Horizon planning: Are UK pensions finally set for a climate-friendly shake-up?

Government today unveiled a raft of regulatory changes designed to shore up pensions investments in the face of looming climate change and low carbon transition threats. 

But ministers have refused to go as far as forcing all large investors and businesses to report on climate risk, sparking disappointment from MPs and industry groups. 

The government today confirmed a range of actions it is undertaking alongside regulators to clarify fiduciary duties for pension managers with regards to the risks and opportunities posed by climate change. It stressed that it views green finance as a "key priority" for delivering clean growth and transitioning to a low carbon economy.

Many of the actions were recommended by MPs on the Environmental Audit Committee (EAC) over the summer, and have been broadly welcomed by businesses, the pensions industry and climate campaigners, who cite the need to guard against climate risk while also unlocking greater investment in UK's green economy.

Mary Creagh MP, chair of the EAC, said the changes would help shift short-term decision making in the UK's financial sector, which tends to favour high carbon industries. "Structural incentives across the investment chain encourage a short-term focus which tends to neglect longer-term considerations like sustainability," she said. "We are pleased that the government and regulators are acting on our recommendations to improve how pension schemes factor climate change risks and opportunities into their decision making."

Many of the actions to 'green' the pensions sector are already underway. Hailed as a "lightbulb moment" back in July, the government has sought to clarify that pension schemes have a fiduciary duty to consider long term risks and opportunities - including on climate change - through a regulatory tweak due to take effect from October next year. And it is now consulting on beefing up obligations on trustees to declare how they intend to consider these risks, and to take better account of their members' views.

The move means UK workplace pension schemes face greater pressure to shift their money away from fossil fuel industries towards greener investments, and take better account of the climate-related risks faced by their portfolios.

"Pension schemes will often have long investment horizons, holding members' savings for many decades," the government said in its response to the EAC today. "Consequently, it is particularly appropriate that pension scheme trustees do consider risks over the long-term."

In addition, the Financial Conduct Authority (FCA) is consulting on rule changes that would require the Independent Governance Committees of contract-based pensions to report on how they manage environmental risks and take account of members' ethical concerns - a move supported by the government. Further details on this are likely to be set out by the FCA in its own separate response to the EAC, the government said.

The FCA has also teamed up with fellow regulator the Prudential Regulation Authority to set up a new Climate Financial Risk Forum aimed at sharing best practice on the "emerging field" of climate risk in the financial services sector. And, the Financial Reporting Council (FRC) has also launched a new project to assess how well companies apply best practice in reporting on climate change.

Mark Campanale, founder and executive director of the influential Carbon Tracker Initiative think tank, said he was pleased to see government support for changes to pension regulations, and urged the investment managers to now decarbonise their holdings in line with the Paris Agreement pathways.

He pointed to investment banks such as Citi, which have suggested the fossil fuel industry could face $100tr of stranded assets unless they urgently shift to lower carbon business models.

"Climate change and the speed of the energy transition in coming decades is bound to have a profound impact on the management of investment funds," he told BusinessGreen. "Financial returns will be vulnerable if trustees who look after the funds from day to day don't take action now."

Diandra Soobiah, head of responsible investment at pensions provider NEST Corporation, agreed the pensions sector could no longer afford to ignore the "significant systemic risk" posed by climate change to member's investments. The government's clarifications on fiduciary duty would therefore give pensions trustees the confidence to factor in financially material long-term risks and opportunities into their decision making, she told BusinessGreen.

"It's an issue that cuts across economies and markets," she said. "But for too long environmental, social and governance issues have been considered separate, rather than integral, to pension fund and asset managers' investment decision making. We agree that climate change should be considered in every point of the investment chain, which is why we've set an expectation for more transparency by disclosing how we manage climate-related risks and opportunities against the TCFD framework."

However, while the government has set out draft plans to extend the number of organisations required to report on energy use and emissions through their company annual reports from an estimated 1,200 quoted firms to around 11,300 large companies and limited liability partnerships, it stopped short of making it mandatory for all large asset owners to do so.

EAC chair Mary Creagh it was "disappointing" the government had not taken the opportunity to follow France's lead in enshrining mandatory climate risk reporting in law for all large firms and investors, while Carbon Tracker's Campanale said it was "puzzling".

But the government argued the climate risks faced by a pension scheme "are entirely determined by the firms in which they invest".

"For large institutional investors to be able to make meaningful disclosures in line with TCFD [Taskforce on Climate-related Financial Disclosure guidelines], there first needs to be widespread reporting by firms," the government said. "A voluntary, industry-led approach to climate risk reporting is encouraged."

Non-profit CDP works with companies, investors, cities and regions to help them better identify, disclose and manage the climate change and environmental risks. The organisation's CEO Paul Simpson said disclosure was the "bedrock of a sustainable economy", arguing the lack of strong mandatory reporting measures from the government was therefore a "missed opportunity".

"Climate disclosure is a vital tool for bringing systemic risks into the spotlight by providing the data to make better investment decisions," he told BusinessGreen. "This failure to act risks leaving the UK behind our EU counterparts."

But John Nestor, chair of the Investment Consulting Committee at the Society of Pension Professionals (SPP), said that even though the government was not making reporting mandatory for large investors right across the board, climate risk and disclosure was still very much "a live subject" being taken seriously by the pensions sector.

"I think this is being well-spotlighted by the regulators, and it is being very much supported by participants in the marketplace by providing insights to trustees and people who oversee long-term retirement savings," he told BusinessGreen. "The atmosphere and scope of this has changed out of all recognition in the last 10 years, and the pace has really picked up in the last five years."

Nestor said the wider regulatory changes currently underway on climate risk and fiduciary duty had the broad support of pensions professionals, but that taking account of pension scheme members' views had to be done in a "proportionate" way.

"We've got to make sure we're appealing to all members of retirement savings buyers, and not just those that have a particular bee in their bonnet and want to stand on a sandbox and make their feelings heard," he said. "So I think we've got to be proportionate, and that means we represent all the membership and not just those who engage."

But he said the shift away from high carbon investments wouldn't happen overnight. "It will be a gradual shift and I think it will be proportionate because a lot of these companies are quite considerable in scale and size, so to completely walk away from them may in fact add to risk," Nestor explained. "But I do think we're now seeing debate and discussion among people involved in retirement savings as to what are the financial and non-financial - perhaps economic and environmental - risks."

The actions set out today by the government are far from the only green finance measures which could come into fruition, however, with its response to the recommendations set out by the Green Finance Taskforce in March set to emerge "in due course". That Taskforce's report covered a far wider reaching set of financial issues beyond pensions, touching on green bonds, corporate governance and energy efficiency lending, among other things.

As a result, ClientEarth's head of climate Alice Garton - who gave evidence to the EAC's green finance inquiry - said while some of the moves made already to de-risk UK pensions were welcome, far more remains to be done across the wider financial sector. She highlighted the raft of legal letters companies, insurers and auditors have received in recent months from ClientEarth reiterating the legal obligations on them to report on climate risk.

"That means that as far as climate disclosure is concerned, we're looking at a conspicuous missing link," she told BusinessGreen. "The FRC needs to do a lot more to bring the market to heel. Expectations need to be set and there must be clear consequences for those falling short. We will be very interested to see the government's response to the Green Finance Taskforce, as many ends remain to be tied."

If it wasn't clear enough before, the IPCC's recent sobering report made it plain that many of us will live to see the devastating impacts of climate change - or a zero carbon global economy. The government, it appears, is beginning to recognise the latter scenario is far more likely if people's pensions are properly looked after over the long term. Now it's over to the financial sector to shift their portfolios and spread green investment across the entire economy.