How do pension schemes meet TCFD obligations?

Across the pensions industry, the focus on climate risk mitigation — and the approach to environmental, social and governance factors more broadly — has ramped up in line with increasing demand from stakeholders and rising regulatory obligations for trustees and fiduciaries of UK schemes.

Speaking at last year’s Pensions and Lifetime Savings Association Annual Conference, Guy Opperman, minister for pensions and financial inclusion, described climate change as “the defining issue of our time”, putting sustainability work firmly front and centre for trustees and scheme boards up and down the country.

Climate change financial risk reporting to become mandatory

It is near inevitable that climate change risk and transition impacts will lead to repricing in financial markets and long-term portfolios

Since October 2019, ESG factors have been in scope to be considered financially material considerations in scheme statements of investment principles.

From October 2021, the bar will be raised again, as trustees of plans with more than £5bn in assets will be required to report on the financial risks of climate change within their portfoliosin line with the recommendations of the Task Force on Climate-related Financial Disclosures.

From October 2022, this requirement will be extended beyond the very largest schemes to all pension funds with more than £1bn in assets. In time, this could also be extended to smaller schemes too.

Across the pensions industry, stakeholders are collaborating in the development of strategies to mitigate climate risk through portfolio construction, risk management, and report progress and positioning to scheme stakeholders.

Climate risk manifests in two ways: physical risk — the first-order risks arising from weather-related events, and transition risk — the risks associated with the transition to a lower-carbon economy.

Physical manifestations of our changing climate give rise to more extreme weather, higher average temperatures, and rising sea levels, all of which drive short and long-term investment implications. 

Advances in climate and data science enable investors to gauge the likely economic impact of climate-related risks on a localised basis and assess the knock-on impacts on portfolios.

The mitigation of physical risks demands action by global governments, regulators and investors, in turn driving ‘transitional’ risks and opportunities across the global economy and markets through increasing regulatory action and technological innovation.

With major transitions reconfiguring entire sectors, from cars to utilities, and technologies transforming global transport networks, infrastructure and the built environment of towns and cities around the world, it is near inevitable that climate change risk and transition impacts will lead to repricing in financial markets and long-term portfolios.

Trustees need to consider climate risk in endgame strategies

Today, many defined benefit schemes are building strategic endgames to delivering pension payments over the next 10, 20 or 30 years, and trustees must factor in both major structural shifts and the more idiosyncratic factors that may impact asset values and, ultimately, threaten the sustainability of pension promises.

As such, it is necessary for schemes to account for both physical and transitional risks in building a holistic picture of their portfolio’s climate risk exposures.

The task of collating information across portfolios and extrapolating climate risk across asset allocation, duration and sector exposures demands complex modelling and data analysis.

Across portfolios, investment and risk managers require climate-adjusted analytics to compare and contrast against standard datasets to support their decision-making.

By bringing together climate science with asset-specific modelling, asset owners can derive a set of climate-adjusted security valuations and risk metrics, which can then instruct ongoing progress towards reducing the carbon intensity of portfolios.

The powerful combination of climate science and asset-specific modelling, coupled with the benefits of delegating responsibility to a fiduciary manager to help manage risks and adjust asset allocation accordingly, can revolutionise the way trustees assess risk across portfolios today — and limit the risks of tomorrow.

Sion Cole is head of UK fiduciary business at BlackRock