Green groups and pension industry welcome proposed reforms which could help shift investment away from fossil fuels towards low carbon economy
UK pension schemes could be given far stronger incentives to move their money away fossil fuel industries and better account for climate risks under proposed government reforms that are being hailed as a "lightbulb moment" for the sector.
The Department for Work and Pensions (DWP) is seeking views on reforming workplace pension scheme trustees' duties to make sure they consider environmental, social and governance (ESG) risks - including climate change - in their investment decisions.
The proposed changes to pensions law were published yesterday, with the Financial Conduct Authority (FCA) - the UK's top financial regulator - stating that climate risk should be considered as "equally important" as other financial risks such as liquidity and inflation in pension scheme strategies.
Trustees already have an obligation to consider material risks, which should clearly incorporate climate and environmental risks. However, the government has previously admitted there is a "lack of attention and outright misunderstanding" among pension trustees of their fiduciary duty with regards to environmental and climate risk disclosure.
Consequently, green groups yesterday hailed the new proposals as a breakthrough moment for the UK pensions industry, while pensions groups also widely welcomed the proposed reforms.
ClientEarth pensions lawyer Danielle Lawson said the DWP and FCA's announcements showed "climate risk has hit the mainstream" and that the proposals helped bust "a persistent myth in the industry" that environmental risks were not as important as other financial considerations.
"This is a lightbulb moment for UK pensions - the FCA's acknowledgment that financially material climate risks should be incorporated into investment decision-making, as part of pension providers' legal duties, opens the door to a much more in-depth consideration of exposure to climate risk for UK markets and financial institutions generally," she said.
The consultation - entitled Clarifying and Strengthening Trustees' Investment Duties - seeks legislative reforms to encourage greater consideration of long-term financial risks such as climate change and to give more weight to pension scheme members' ethical and environmental concerns.
The draft legislative reforms were first announced in December last year and came in response to the concerns from the Law Commission that there are currently too many barriers to considering ESG and climate issues in pension scheme governance.
Under the new proposals changes to the Occupational Pension Schemes (Investment) Regulations 2005 would require trustees to clearly set out their policies on evaluating long-term investment risks, while making it easier for them to invest members' funds in assets that deliver sustainable market returns.
Trust-based schemes would also have to draft new statements of investment principles (SIPs) before October 2019 outlining how they will evaluate such risks, and would thereafter have to report annually on how they have complied with their SIP and engaged with companies they have invested in.
Head of policy at campaign group ShareAction, Bethan Livesey, said pension funds have for too long disclosed "vague, high-level statements on their approach to ESG factors" while also failing to report on what they were doing to protect members from rising investment risks posed by climate change.
"These regulatory changes will help expose negligence and neglect, and help protect savers from poorly managed risks," she said.
According to the DWP, the timetable for passing the reforms into law is "subject to demands on Parliament's time", but if the draft regulations were to be laid in autumn of this year, DWP "would propose a coming into force date for the first measures of 1 October 2019".
However, the consultation document also states that if the regulations are not laid until early 2019, "most provisions would have a 'coming into force date' of 6 April 2020". The consultation closes on 16 July.
For contract-based schemes meanwhile - which also includes the rapidly growing market for auto-enrolment - the FCA is planning a separate consultation next year with the intention of implementing similar policies.
The UK Sustainable Investment and Finance Association (UKSIF) said the DWP consultation made clear the government expects all trust-based schemes to address ESG risks and to have policies on stewardship, while the FCA language makes also clear this will be expected in contract-based schemes.
Simon Howard, CEO of UKSIF, welcomed the steps outlined by the government and FCA, which he said would help clarify widely recognised confusion among pension schemes over addressing climate change risks.
"By taking these steps the government and FCA are protecting pension savers from serious financial risks, and they are nudging pension schemes towards the opportunities which will arise as the economy takes the necessary steps to adapt to today's environmental, social and governance imperatives," he said. "All schemes, and not just the leaders, will have to recognise the world is changing."
Pensions bodies also welcomed the moves to better address climate risk. Institute and Faculty of Actuaries president, Marjorie Ngwenya, said: "Those individuals who are being automatically enrolled into a pension as they enter the workforce will be saving for decades to come and it is important that their investment managers not only think about financial returns, but also the impact those investments are having on the kind of world we will be living in by the time they come to retire."
The new package of proposals are part of a wider trend that has seen climate risks pushed up the agenda for growing numbers of investors, most notably through last year's publication of climate disclosure guidelines from the Taskforce on Climate-related Financial Disclosures (TCFD).
A host of high profile investors and businesses have pledged to report in line with the TCFD's recommendations on a voluntary basis. However, the latest government proposals provide further evidence that investors can also expect to face growing regulatory pressure as they seek to better respond to climate-related risks.
The pension reforms set out by the government yesterday have certainly been long awaited, and reaction suggests they are that rare thing - a policy welcomed across the board by industry, businesses, and campaign groups alike. If they are enacted quickly, they will no doubt give yet further impetus for pension funds and asset managers to tackle climate risks, ditch high carbon industries, and move more of their money into the low carbon transition.
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