Climate risk can sometimes feel like a dark shadow looming over a pension scheme. It’s not fully discernible, but you know it’s there, and you have a nagging feeling that it’s something you should be dealing with… but how? And what if you’d also like to leverage your influence as an asset owner to have an impact on climate change? Whether it’s climate risk, climate impact or both that have been playing on your mind, there is now a good amount of experience from early movers which can help shape the next steps for those who are looking to move ahead on their climate journey.
In our previous article: Navigating climate risks: A perspective on trustee fiduciary duty in UK pension schemes, we explored how trustees might think about managing climate risk and, where appropriate, have a positive impact on climate change through the lens of their fiduciary duty. One of the challenges we raised was the need for further guidance for trustees in relation to exercising their fiduciary duty. Specifically, in the context of choosing investments that could have a positive climate impact but potentially a lower expected return compared to alternative investments. We hope that the new government continues the existing Department for Work and Pensions (DWP) plans for roundtables to give more guidance to trustees in this key area.
While we’re expecting further guidance to come on fiduciary duty, many schemes have felt able to take tangible steps already. The Pensions Regulator (TPR) highlighted examples of ways schemes were addressing climate risks in its second review of climate-related disclosure reports (sometimes known as Task Force on Climate-related Financial Disclosures (TCFD) reports)[1], a requirement for the largest pension schemes in the UK.
In this article, we explore some of the practical actions that trustee boards can take as they navigate their climate journeys. These actions can be applied to all pension schemes, irrespective of size.
01
Climate destabilisation is a key systemic risk for society that presents significant risks and opportunities to pension schemes. According to the DWP “…as trustees are ultimately responsible for identifying, assessing and managing climate-related risks the scheme is exposed to, they should have sufficient knowledge and understanding to understand the results of any analysis and know-how to take action in light of these results, or indeed to challenge assumptions, external advice and information.”[2]
Climate change is a broad and complex issue with many of the main concepts often overlooked in popular media reporting of the issue. As a result, a lot of trustees may feel they lack sufficient knowledge in this new and challenging area. A thorough grounding in climate fundamentals is, in our view, vitally important for pension scheme trustees as they progress on their climate journey. Finding a pension scheme-specific climate fundamentals course is surprisingly tricky, which is why WTW has created one. Our course can be flexed, both in terms of length and content, to fit the needs of different trustee groups or individuals. Further information can be found on the course registration page. The course has already been successfully run for a major firm of Independent Professional Trustees.
02
Our first article explained the importance of being clear about your ambitions in relation to both: (1) climate risk; and (2) climate impact. These points are often conflated which can lead to confusion when trying to navigate the tricky waters of fiduciary duty. Having a clear perspective on where the trustee’s views lie on each topic in isolation will help to steer future investment strategy decisions. We find that a discussion around the spectrum of positions in figure 1 is a useful way to explore the perspectives of the trustee board and, importantly, ensure that everyone is clear on what they mean when they say they are taking climate into account in the strategy.
This is perhaps particularly interesting for those considering ‘uses of surplus’ for schemes with strong funding positions, and therefore have a high likelihood of benefits being paid when due.
Narrow mission
Pay benefits as they fall due
Member mission
Maximise the value of members' benefits
Wider mission
A £ of pension is worth more in a world worth living in
03
TPR’s General Code presents a good opportunity for trustees to think about how climate risks are considered. Many larger schemes will already be doing this in the context of their climate-related disclosures but the General Code now extends these considerations to smaller schemes – it requires consideration of risks such as climate change by the newly required Risk Management Function. However, this is easier said than done, especially given the systematic and complex nature of climate risk.
In a future article, we will consider the ways trustees can engage with complex risks like climate in the context of the risk management activities envisaged by the Code.
04
We have already seen a lot of movement from our client base, with many actively thinking about climate when considering their pension scheme’s investment strategy.
One recent example saw a trustee board undertaking a detailed review of its global equity portfolio, including reviewing the portfolio’s climate exposures and the managers’ approaches to stewardship activities. The trustees identified high negative exposure in the portfolio to a plausible climate transition scenario that aligns to the Paris Agreement. The trustees also observed a perceived lack of engagement on climate stewardship issues by some of the appointed asset managers. Considering all available information and analysis, the trustees decided to remove an active manager and change the index underlying their passive equity strategy such that it would increase their exposure to companies that would be positively impacted by a climate transition aligned with the Paris Agreement.
05
While an investment strategy change was the right solution in the previous case, an increased focus on stewardship may be a better fit for others.
Another recent example saw us working with a small defined benefit (DB) client to establish stewardship priorities to help them take more active ownership and engagement in the process of monitoring their investment managers’ stewardship activities. It was identified that the current process of managers self-reporting with huge quantities of data was unhelpful for the trustee to properly assess these activities. We therefore worked with the trustee and created a dashboard to identify key stewardship priorities to focus on as part of the reporting process, which was facilitated by training on the topic, discussions on possible priorities and a survey of the trustees to establish consensus views.
Having identified their stewardship focus areas to be climate change, biodiversity and human rights, the trustee turned its attention to how these might enhance their monitoring. The trustee’s investment managers were asked to present on work they are undertaking to address the trustee's priorities and their key exposures (using a variety of metrics), and how they are using engagement to encourage improvements where they have greater exposure. It has also enabled the trustee to request specific voting information on companies with the highest exposures to understand whether the managers are using the trustee’s rights to encourage positive improvements: a great way to check whether managers are living up to their policies in practice.
06
In both of its reviews of climate-related disclosures, TPR encouraged trustees to prepare climate action plans. The points above could all usefully form a starting point for such a plan which we expect would include actions across the full breadth of climate change impacts from investment to funding, covenant, member engagement and governance. Having all climate actions summarised in one place will provide trustees with a useful document that can be easily reviewed as part of any regular trustee meetings. This document may also be a helpful reference point for those schemes that need to prepare climate-related disclosures.
The impacts of climate change are wide-reaching and complex, and it can make understanding and managing the impact of climate risk on a pension scheme a daunting task. It can therefore be helpful to follow a structured approach like we’ve set out in this article. In-depth climate training will also provide a solid understanding of the challenges and opportunities that climate change poses. Together, we believe that these actions can push back the dark clouds and illuminate your path toward climate action. In our next article, we will cover the governance challenges of managing climate risk, so look out for that release shortly.
