The DWP has launched a new consultation, in which it is seeking views on proposals to require trustees of large occupational pension schemes, authorised master trusts and schemes offering collective money purchase benefits to have an effective system of governance, monitoring and risk management relating to climate related risks and opportunities in place from 1 October 2021. This will include the need for schemes to carry out scenario analysis and to select and calculate metrics and set targets for the assessment and management of climate risks and opportunities.
The DWP is also seeking views on whether schemes should report these in line with the Task Force on Climate-related Financial Disclosures’ (TCFD) 11 recommendations, by the end of 2022.
The requirements would initially apply to schemes with more than £1 billion in net assets, authorised masters trusts and schemes offering collective money purchase benefits. However, they may be extended to smaller schemes in the future. Even so, the current proposals would mean more than 75% of pension scheme assets and 80% of pension scheme members in the UK would be in schemes that are subject to these new requirements.
In light of the impact of Covid-19, the DWP has decided to exclude smaller schemes to begin with, and give the largest schemes a minimum of one year to prepare. It is hoped this strikes a balance between giving schemes the opportunity to recover from the disruption caused by Covid-19 whilst recognising that delaying decisive action on climate risk will only expose companies, trustees and pensions savers to potential turbulence in the future.
Whilst these proposals are subject to change, it is unlikely significant amendments will be made. The new requirements will be introduced using new powers which have been inserted into the Pension Schemes Bill (which will enable the DWP to introduce new governance and disclosure requirements for occupational pension schemes in relation to climate-related risks).
It is evident that the DWP is committed to addressing climate-related risk in the context of pensions. The consultation paper makes clear that the DWP sees occupational pension schemes (as significant UK asset owners) having a vital role to play in the energy transition and fight against climate change. Given this clear intent, it is advisable that trustees of schemes that are in scope begin to compare their approach to addressing climate-related risks with these proposed requirements, to determine what changes they will need to make.
The consultation period runs until 7 October 2020 and the implementing regulations are likely to be introduced in the first half of 2021.
Key proposals
The DWP hopes that these mandatory TCFD-aligned disclosures will allow trustees to better demonstrate how consideration of climate-related risks and opportunities is integrated into their scheme’s entire governance and decision-making processes.
The proposals set out numerous actions that trustees will be required to take and reflect the areas covered by the TCFD recommendations - Governance, Strategy (including Scenario Analysis), Risk Management and Metrics & Targets.
Governance activities
Under the DWP’s proposals trustees of in scope schemes would be required to:
- establish and maintain on an ongoing basis oversight of climate-related risks and opportunities, and
- satisfy themselves that persons managing the scheme are assessing and managing climate-related risks and opportunities.
Strategy and scenario analysis
The DWP is also proposing that trustees of in scope schemes will be required to:
- identify, on an ongoing basis, the climate-related risks and opportunities that will have an effect on their scheme's investment and, in the case of defined benefit (DB) schemes, funding strategy, over the short, medium and long term, and
- assess, on an ongoing basis, the impact of the risks and opportunities identified on the scheme’s investment and, in the case of DB schemes, funding strategy.
Statutory guidance will be published covering various matters, including among other things, the levels at which the identification and assessment of risks and opportunities should be carried out and examples of the factors trustees might consider to determine which risks and opportunities could have a material financial impact on their scheme’s investment and, where appropriate, funding strategy which trustees must, therefore, have regard to.
In addition, at least annually, trustees will need to assess and publish the resilience of their scheme’s assets, liabilities and investment strategy and, in the case of DB schemes, funding strategy to climate-related risks in at least two climate-related scenarios, including at least one scenario that represents an eventual global average temperature rise of between 1.5°C and 2°C on pre-industrial levels. As scenario based analysis is considered the most complex part of the TCFD recommendations, the regulations would only require trustees to conduct scenario analysis “as far as they are able to do so”.
Risk management activities
The DWP is also proposing that trustees of in scope schemes would be required to publish how they adopt and maintain, on an ongoing basis, processes for identifying, assessing, managing and integrating climate-related risks into their overall risk management framework.
Metrics and targets
The consultation includes a proposal to require trustees of in scope schemes to select at least one greenhouse gas emissions-based metric and at least one non-emissions-based metric, to set targets annually in relation to at least one of these metrics and to calculate, at least quarterly, the performance of the scheme’s assets against these targets. Trustees will be required to disclose the emissions data the scheme has calculated. Where trustees have only been able to obtain partial or estimated emissions data that does not cover their whole portfolio they will need to explain why this is the case.
