Pension funds must not ‘sell our future’

In monetary terms, the London School of Economics predicted in 2016 that climate change alone would wipe $2.5tn (£2tn) off global financial assets. Keeping climate change to below 2C would see the value of financial assets falling by $315bn, even when the costs of cutting emissions were included. 

Policymakers are responding domestically and internationally. As if stung into action by 16-year-old schoolgirl Greta Thunberg taking to task the entire political class for “selling our future”, the British government has now enshrined a 2050 net zero emissions goal in legislation.

As regulations are defined, pension funds are essentially self-assessing what ESG factors are financially material to them, and do not necessarily have the information or capacity to respond

However, despite the many positive signs, the overarching question remains: are we collectively acting fast enough before we run out of time?

Regulators step up

Since Bank of England governor Mark Carney spoke four years ago about the threat that climate change poses to financial stability, the context for financial policymakers and regulators has been changing. There is now widespread recognition that institutional investors are crucial to managing the transition. In response, policymakers and regulators are starting to introduce tighter frameworks in which pension funds need to operate. 

All local government pension schemes are now required to address longer-term financial risks arising from environmental, social and governance factors in their investment strategy statements. Likewise, trustees of private sector occupational schemes must now explain how “financially material” ESG considerations, including climate change, are taken into account in their scheme’s statement of investment principles by October this year.

The Pensions Regulator has indicated possible sanctions for pension funds that do not comply with these regulations. 

This strengthening of the regulatory framework, carrying direct implications for pension funds, is being reinforced by the broader measures on the agenda led by western European financial policymakers. The central banks’ Network for Greening the Financial System, the European Commission’s Sustainable Finance Action Plan, and the ongoing work of the Task Force on Climate-related Financial Disclosures are all contributing to a more robust enabling environment for investors to address climate change.

Pension fund action – the state of play 

Pension funds are both highly exposed to the risks of an unsustainable future and in a strong position to influence, and benefit from, a more sustainable outcome.  

There are, encouragingly, a growing number of examples of pension funds now taking action. Some funds are taking steps to understand their ESG impacts, for example, by seeking to align the effect of investment portfolios with the UN’s Sustainable Development Goals.

Others are taking steps to adjust investments through the introduction of low-carbon funds, or by building sustainability into their investment mandates with asset managers.

We are still, however, far from a situation where all pension funds act systematically and at scale to influence sustainable investments, as last year’s Environmental Audit Committee exercise with top UK corporate pension funds demonstrated.

In particular, many funds still believe that their fiduciary duty is simply to maximise risk-adjusted returns and do not see the management of ESG risks as integral to this – still regarding sustainability as an ethical issue.

Asset managers can compound this problem by making ESG an ‘optional extra’ that has to be specifically built into a mandate, rather than adopted as business as usual. 

There is also a question mark about who defines what is financially material. As regulations are defined, pension funds are essentially self-assessing what ESG factors are financially material to them, and do not necessarily have the information or capacity to respond.

What needs to be done?

In order to protect their beneficiaries as well as the world that their beneficiaries will be living in, pension funds need to find a way to keep up with the pace of change. Their approaches should include:

• Supporting regulators to put in place a framework that enables climate and other ESG risks to be managed effectively, and backing innovative and ambitious policy action. 

• Recognising that responding to the climate emergency involves investment opportunities as well as risks.

• Leading from the top, with board chairs and their trustees setting the direction within their funds and across the investment chain.

• Asking tough questions of asset managers and investment consultants, building ESG requirements and metrics into their instructions.

• Engaging with their beneficiaries, who increasingly want to know where their money is being invested.

• Opening up a frank dialogue with corporate sponsors to align ambitions on addressing climate change. 

Bringing policymakers and pension funds together to bottom out the barriers, work out solutions, and drive systemic change to how ESG considerations are integrated into investments is a critical next step.

It is why A4S, Pensions for Purpose and Sustineri are convening a group of senior representatives from LGPS, corporate pension schemes and the regulatory community – including Parliamentary Under-Secretary of State for Pensions and Financial Inclusion Guy Opperman – on July 1 during London Climate Action Week.

Ultimately, the voluntary approach that financial regulators are pursuing may be inadequate if the institutional investment community and the wider financial ecosystem is to meet the “action yesterday” challenge laid down by Ms Thunberg and her generation. 

Pension funds need to be clear that ESG is a core financial issue that not only sits at the heart of their responsibilities to their beneficiaries, but to the resilience of their own institution.

Kerry Perkins is senior engagement and implementation manager at the Prince’s Accounting for Sustainability Project. Richard Folland is a co-founder and partner of Sustineri.