New industry guidance on climate risks signals direction of travel for pension schemes

The Pensions Climate Risk Industry Group (PCRIG) has launched a consultation on draft guidance aimed at pension scheme trustees to help them assess, manage and report on climate risks using the recommendations from the Task Force on Climate-related Financial Disclosures (TCFD).

Although the guidance is non-statutory it has been developed in collaboration with the DWP and it has the support of the Pensions Minister. Therefore, it should be taken as a clear signal of the direction of travel. The consultation must also be seen in the light of amendments to the Pension Schemes Bill which were recently tabled by the DWP, which would give the Pensions Minister the power to require climate change risk governance and TCFD reporting by pension schemes.

These changes will raise the stakes both in terms of what is expected and also what is required of trustees when it comes to assessing, managing and reporting on climate risk. Therefore, it is important that trustees take this guidance seriously and consider how to respond in the context of their scheme.

Draft guidance

The draft guidance is divided into three parts:

Part 1 sets out why climate risk is a financial risk to pension schemes and looks at trustees' legal obligations and the TCFD recommendations. In doing so, it examines

• the types of climate change related risks and the impact of policy response on schemes,
• the legal requirements on trustees to consider climate change related risks including their fiduciary duties and their statutory obligations (including the impact of the recent amendments to the Pension Schemes Bill which, if passed, will require pension schemes to publish climate change-related risk information as well as requiring schemes to ensure that they have effective governance in place to manage climate change risks), and
• the TCFD’s 11 recommended disclosures issued in June 2017 through which organisations can identify and disclose decision-useful information about material climate-related financial risks and opportunities. They are structured around 4 themes that represent the core elements to how organisations operate: governance, strategy, risk management and metrics and targets.

Part 2 sets out a suggested approach for the integration and disclosure of climate risk within the typical governance and decision-making processes of pension trustee boards, including defining investment beliefs, setting investment strategy, manager selection, and monitoring. In particular, it considers:

• how trustees should define, develop and maintain climate-related investment beliefs which includes also documenting and formalising governance policies and roles in relation to climate change
• how to integrate climate-related risks when setting scheme investment strategies and manager selection, such as how different investments could be affected by the transition to a low carbon economy, or how climate risks may affect different asset classes and sectors
• trustees’ approach to stewardship on climate issues and how they should be clear on how stewardship fits within the scheme’s investment strategy and how it helps them meet their climate-related objectives
• additional points for DB schemes including assessing the impact of climate-related risks on sponsor covenant, questions trustees may wish to raise with sponsors as well as consideration of climate issues in DB scheme funding more generally, and
• methods of reporting and member communication.

Part 3 contains technical details on recommended scenario analysis and metrics that trustees may wish to consider using to record and report their findings. In this Part, the guidance:

• emphasises the importance of scenario analysis a crucial step in trustees meeting their legal duty to manage climate-related risks and a helpful technical for assessing a scheme’s resilience to different future accounts. The TCFD guidance for asset owners, including pension scheme trustees, also requires them to consider how resilient the scheme’s strategies are to a range of climate related scenarios, which illuminate the possible impacts of both transition and physical risks and opportunities
• recommends three scenarios that trustees could use:
  • orderly transition, 2⁰C or lower scenario [significant transition risks, lower physical risks] – emission reductions start now and continue in line with the Paris Agreement
  • abrupt transition, 2⁰C or lower scenario [severe transition risks, lower physical risks] – little climate action in short term, followed by sudden unanticipated tightening as countries rush to get on track, and
  • no transition, pathway to 4⁰C+ scenario [no transition, severe physical risks] – continuation of historic emission trends and failure to transition away from fossil fuels, and
• recommends using weighted average carbon intensity as the leading metric when setting metrics and targets. Other recommended metrics include outcome metrics such as exposure to carbon-related assets, funds invested in low carbon opportunities; and process metrics such as share of board meetings given to climate risk, and shares of portfolio in which climate engagement is carried out, or acceptable quality data has been obtained.

Quick start guide

The guidance is accompanied by a “quick start” guide which sets out five easy steps that trustees can take to get started. These are:

1. Checking they have got the governance and risk management right.
2. Integrating risks and opportunities into investment and funding strategies.
3. Ask consultants and asset managers to demonstrate climate competence.
4. Conduct scenario analysis.
5. Monitor metrics.

Comment

This consultation serves as a further demonstration of how environmental, social and governance issues and, in particular, climate change continue to rise up the agenda for trustee boards, pension providers and asset managers.

The guidance, combined with the proposed amendments to the Pension Schemes Bill (which will require trustees to assess the exposure of their scheme to climate change-related risks and to report on these) will expand the steps trustees are required to take in this area.  It is therefore vital that trustees understand the proposals and decide how best to respond to the consultation.

In light of current events, the date for responding to the consultation has been pushed back from 7 May 2020 to 2 July 2020.

Related posts

DWP raises the stakes on climate change

Practical guide: Pensions and ESG - The evolving legal and regulatory landscape

Video: Pensions and ESG - How are pension funds and asset managers responding?

Recent posts

COVID-19: Pressure points: Key pensions-related guidance (UK)

Supreme Court rules that Morrisons not vicariously liable for 'rogue' employee's data breach

COVID-19: Pressure points: Key actions checklists for trustees and sponsors of DB schemes (UK)

COVID-19: Pressure points: Regulator gives green light for trustees to suspend transfer values and updates guidance on deferring employer pension contributions (UK)