Trustees should stress-test their portfolios against a range of climate change scenarios, according to provisional guidance launched on Thursday, as pensions minister Guy Opperman warned of consequences for those in dereliction of their duties.
An amendment to the pension schemes bill will give the government the power to mandate disclosure of climate change risks and strategy in line with the Taskforce on Climate-related Financial Disclosures, Mr Opperman confirmed in a speech on Thursday.
In anticipation of this change and in response to other recent legislative developments, the Pensions Climate Risk Industry Group, set up by several government departments and the Pensions Regulator, has issued draft guidance on integrating climate considerations into pension scheme governance and disclosure.
I don’t think anyone’s trying to tell trustees what to invest in. But it is the job of regulators and the industry to provide encouragement and tools to help trustees do their job, and their job is to think about risk
Stuart O’Brien, Sackers
Subject to a consultation that is now open, the guidance is split into three sections, covering the portfolio threats posed by climate change and corresponding regulation, how trustees can embed awareness of this into their strategies and disclosure, and technical considerations such as how to stress-test their portfolios and sponsor covenants.
Covering the TCFD’s requirements for metrics and targets, risk management, strategy and governance, the guidance suggests that eventually detailed stress-testing exercises should inform changes to schemes’ strategic asset allocation.
However, the document’s authors recognised that many boards are only just beginning to think seriously about climate change, recommending that schemes start by writing down investment beliefs, such as the extent to which market prices currently reflect climate risk, and their views on whether engagement is more effective than divestment.
Minister repeats threats
The launch of the guidance and accompanying speech by Mr Opperman, at the Pensions and Lifetime Savings Association’s Edinburgh investment conference, was met with a crotchety response from some.
One trustee in the audience reportedly asked the minister if the government was telling them how to do their job as an investor, eliciting an equally sharp response from Mr Opperman that those not adequately considering climate change as a risk are in dereliction of their duties.
In his earlier speech, the minister called climate change “the defining issue of the 21st century”, adding: “On this issue I am unquestionably in a hurry. I’m expecting the regulator to take decisive action.”
A consultation planned for early summer will ask which schemes should be the first to see TCFD reporting phased in. Mr Opperman said he is also interested in reporting against the goals of the Paris Agreements on climate change as a next step.
He said trustees should expect detailed analysis of risk exposures, free of greenwashing, from their managers, adding: “If you’re not getting those, in my view you should dismiss them and move on to someone else.”
Three key scenarios to analyse
The PCRIG’s guidance strikes a less confrontational tone, presenting research into the possible impacts of climate change on asset values, and on covenants – suggesting that defined benefit trustees with sponsors exposed to the transition to a green economy may want to consider speeding up recovery plans.
It presents a range of options to trustees, including whether to report in a standalone TCFD report, in the scheme’s annual report, in the chair’s statement, or in another member communication.
“I don’t think anyone’s trying to tell trustees what to invest in. But it is the job of regulators and the industry to to provide encouragement and tools to help trustees do their job, and their job is to think about risk,” said Stuart O’Brien, partner at Sackers and chair of the PCRIG.
“We’re trying to move the conversation along, we’re trying to bang the drum a bit so that products develop, and we’re trying to help trustees meet an existing duty and get ahead of regulation.”
Source: Lloyds Banking Group/PCRIG
Mr O’Brien continued: “It’s about recognising that trustees have an age-old duty of responsibility and prudence, and this is some guidance to do that.”
A core part of the guidance focuses on scenario analysis, which should eventually inform investment strategy, manager selection, review and monitoring.
The guidance does not stipulate whether initial attempts should be qualitative or quantitative, whether it should be top-down or bottom-up, or whether trustees should commission analysis from managers and advisers instead of using free tools provided by the Bank of England and others.
But it does recommend addressing three types of economic transition in response to climate change: an orderly transition where government acts quickly and steadily; a disorderly transition where governments are slow to act and then suddenly tighten policy; and a scenario where governments fail to respond and climate begins a pathway to four degrees above pre-industrial levels.
Some large schemes like those sponsored by Lloyds Banking Group have undertaken detailed portfolio analysis, examining the probable behaviour of different assets.
According to Mr O’Brien, most trustees who have begun this analysis are still in the very early stages, but he stressed that even mature DB scheme should pay it at least some thought: “The important thing is they just do it and try to do it.”
Guidance welcomed
The guidance was unsurprisingly welcomed by climate campaigners. Peter Uhlenbruch, joint head of financial sector research and standards at ShareAction, who sits on the PCRIG, said: “We expect this guidance to deliver tremendous practical value to UK trust-based schemes, many of whom, according to our own research, remain at early stages of managing climate-related risks and opportunities.
“Future-proofing the billions of funds managed by these trustees against the unprecedented climate-related challenges that lie ahead is an enormous task, one that we hope this guidance will offer invaluable support. Now there’s really no excuse for dallying,” he added.
Regulator’s ESG letter ‘as vague as trustees’ statements’
The Pensions Regulator’s response to schemes not publishing newly required statements of investment principles has been lambasted by the non-profit that first uncovered the extent of non-compliance.
But the development was also welcomed by consultants. Kate Brett, European head of responsible investment at Mercer, said trustees “should start getting the wheels in motion now by understanding where their exposure to climate-related financial risks lie through climate scenario analysis and stress-testing”.
“Climate risk is the topic of the decade, and that’s true too for pension scheme trustees. We are already very much aligned with the thrust of the PCIRG consultation,” echoed Pete Smith, principal at Barnett Waddingham.
