Need to know:
- The quickest way to make a difference to a pension scheme is to incorporate climate-friendly investments in the default fund.
- A Department for Work and Pensions (DWP) consultation could make it easier to find environmental, social and governance (ESG) funds with acceptable charges.
- There can be risk and conflict as the pension investment strategy is not controlled by the employer.
Pension schemes will soon have to comply with new reporting requirements on the financial risks of climate change in their portfolios.
The Pensions Regulator (TPR) is demanding that from October trustees of schemes over £5 billion disclose their climate-related risks in line with recommendations set by the Task Force on Climate-related Financial Disclosures (TCFD). This was established by the Financial Stability Board (FSB) in response to the Paris Agreement, which aims to limit global warming to well below two degrees Celsius, compared to pre-industrial levels.
Compliance will be a matter of enhanced governance, designed to ensure that pension trustees do everything possible to protect the long-term returns of savers. However, much more should be done to prioritise environmental, social, and governance (ESG) considerations in investment decisions.
One challenge is that there is no clear terminology. Clare Reilly, chief engagement officer at PensionBee, says: “A ‘green pension’ is a catch-all term. Often it's used interchangeably with ‘responsible’ or ‘sustainable’ investing. Green funds can invest in [organisations] that meet strict criteria, such as being Paris-Aligned, or they can exclude certain industries completely, such as fossil fuels or tobacco.”
“Instead of engaging members using terms like ‘responsible’, ‘sustainable’ or ‘ESG’, we should talk in terms of specifics, for example that members’ money has been used to influence directors at a large oil [firm] to properly consider climate change, or that it has helped reduce emissions,” says Callum Stewart, senior defined contribution (DC) consultant at Hymans Robertson.
Default fund considerations
While, at minimum, workplace pension schemes should offer an ESG fund for self-selection, the quickest way to make a big difference is to incorporate an ESG element into the default arrangement. “There’s an increasing imperative to incorporate ESG considerations into the design and management of default funds,” says Dale Critchley, policy manager (workplace savings and retirement) at Aviva. “In selecting this default fund, the employer should ask their adviser or provider for details of the options available. We expect to invest £10 billion of assets from our auto-enrolment default funds and other policyholder funds into low-carbon strategies by the end of next year.”
Fund charges can be an issue. When PensionBee tried to launch a fossil fuel free plan, for example, it took a year of campaigning before customers had pledged sufficient critical mass for a Legal and General fund to be launched in December 2020 within the current 0.75% charge cap. However, the Department for Work and Pensions (DWP) consulted with the industry in April with a view to bending the charging cap to allow schemes to invest in green energy assets such as windfarms, by smoothing performance fees over five years.
Time for change
“There are already significant examples of pension schemes making a difference: engaging with [organisations] about transitioning their business models or simply stopping poor climate behaviours,” says Joe Dabrowski, deputy director, policy, at the Pensions and Lifetime Savings Association. “Other examples include aligning pension fund investments with the commitments of the Paris Agreement, investing in green businesses and technologies, signing-up to the Climate Action 100+ initiative, signalling their commitment to a strong governance framework while helping to reduce greenhouse gas emissions and provide enhanced disclosure on climate risk and setting specific targets on temperature or fossil fuel investments.”
The governance required to ensure that consideration of climate change is integrated across decision-making is generally underestimated, says Tomi Nummela, Senior Associate, responsible investment and sustainability at Mercer. “Climate change is a significant risk for schemes whatever their size or investment strategy and schemes need to build capacity in this area. The long-term goal towards net zero 2050 needs to be broken down into what [the] path is in terms of carbon emissions, starting with a five-year target.”
However. climate risk can be a difficult issue for employers because direct control over investments rests with the trustees in occupational schemes or master trusts and with the provider in auto-enrolment vehicles.
“It is a good idea for an employer to engage with its pension provider on, say, an annual basis to understand exactly how the provider is approaching climate risk in the context of its investment strategy and also its stewardship and engagement activities,” concludes Carolyn Saunders,head of pensions and long-term savings at Pinsent Masons.
