DWP presses ahead with TCFD rules in time for COP 26

In his foreword to the consultation response, pensions minister Guy Opperman wrote that the amendments, which include changes to scope and timing of the reporting requirements, as well as to scenario analysis risk management, metrics, targets and penalties, were intended to make sure the added regulatory burden is “reasonable and proportionate whilst still retaining the wider benefits of the measures”.

The new measures, on which the government will legislate “this summer” will see the UK “become the first G7 country in which trustees of pension schemes are statutorily required to consider, assess and report on the financial risks of climate change within their portfolios,” Opperman wrote. 

“By October 2022 we will have captured more than 70 per cent of assets under management, and over 80 per cent of members,” he said.

The first climate risk reports are likely to be a ‘work in progress’ with the first wave acting as guinea pigs, as trustees rise to the challenge and TCFD reports improve and evolve

Kate Smith, Aegon

Trustees should now focus on implementing these “world-leading” measures, he continued.

Schemes with more than £5bn of assets will have to comply with the new rules from October, publishing Taskforce on Climate-related Financial Disclosure reports and including a link to these in their annual report and accounts.

Subject to another consultation, the measures will then expand to include smaller schemes from 2024.

Data gaps and trustee duties

The government’s statutory guidance sets out the duties that will fall on trustees. 

Trustees will be required, “as far as they are able”, to undertake scenario analyses that take into account the potential impact of climate change on the scheme’s assets and liabilities, the resilience of the scheme’s investment strategy and the resilience of any funding strategy.

They will have to collect scope one, scope two and scope three emissions data, and other information relevant to their chosen metrics, which will in turn be used “to identify and assess the climate-related risks and opportunities which are relevant to the scheme”.

The ‘as far as they are able’ condition attached to many trustees’ duties reflects the government’s acknowledgment that there may be gaps in the data they are able to obtain “about their scheme assets for the purposes of carrying out scenario analysis or calculating metrics,” the guidance stated. 

The DWP recognised that there could be challenges in quantifying climate risks in some sovereign bonds, relevant contracts of insurance, asset-backed contribution structures and derivatives, as well as limitations in the scenario analysis of liabilities, funding strategy or the sponsoring employer’s covenant, it added.

Where such gaps do exist, trustees are expected to do their best to fill these, either by finding the data or modelling from existing data, but not if this would incur “disproportionate” costs in time or money.

“If trustees are able to obtain data or analysis in a format which is usable but only at a cost — whether directly or indirectly via liaison with advisers — which they believe to be disproportionate, they may make the decision to treat this data or analysis as unobtainable. A robust justification for doing so should be set out in their TCFD report,” the guidance states.

Kate Smith, head of pensions at Aegon, said: “The first wave of schemes is likely to face significant challenges as not all the jigsaw pieces are currently in place, as the [Financial Conduct Authority] has still to consult on proposals to force investment fund managers to provide the necessary data to trustees.

“The guidance therefore recognises that there may be many data gaps in the first year’s climate risk disclosures, so trustees will be expected to carry out scenario analysis and calculate the metrics ‘as far as they are able’.” 

“The first climate risk reports are likely to be a ‘work in progress’ with the first wave acting as guinea pigs as trustees rise to the challenge and TCFD reports improve and evolve,” she added.

Amendments introduced after industry criticism

A number of changes were made in response to industry criticisms and concerns aired during the consultation.

For example, the government has “refined the definition of a relevant contract of insurance” to change the way bulk annuity contracts interact with the regulations.

The updated guidance specifies that bulk annuity contracts do not require “an exact matching of the cost of benefits”, the “intention to meet costs in all circumstances — only irrespective of future financial market conditions or scheme member longevity”; or the insurer “having unfettered discretion in relation to the investment policy of the assets used to meet its liabilities under the contract”.

Additionally, trustees that are subject to the requirements for part of a scheme year will now only have to produce a report covering that time.

While trustees will still have to undertake scenario analysis in the first year they are subject to the regulations, an amendment means that the triennial cycle will be reset to three years whenever they carry out fresh analysis.

A number of industry experts welcomed the relaxed requirement on scope three emissions reporting, with the government saying trustees will not now have to report these “in the first year that they are subject to the requirements”.

Scope three emissions, also known as value chain emissions, are the result of activities from assets not owned or controlled by the reporting organisation, but which the organisation indirectly impacts in its value chain. These emissions often account for the majority of an organisation’s total greenhouse gas emissions.

The government’s regulations acknowledged that reporting scope three emissions was “likely to be challenging”, hence the easement. 

Trustees should seek to ensure that the emissions of scheme assets are calculated in line with the Greenhouse Gas Protocol methodology. The emissions should then be apportioned using “a consistent approach to allow, so far as possible, for aggregation and comparability across asset classes and funds and between schemes,” the guidance stated.

Simon Jones, head of responsible investment at Hymans Robertson, noted that the “need to disclose more comprehensive emissions data from the second year of the new requirements being in place clearly places the financial services industry on notice that pension funds require this information, but gives additional time for data providers to enhance and finalise their scope three data reporting capabilities”.

Sackers partner Stuart O’Brien told Pensions Expert that scope three reporting was “one of the aspects of the original proposals which many trustees were concerned might be particularly challenging, so an extra year for this will, I’m sure, be welcomed”.

Broader focus welcomed

Jones welcomed the fact that the DWP was treating climate change as “one of many wider environmental, social and governance factors that trustees should be considering within their integrated risk management processes”.

“Whilst climate change is a significant financial risk and clearly warrants significant attention, trustees need to continue to ensure that they address other ESG issues, many of which could be exacerbated by the ongoing impact of climate change,” he said.

The new legislation builds in “a degree of pragmatism and recognition that individual schemes are best placed to assess their own climate positions”, he continued, while the review planned for 2023 will give the DWP “opportunity to reflect on the efficacy of its proposition”.