As the world transitions to a less carbon-centric economy, in this edition of Pensions Watch we focus on the emerging best practice among those pension schemes and asset owner collaborations taking the lead in establishing a road map to net zero.
The increasingly central role of climate risk management1
Pensions Watch has long maintained that successfully running a pension scheme has increasingly become a complex exercise in risk management.2 Central to this exercise and ever more critical to the success of scheme outcomes is managing the Environmental, Social and Governance (ESG) risk factors, particularly the potential physical and transition climate risks, attaching to a scheme's asset holdings.3 After all, a failure to act more decisively in stemming the myriad sources of greenhouse gas (GHG) emissions, curtailing the financing of carbon emitting technologies and in seeking to change industry and individual company behaviours and business models, could result in a deeply impaired economic and financial system. This would, in turn, severely inhibit the ability of asset managers to generate and pension schemes to derive sustainable investment returns and expose schemes to unacceptably high and largely unmanageable risks.4
Read previous Pensions Watch articles by clicking on the links below
Pensions Watch 1, Pensions Watch 2, Pensions Watch 3, Pensions Watch 4, Pensions Watch 5, Pensions Watch 6, Pensions Watch 7, Pensions Watch 8, Pensions Watch 9, Pensions Watch 10, Pensions Watch 11, Pensions Watch 12, Pensions Watch 13, Pensions Watch 14, Pensions Watch 15, Pensions Watch 16, Pensions Watch 17
This post is funded by Columbia Threadneedle Investments
1 This edition of Pensions Watch supplements editions 1, 7 and 16, which also consider aspects of climate change risk management and reporting on climate risk exposures. See: https://www.columbiathreadneedle.co.uk/en/inst/ insights/pensions-watch-november-2020/; https://www.columbiathreadneedle.co.uk/en/inst/insights/pensions-watch-issue-7/; and https://www.columbiathreadneedle.co.uk/en/inst/insights/pensions-watch-issue-16/. For more on the climate challenges faced by pension funds and the potential solutions, see: There is no Planet B: Why climate change risk management is the world's hottest topic and how asset owners and asset managers should be responding. Chris Wagstaff. Columbia Threadneedle Investments. June 2020. See: https://www.columbiathreadneedle.co.uk/en/inst/insights/there-is-no-planet-b/
2 Most textbooks characterise risk as the range of uncertainty surrounding an expectation about a future outcome. Others, the possibility that more things could happen than probably will happen. Indeed, as events rarely unfold in the way we initial expect, while others occasionally catch us off guard by seemingly surfacing from nowhere, it pays to expect the unexpected. Nowhere is this truer than within the world of pension scheme management. This is where the late Donald Rumsfeld's infamous 2002 quote comes in: "There are known, knowns. These are the things that we know. There are the known, unknowns… [the] things that we know we don't know. But there are also unknown, unknowns… the things we don't know we don't know." While ridiculed at the time, Former US Secretary of Defence, Rumsfeld was simply pointing out that while the sources of some risks - the known, unknowns - are known and might even be quantifiable, others - the unknown, unknowns - the bolts from the blue, or Black Swans, cannot always be anticipated, let alone quantified. As pension scheme management is littered with known, unknowns and unknown, unknowns, pension fiduciaries, must ensure that the uncertainties surrounding future outcomes are efficiently managed within acceptable tolerances.
3 For a defined benefit pension scheme, this also extends to the impact on the sponsor covenant and the scheme's liabilities.
4 An alarming, albeit slightly tangential, example of how climate change could turn the world upside down is provided by Bill Gates in his recently published book, How to Avoid a Climate Disaster, in which he writes: "During the age of the dinosaurs, when the average temperature was perhaps 4 degrees Celsius higher than it is today, there were crocodiles living above the Arctic Circle."