Systemic issues won't be addressed until regulator thinks systemically

Now, it is nothing new to describe climate change as a systemic risk, and it is right for the regulator to raise it as something trustees should consider. But it is now time for the regulator to show that it too is thinking systemically about climate change.

Schemes are already expected to have policies on climate change and other financially material environmental, social and governance risks and many schemes will need to report on their implementation.

The current policy approach to climate change is, therefore, to ask trustees to think about the risk it poses to their scheme and to mitigate this risk. 

A truly systemic approach from the regulator would recognise the dependencies across the pensions sector and look at how all schemes are contributing to systemic risks

Trustees can decide ‘to do nothing’

But this is an approach that permits trustees to make the assessment that their scheme’s asset mix or its funding position are not particularly threatened by climate change and to do nothing.

There could even be schemes with similar exposure to climate change, but whose trustees have made a different assessment of risk or feel less compelled to act.

And doing nothing will mean not undertaking stewardship of high-carbon companies and not talking to asset managers about climate change. 

However, this inaction will impact on the situation faced by other pension schemes, whether they are schemes with longer time horizons or with sponsoring employers more exposed to climate change.

We therefore have the undesirable situation where some schemes may have to work harder to address greater risks from climate change because their peers can, quite legitimately within the existing law, decide to do nothing.

This is the case, even though in some asset classes, for at least some of the time, they may be invested in the same things.

TPR should address sector as a whole

A truly systemic approach from the regulator would recognise the dependencies across the pensions sector and look at how all schemes are contributing to systemic risks.

There are parallels here with financial regulators that have objectives around market competitiveness — they take responsibility for the integrity of the sector as a whole.

Furthermore, climate change is not the only systemic ESG risk in town. Most notably, the Dasgupta Review examined the economics of biodiversity and the large-scale risks that biodiversity loss poses across society and the economy.

There is talk of a need for nature-related disclosures, along the lines of the climate-related disclosures the Department for Work and Pensions will soon require occupational pension schemes to make.

But we cannot just keep tacking on endless categories of disclosures, to do so would be intensive at a regulatory level and vastly increase complexity for schemes.

The government has just updated the regulatory remits for the Prudential Regulation Committee and the Financial Conduct Authority to include climate change. Would a parallel solution for TPR be a new regulatory objective of managing systemic ESG risk across the sector?

In practice, this could mean providing things like sector-wide resources and data on ESG risks for schemes to use in their own assessments.

Finally, TPR needs resources to invest in ESG expertise, particularly in its supervisory capacity.

This does not mean that it should issue more penalties — it may be more effective to work with trustees to identify the gaps in their knowledge, policies and practices.

Indeed, a regulator that is quick to issue fines may only encourage more box-ticking and a heavier reliance on consultants.

But a regulator that demonstrates it will take climate change, and other systemic ESG factors, seriously and that it wants to drive better practice across the sector could be a powerful force for change. 

Bethan Livesey is director of policy at ShareAction