'A positive start': Government unveils climate risk rules for UK pensions sector

The consultation confirms a "significant portion" of mandatory requirements can be brought forward to 2023. These include a review on reporting requirements being extended to include all schemes, regardless of size, according to the Department for Work and Pensions (DWP).

It said the measures - which mean trustees will be legally required to assess and report on the financial risks of climate change within their portfolios - will "accommodate continued rapid evolution in climate-related modelling, management and reporting".

Under the changes, the government will exercise new climate change risk powers contained within the Pension Schemes Bill, which is soon to become law. It follows proposals unveiled last August to require the 100 largest occupational pension schemes - those with £5bn or more in assets and all authorised master trusts - to publish climate risk disclosures by the end of 2022.

Schemes with more than £5bn in assets and authorised master trusts will, however, now need to have effective governance, strategy, risk management, and accompanying metrics and targets for the assessment and management of climate risks and opportunities in place by October this year.

The requirements laid out in the consultation, which runs until mid-March, place the UK on track to become the first major economy to require climate risks to be specifically considered and then reported by pension schemes.

It also comes ahead of the government's pledge to boost the UK's commitment to global climate initiatives as it prepares to host COP26 in November, as well as wider plans for the economy to be net-zero in 2050.

Writing in October, Pensions Minister Guy Opperman said sustainable pension investments were vital in the government's overarching plans to push the UK to its net zero carbon emissions target.

And, speaking at Professional Pensions' virtual Investment Conference this morning, Opperman said "the most significant barrier that is holding the UK back in that issue is the sheer number of members trapped in inadequate poorly performing schemes".

"We have all been through an incredible journey this year, when there's an opportunity to contribute to a better financial future for ourselves and a better future for the planet," he said. "This challenge demands all of us to take action and that is why I want every market participant to engage constructively with these proposals and these measures to help us shape a policy that delivers the protection for members."

"Climate change is a major systemic financial risk to the long-term sustainability of private pensions, and £2trn in assets under management, all occupational pension schemes, are exposed to this climate related risk. Together, we can build a better, safer pension system," added Opperman.

The measures laid out today were broadly welcomed by environmental groups. Rachel Haworth, UK policy manager at campaign group ShareAction, said the WWP had "broken new and important ground in developing detailed regulations and guidance in this area".

"It is critical for pension funds to take a forward-focused approach to managing climate risk to safeguard both the financial interests of their beneficiaries and the stability of the wider world in which they live," she said. "While the proof of the pudding is in the eating, the proposed regulatory framework and guidance seems well-considered and fit for purpose."

However, Haworth said that while efforts to price in climate-related risks into financial markets were "a positive start", the systemic nature of the risk posed by climate change required broader "economic transformation".

"DWP states that it has explored the methodologies available for measuring the climate impacts of pension fund portfolios but concluded that more work is required before these can be implemented," she explained. "We call on DWP and the pensions industry to accelerate this work in line with the urgency and scale of the climate crisis." 

Pension sector concerns

Within the pensions sector, however, there remain concerns about certain aspects of the new measures laid out today. Opperman told the conference ealier that he recognised there were some "legitimate and constructive concerns" about the incoming risk requirements.

"We sought to amend our policy according to these particular concerns so firstly I decided to simplify requirements on publication timings," he said. "It is vitally important these disclosures are robust and set a possible benchmark for subsequent schemes that later come into scope. I've kept the scope of these requirements the same, but I've authorised master trusts and schemes and assets to be in scope for 2021."

Several other changes have also been made to the original policy proposals. A TCFD report publication deadline of seven months will apply for all relevant schemes from their scheme year-end date.

"This will allow [the] government to identify best practice and, subject to consultation, extend the measures to smaller schemes," Opperman said. "The publication of the government's green finance strategy was a clear signal for larger pension schemes that there will be an ambitious timescale for these regulations coming into force. As such, smaller schemes should also interpret the bringing forward of this review."

Scenario analysis

Trustees must also undertake scenario analysis in the first year and every three years thereafter. In other years they must review whether analysis needs to be reconsidered and justify to The Pensions Regulator if no changes are made.

