An initiative to probe schemes on legal duties regarding climate change risks has caused quite a stir in the industry. Stephanie Baxter asks if trustees should be concerned?
At a glance
- The Climate and Pensions Legal Initiative was launched following concerns many funds are failing to take steps to assess and mitigate risks posed by climate change
- It will check schemes are fulfilling legal duties to protect investments from these risks. Industry participants say it is misleading and are heavily sceptical however
Pension schemes around the world are being called up on their investments in companies exposed to financial risks from climate change. Some are facing demands from members to divest from oil and tobacco while others are criticised for failing to mitigate these risks.
A stir has been caused by an initiative to check UK schemes are fulfilling their legal duties to protect investments from climate change risks following concerns "many funds" are not. Non-governmental organisations (NGOs) ClientEarth and the Asset Owners Disclosure Project (AODP), which launched the project, said it could result in a legal test case if funds fall below required standards.
What are trustees' legal duties?
Norton Rose Fulbright senior knowledge lawyer Lesley Harrold says it is "misleading" to say trustees have legal duties to assess financial risks from climate change specifically. Schemes do have a legal duty to assess and manage financial factors that are relevant to their investment duty of balancing returns against risk.
But she says: "There are no legal duties for trustees to take into account climate change; it's just interpreting what the Law Commission said. What is ethical to one person is not necessarily ethical to another - so it's a very subjective consideration."
The NGOs took their interpretation from the Law Commission's review of fiduciary duty where it said trustees should take ethical, social and governance (ESG) issues into account where they are "financially material". It said it was the "trustees' discretion, acting on proper advice, to evaluate which risks are material and how to take them into account".
Also, the commission pointed out the ESG label was "ill-defined", covering a wide variety of risks and factors and that trustees should instead consider risks in terms of financial and non-financial. A consultation on the recommendations finished in April and the government will publish its response later this year.
BESTrustees chairman Alan Pickering is concerned about the increasing pressures on trustees: "It makes me quite angry when people say trustees should do this in corporate governance, and do that in terms of protection from environmental issues. Our job as DB [defined benefit] trustees is to ensure pension promises are kept and in DC [defined contribution] that members prosper despite having to shoulder risks their predecessors never had to."
He says being a trustee is "difficult enough" and that his approach to investment is "if it's legal, it's investible.
"As a trustee I'm concerned that everybody with a view on how they want the world to change wants trustees to be the advanced vanguards of their particular revolution. Even though that revolution might be a good one rather than an insurgency one, it really is placing trustees in an invidious position if we're expecting them to take the lead in these areas."
Challenging to assess risks
Assessing financial risks posed by future climate change and whether they are material is no easy task, partly because a lot of companies still aren't transparent enough. This is changing at some companies, however.
BP must now increase disclosures on such risks after a resolution brought by a group of institutional funds (and supported by the firm) was backed by 98% of its shareholders. Similar resolutions brought against Shell and Statoil will be voted on in May. The fact that many of those shareholders are UK schemes indicates some are trying to assess these risks.
City Noble director Eamonn O'Connor says if trustees are managing their portfolios effectively they would be aware of all the financial risks from short-term factors to long-term trends and big issues such as climate change-related risks.
A survey by the AODP found many large UK schemes were failing to protect their portfolios from these risks and lagging behind foreign investors while founder Julian Poulter claimed members were frustrated by funds' "lack of response" to the risks.
O'Connor says: "Maybe the point is that trustees do not have enough knowledge of their holdings or there is something wrong in the relationship between trustees and their asset managers? Or maybe something wrong in the ability of trustees to probe, question, understand fully the risks climate change-related or otherwise in their holdings? I don't know the answer."
Making a value judgement
Even if trustees find long-term risks, they would need to judge them against the short-term risks of changing the investment strategy.
O'Connor says: "I suppose it's a value judgement. UK schemes continue to invest in companies that I presume others might see as a very long-term risk such as those in fossil fuel extraction and mining. What are the short-term financial risks of getting out of organisations that are generally paying good dividends and providing cash flow that DB schemes are pleased to have?"
Harrold says a court could potentially view this from the perspective of the judgment in the Merchant Navy Ratings Pension Fund (MNRPF) legal battle which said trustees could also take the employers' interests into account if they think it reasonable, complicating the notion that their primary responsibility is to act in the members' best interests.
"Trustees have huge flexibility in exercising their fiduciary duties regarding investments," she says.
The Law Commission also said trustees could take non-financial ESG considerations into account in their fiduciary duty on condition that most members would share their concerns and did not risk significant financial detriment.
The Universities Superannuation Scheme, the second highest placed scheme in the AODP's ranking, is surveying its members to establish their ethical stance, after coming under pressure from unions and campaigners. But Pickering says none of the schemes he is involved with is actively seeking members' views on ESG issues and that he would have a dialogue with the employer about its views on investment.
He explains: "If I as a DB trustee do something which the employer finds anathema he's going to give me less money than if he's comfortable with what I do with it. I'm not sure if I'd want to do a poll of the members, because if it suggests an investment strategy which is less than optimal, what do I do with it if it ends up giving me less money from the employer than if I'd had a strategy that's optimal from both trustee and employer perspectives."
It is becoming increasingly apparent that trustees may need more guidance. This could be provided by The Pensions Regulator (TPR) which Harrold says would be well-received by trustees given its thorough work on the DB funding code that takes on board how much trustees need to consider.
O'Connor says the regulator could not add much however: "One of two things has to happen to give proper effect to ESG: either make changes to trust law or to the legal structure of pension schemes."
In this week's Pensions Buzz, we want to know whether or not you believe that business facing financial distress should be able to suspend their auto-enrolment contributions to avoid rising costs.
The Pension Protection Fund (PPF) is consulting on proposals to charge a "risk reflective" levy for commercial defined benefit (DB) consolidation vehicles.
The funding gap across FTSE 350 schemes could be slashed by as much as £275bn if schemes look beyond traditional ways of creating value. Victoria Ticha examines how
There will be "many flavours" of defined benefit (DB) consolidators but consolidation will only be the right answer for a minority of schemes, Alan Rubenstein says.