The consultation sets out a process that trustees could follow when undertaking this exercise, which involves them:
- selecting the characteristics that they want to quantify (for example, carbon intensity or the percentage of the portfolio in “green” investments)
- obtaining the data on those characteristics, as far as they are able, and
- calculating a metric, of their choosing, to measure or communicate that characteristic using the data they were able to obtain (for example, weighted average carbon intensity).
The DWP goes on to note that, much like scenario analysis, being able to accurately calculate emissions-related metrics for a portfolio is an aspect of the TCFD recommendations that is dependent on data flows and information from other entities such as investee companies. Therefore, once again, the DWP proposes that trustees will only be required to obtain data on the emissions of their various investments "as far as they are able".
Disclosing TCFD reports
The DWP proposes that schemes will be required to:
- Publish their TCFD report – trustees of affected schemes would be required to publish their TCFD report on their scheme’s website, and to require that TCFD reporting is referenced in their scheme’s Annual Report.
- Inform members – members will need to be told via their annual benefit statement that the information has been published and where they can locate it.
- Report to the Pensions Regulator – trustees will be required to provide the Regulator with the address for the website on which they have published their TCFD report via the annual scheme return form. They will also be required to confirm where they have published their Statement of Investment Principles Implementation Statement and the excerpts of the Chair’s Statement that need to be made publically available.
Industry guidance and the Paris Agreement
Trustees will be able to draw on non-statutory guidance from the Pensions Climate Risk Industry Group (PCRIG) to help fulfil these new requirements. The consultation on the PCRIG's draft guidance closed on 2 July 2020, and the final guidance is expected to be published this Autumn.
The proposals set out in the consultation paper do not include a requirement for affected schemes to measure and report the implied temperature rise of their portfolios in line with the Paris Agreement, as further work needs to be done to translate what the Paris Agreement commitments mean for businesses and investors in practice. However, the DWP has said it intends to consult on Paris Agreement alignment in the near future.
Scope and timing
The DWP has set out a proposed timetable for the introduction of these new governance and reporting duties which varies based on a scheme’s size. Under the proposed timetable:
- Trustees of occupational pension schemes with £5 billion or more in net assets would be required to publish a TCFD report in line with the TCFD recommendations within the first 7 months of their first scheme year to end after 1 October 2021 or by 31 December 2022 (at the latest).
- Trustees of occupational pension schemes with £1 billion or more in net assets (but less than £5 billion) would have an additional year to prepare for the measures. Trustees of such schemes would be required to publish a TCFD report within 7 months of their first scheme year to end after 1 October 2022 or by 21 December 2023 (at the latest).
- Trustees of master trust or collective money purchase schemes would be required to publish a TCFD report within the first 7 months of their first scheme year to end after 1 October 2021 or by 31 December 2022 (at the latest).
By the end of 2023, the DWP expects the proposed requirements to cover 367 pension schemes. This represents over 24.5 million members and £1.33 trillion in assets under management. The DWP proposes calculating which schemes meet the asset thresholds by applying an asset test at scheme year ends. Examples of how this would work are set out in the consultation paper.
The DWP intends to carry out a review of the effectiveness of the proposed TCFD aligned reporting and governance measures in 2024 and it will also consider, at that time, whether and, if so, when to extend the measures to schemes with less than £1 billion in net assets (which are not master trusts or schemes offering collective money purchase benefits).
Penalties
The DWP propose a mandatory fine for failure to publish a TCFD report. Penalties for other breaches will be subject to the Pension Regulator’s discretion. For example, the Regulator will be given the power to issue compliance or penalty notices where it deems a scheme’s TCFD report to be inadequate.
The level of the fine will be determined by the Regulator, with a minimum fine of £2,500. The maximum fine will be £5,000 for an individual trustee and £50,000 for a corporate trustee.
In addition, failure to notify members via the Annual Benefit Statement or to include a link to the TCFD report in a scheme’s Annual Report will be subject to the existing penalty regime set out in Regulation 5 of the Disclosure Regulations 2013.
Comment
The proposals outlined in the consultation reflect the DWP’s increasing focus on climate-related risks, and they build on the amendments made to the Pension Schemes Bill. Guy Opperman MP has made clear his view that the industry needs to take ‘urgent action’ to address climate-related risks and that he intends to ‘waste no time' in introducing new measures. Further consultations on additional requirements, including alignment with the Paris Agreement, are expected before implementing regulations are introduced next year.
Whilst the DWP recognise that trustees are still responding to the impact of Covid-19, it considers that now is the time to ‘build back better’ to ensure that pension scheme governance is as robust as possible to withstand the potential shocks that climate change may bring.
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