Universities Superannuation Scheme is one of few UK pension funds actively addressing climate change risks. Co-head of responsible investment David Russell tells Stephanie Baxter how to bring the rest of the industry up to speed.
- USS does not believe climate change risks can be ignored just because they’re hard to measure
- USS has made a number of investments in renewable energy and clean technology
- It believes more work is needed to help trustees and pension professionals understand the risks
A recent PP survey showed most of the pensions industry does not believe climate change is a material financial risk to portfolios. Why do you think a lot of people still hold that view?
In the current pension landscape it is not that surprising that environmental issues may not figure highly among pension fund trustees and professionals. There are a great many issues clamouring for their attention and some are more immediately demanding and more easily resolved.
There is also a sense among some that climate change policy is primarily a matter for governments and that trustees and investors cannot and should not be doing the government's job for them. However, we would argue that climate change is a risk, and like any risk, its impact should be assessed and managed.
Climate change risk can be difficult to measure and model - its timing and impact on specific assets is highly uncertain and as mentioned, government policy is not stable in this area, but that does not mean that the risk is any less. Bank of England governor Mark Carney has highlighted climate change as a risk to financial stability, so it is something we should not ignore just because it is difficult.
There is no doubt that more work is needed to help trustees and pension professionals understand what risks climate change poses to their investments.
The standard risk models and stress tests which are conducted to gain comfort on the prudence and appropriateness of asset allocation and portfolio construction do not include a climate change 'shock'. Including this would make the cost comparable to assessing the risk to the pension fund of devaluation in sterling or a stock market correction.
We have modelling and predictions by scientists on the economic impacts of a changing climate if it is not addressed, which could be used as the basis for this. Then, pension funds could make an informed assessment of their ability to provide the returns they need to meet the pension promises made to their members and beneficiaries.
Perhaps the survey results also reflect the wide gap between the views of small to mid-sized schemes, and large pension schemes which have been outspoken on climate change risks. Do you think this is an issue?
While there are a number of small funds which are actively and publicly addressing climate risk, it is undoubtedly true that the larger schemes are more prominent on this topic. The availability of resources and personnel to dedicate to the issue are obvious considerations, as are issues like finding time to discuss climate change in congested board meetings.
But climate change poses as much of a risk to small schemes as it does to large ones. Working in collaboration with groups such as the Institutional Investors Group on Climate Change (IIGCC) and the United Nations supported Principles for Responsible Investment (UNPRI) can help smaller schemes address these resource issues.
How big a financial risk is climate change for a large scheme like Universities Superannuation Scheme (USS)?
As a large investor in global markets and as an owner of a number of real assets such as property and infrastructure, it is clear that we have financial risk associated with climate change, but it is difficult if not impossible to put a precise sterling figure on it.
We actively encourage the companies in which we invest to manage their risk and engage with governments to encourage them to put in place the policies needed to address the risk at a national and supranational level.
USS is part of the group of investors that recently urged for G20 regulation on climate change risk disclosure. What were the reasons for USS's involvement?
Our reasoning ran as follows: In order to address climate change, appropriate climate change related policy needs to be enacted, as without appropriate policy, companies, markets and society will not make the shift required to achieve a low carbon economy within the timescales needed.
For policy change to be really effective a co-ordinated approach between countries to avoid opportunities for regulatory arbitrage is needed. The G20 as the forum for the largest global economies is the best placed vehicle to achieve this.
By working with fellow members of the IIGCC, and peer funds in the other investor groups around the world, we can ensure that the long-term investor voice is heard in these national, regional, and international discussions on the future of climate change policy.
How does USS manage risks associated with climate change and ESG in its investment management approach, and has it undertaken any internal analysis on the impact on its portfolios?
The scheme firmly believes that climate change, just like any other investment risk, needs to be addressed as part of our usual investment activities. Our fiduciary duty is to maximise long-term risk-adjusted returns so we need to assess both risk and reward.
We have undertaken carbon footprints of the public equity portfolio on a number of occasions, and it has always been underexposed to carbon compared to its benchmark. We disclosed the results of the most recent exercise in our 2015-16 annual report which is available on our website.
In addition, we now have an internal system which can provide real-time ESG data directly to public equity portfolio managers which enables them to see where their biggest carbon contributing positions are.
We also assess climate change related risk as part of the due diligence we undertake for investments in our private market portfolios. This includes the infrastructure, property and other direct investments which we make.
The scheme has made a number of investments in renewable energy and clean technology, all of which help address climate change. Our investments in these assets, as with all scheme investments, are driven by our expected returns from such investments.
What needs to happen to bring the rest of the industry up to speed?
There is a critical role here for pension consultants and the representative bodies of the pension sector. Many consultancy firms have specialist responsible investment teams who are experts in climate change related pension risk. But this specialist knowledge seems to stay in these teams, and not get disseminated to trustees and pension funds via the principal pension consultants.
There is also a stronger role here for the representative bodies in the pension sector which could be doing more the raise the profile of the issues, what the risks are and how they can be addressed by their members.
Including climate change as a standard stress test for judging the suitability of the pension fund's asset allocation would definitely bring it more into the mainstream.
Is there a need for a more collective approach among pension funds that brings in small to mid-sized schemes to learn from larger pension funds?
There are collective groups where pension funds of all sizes and nationalities work together to address climate change risk. The IIGCC, which USS set up in 2001, has more than 130 members from across Europe, and actively engages with companies and policy makers to ensure that climate change is addressed.
In addition, the UNPRI provides a collaborative framework to address climate change risk. They provide excellent opportunities for pension funds which lack resources to add their weight to such engagements, helping address climate change risk at the same time as sharing resources and minimising individual fund costs.
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