How fiduciaries can get a handle on climate change

In a speech at insurance market Lloyd’s last week, Bank of England governor Mark Carney criticised investor disclosure frameworks and called for a “climate disclosure task force” to improve current practices and help end financial and political short-sightedness.

“The existing surfeit of existing schemes and fragmented disclosures means a risk of getting lost in the right direction,” said Carney.

“With better information as a foundation, we can build a virtuous circle of better understanding of tomorrow’s risks, better pricing for investors, better decisions by policymakers, and a smoother transition to a lower-carbon economy.”

The rise of divestment 

Momentum to ignite change has galvanised the divestment movement over recent months.

Outflows from fossil fuels have grown 50-fold to $2.6tn (£1.7tn) over the past 12 months, according to a new report released by Arabella Advisors last month.

More than 400 institutions and 2,000 individuals, including governments and investors from 43 countries and multiple sectors, have pledged to divest from fossil fuels.

Initiatives are also gaining traction among pension funds. At the beginning of September the California Assembly mandated two of the state’s largest public pension plans – the $292bn (£187bn) California Public Employees’ Retirement System and the $191bn California State Teachers’ Retirement System – to divest from coal.

However, under the bill, CalPERS trustees are not required to divest if doing so is deemed to be inconsistent with the board’s fiduciary duty to members – meaning the fund’s ongoing coal stock holdings will remain intrinsically tied to the scheme’s risk management processes.

How much does the LGPS invest in fossil fuels?

Trustees and scheme managers are duty bound to members to consider all material financial risks, a position at odds with pressure to divest on moral or ethical grounds.

An update from the Department for Work and Pensions expected later this autumn will help firm up trustees’ fiduciary duty with regard to environmental, social and governance factors in new scheme rules.

The first analysis of the fossil fuel holdings across the Local Government Pension Scheme compiled by Fossil Free, 350.org and others, found that more than 6 per cent of the scheme’s £231bn aggregate assets is currently invested in fossil fuel corporations.

The LGPS directly holds £5.5bn in fossil fuel companies, a fifth of which is held in Shell, with a further £8.6bn exposure through funds and pooled vehicles.

The report has sparked a widespread response from climate change campaigners and LGPS members, evidence of rising governance challenges for the LGPS.

The London Borough of Merton Pension Fund and Worcestershire County Council Pension Fund hold the highest percentages relative to total scheme assets, with nearly 11 per cent of each of their total portfolios held in fossil fuel companies.

A spokesperson from Worcestershire County Council Pension Fund said: “Our key aim must be to ensure we can continue to pay pensions as they fall due, thus the obligation of the pension committee is to make investments that provide the appropriate risk-return trade-off.

“Responsible investment factors, such as low carbon, may be relevant as an additional consideration. However, screening out stocks for investment/divestment on ethical grounds only is in conflict with the committee’s fiduciary duty if the decision risks financial detriment to the fund.”

The spokesperson added that the scheme also holds ‘green’ assets in its portfolio, such as infrastructure investments in renewable energy assets.

Greater Manchester Pension Fund and Strathclyde Pension Fund have the two largest fossil fuel holdings in absolute terms, with respective holdings of £1.3bn and £752m.

A spokesperson from Strathclyde Pension Fund, which is a signatory of the Carbon Action initiative, said: “SPF’s main exposure to fossil fuels is through its listed equity portfolios and the value will vary over time, dependent on the decisions made by active managers. However, the £752m figure quoted would represent around 5 per cent of total fund assets; which appears to be slightly lower than average for the sector.”

Investing in low carbon

However Aled Jones, head of responsible investment for the EMEA region at consultancy Mercer, said divestment was not the most effective strategy for schemes to combat climate change.

“A much more positive and probably influential action is to allocate capital in a way that will shift assets towards the low carbon economy, invest in strategies that have a positive approach to things like solutions to climate change and sustainability themed strategies in equities and infrastructure,” said Jones.

A spokesperson from the fund said its committee members backed active investment over divestment and the fund will continue to use its influence as a shareholder.

In June this year, SPF's committee approved an investment of £50m in offshore wind, £30m in onshore wind, £33m in trade finance and £20m in UK private debt.

SPF is also a signatory of Carbon Action, a Carbon Disclosure Project-led initiative which aims to accelerate company action on carbon reduction and energy efficiency activities which deliver a satisfactory investment return.