved as much or as little as they like, which makes it ideal for small funds.
What do trustees make of the report's recommendations?
Huw Evans, a trustee executive at BESTrustees who sits on several schemes, finds the questions to ask fund managers useful, but thinks there is a misunderstanding of the role of trustees and how the investment chain works.
"Climate change is a potentially important consideration but most schemes have bigger issues to deal with. The ESG activists have a pretty weak grasp as to what the job of trustee actually entails. When trustees look at risk, they don't look at the risks to humanity, they look at the risks of failing to pay the benefits due.
"The report also envisages trustee involvement in investment decision-making at a lower level than happens in most funds; they're not direct investors to a large extent. For example, trustees may have delegated to a fiduciary manager. The fund management industry can generate as much paper as it likes about ESG but if we can't get a Section 36 advice letter from consultants saying this is an appropriate investment for your fund, then it's not happening."
As most private sector schemes have de-risked away from equities and are close to the end of their journey, they don't have long time horizons. Most of the schemes interviewed in the research are still open and have much longer horizons than most private sector schemes, which are not taking a 100-year view. "Most companies want to be shot of these DB schemes within 10 years through buyout, so that changes the way risks are approached," he says.
Where schemes are heavily invested in bonds and there is a risk of default arising from climate change, then Evans argues that would form part of the fundamental analysis. "The real risk of investing in bonds is default rather than downgrades because you typically bought them for the cash they throw off. If climate change risk is a potential source of underperformance, fund managers should already be thinking pretty hard about that when they start to buy the bond. It's not about trustees interrogating them in-depth."
In fact, there is an argument for more focus on risks of climate change to the employer covenant, which is a "bigger deal", as they "can just trade out of investments if necessary".
"What are the risks to the business of energy costs going through the roof? There are more moving parts than the activists are taking into account," says Evans.
Pinsent Masons' report will help trustees ask the right questions of advisers and managers. But as investment is only one part of the wider picture for schemes, guidance on the risks to covenant would be welcome.
Ross Trustees has secured investment backing from private equity investor LDC, as it prepares to capitalise on growing demand for professional trustee services.
Lee Sanders says the fast and adaptive market response to the crisis of 2020 has shown how much the financial system has improved upon the credit market liquidity issues that were at the heart of the 2008 global financial crisis (GFC).
Defined benefit (DB) schemes that provide GMPs must revisit and, where necessary, top-up historic cash equivalent transfer values (CETVs) that have been calculated on an unequal basis, a landmark court judgment said last week.
The stabilisation of US economic growth amid unprecedented fiscal and monetary stimulus has raised questions about the likelihood of inflation returning. Global Head of Fixed Income, Jim Cielinski, and Global Bonds Portfolio Manager, Andy Mulliner, explain...