"We see a strong possibility that in practice, at least initially, trustees will need to do scenario analysis more frequently than every three years," Opperman said.

Deputy director for policy at the Pensions and Lifetime Savings Association (PLSA), Joe Dabrowski, said the expected time frame "strikes the right balance between encouraging trustees to understand, report and address the risks in their portfolios", without making the requirements too burdensome.

Opperman labelled scenario analysis as "one of the most complex and costly sections of TCFD", with the consultation also noting trustees are not expected to spend "disproportionate amounts of time attempting to fill non-material data gaps" in relation to firms which are unlikely to contribute to the level of climate-related risk faced.

Trustees must instead focus on carrying out scenario analysis using an ‘as far as they are able' approach.

The consultation states: "This means taking all such steps as are reasonable and proportionate in the particular circumstances taking into account the costs, or likely costs, which will be incurred by scheme and the time required to be spent by the trustees or people acting on their behalf."

But Opperman warned that changes were "not an invitation for trustees to do scenario analysis and then forget about it".

Despite some concerns, the government confirmed it will continue with its proposal to include consideration of the covenant as part of trustees' assessment of their funding strategy.

Stuart O'Brien, a partner at specialist pensions law firm Sackers, said: "The statutory guidance sets clear expectations that for defined benefit (DB) schemes, scenario analysis will need to cover not just the assets, but also sponsor covenant and the potential implications of different climate scenarios on actuarial assumptions. This will likely be new territory for lots of schemes. Schemes with DB and defined contribution (DC) sections will need to do scenario analysis separately for their DB section and the DC default fund."

Lincoln Pensions managing director Michael Bushnell added: "The recognition by the Department for Work and Pensions that trustees should consider how it will impact their covenant is an important development. Although trustees have rightly raised concerns about additional costs, the covenant is a scheme's most material asset, so understanding it should be the focus of any pension strategy.

"By considering potential climate change scenarios, trustees can understand their covenant climate change risk and reflect it in their funding and investment arrangements."

Metrics update

The changes will also mean trustees must now select a minimum of two emissions-based metrics, one of which must be an absolute measure of emissions and one which must be an intensity-based measure of emissions, as well as one additional climate-related metric.

Trustees will be required, again as far as they are able, to obtain the data required to calculate their chosen metrics yearly, rather than the previous proposal of quarterly.

Performance against targets will also now be measured annually rather than quarterly.

"We've also provided an annual review of any targets to determine whether they should be maintained or replaced," Opperman said. "Trustees must recognise the methodologies and data are evolving rapidly and recognise the value in schemes regularly updating their calculations to ensure consistency and attention to risks and opportunities, and the government has recognised the evolution in the space that we're dealing with."

O'Brien said this requirement would likely be "one of the harder aspects of the regulations for trustees to get to grips with".

"Trustees will need to think hard about how the targets they set align with their fiduciary duties and what is in the best financial interest of their scheme members," he continued.

A trustee learning curve

The consultation has also noted a new requirement that trustees must have an appropriate degree of "knowledge and understanding" of the principles relating to climate change risks and opportunities."

But it also outlined the government's recognition that some trustees' knowledge of climate change and TCFD recommendations is "low at the present stage".

"The policy intent here is that trustees understand the outputs of activities such as conducting scenario analysis and calculating emissions-based metrics and can incorporate such activities into their new climate change risk management processes," the consultation stated.

"We are not proposing to require that trustees must be experts on climate change or its financial implications, but they must have sufficient expertise to allow them to properly exercise governance over the risks and opportunities it presents. We are not requiring that trustees are able to carry out highly technical climate risk assessments themselves, but they need to understand the principles of the activities sufficiently to be able to commission them, interpret them and act on them."

O'Brien said: "In my view this just reflects the reality that you need a base level of knowledge to properly consider the financial implications of climate change on a pension scheme and to fulfil your fiduciary duties. That this is now enshrined in legislation though is quite symbolic."

Responses to the consultation will close on 10 March.

 

A version of this article originally appeared at Professional Pensions