A Step Forward in UK Pension Scheme ESG Reporting

Alasdair Smith, Counsel for the pensions team at law firm Linklaters, outlines how UK climate reporting requirements for pension schemes are evolving. 

The government estimated in June 2022 that pension fund assets in the UK totalled around £3 trillion. Given that ESG concerns are nudging towards the top of the agenda for all boards, it is no wonder that pension funds, as significant investors, have been tasked with upping their governance and disclosures in relation to climate-related risks. 

Stemming from the release in 2017 of the Financial Stability Board’s Taskforce on Climate-related Financial Disclosure recommendations, the government has introduced wide-ranging requirements for UK pension schemes. Large occupational pension schemes, meaning those with assets in excess of £5 billion, had to comply with new governance requirements from 1 October 2021 and new disclosure requirements within seven months of the end of the scheme year underway from the same date. From October 2022, schemes with assets in excess of £1 billion will fall within scope. 

Under the current requirements, trustees are required to calculate and disclose three metrics: 

  • an absolute emissions metric: this gives the total greenhouse gas emissions of the scheme’s assets; 
  • an emissions intensity metric: this gives the total greenhouse gas emissions of the scheme’s assets per unit of currency; and 
  • one other metric which relates to climate change of the trustees’ choosing. 

These metrics are aimed at encouraging trustees to understand and monitor climate-related risks and opportunities inherent in their scheme’s portfolio. This should then allow them to engage more meaningfully with their investments (either directly or through their asset managers) to ensure that climate-related risks are being taken into account and that the associated financial risks to the scheme are properly understood and mitigated. 

More metrics

Following a consultation last year, the government announced in June that all schemes which fall within scope on 1 October 2022 (i.e. any scheme with assets in excess of £1 billion), will need to consider and report on a further climate change metric.  

Whereas previously it was optional for trustees to measure the extent to which their scheme’s investments are aligned with the Paris Agreement goal to limit global warming to 1.5 °C above pre-industrial levels, this will now be added to the absolute emissions and emissions intensity metrics as being a compulsory metric against which trustees will need to assess their scheme.  

Given this, if trustees had previously chosen the portfolio alignment metric as part of their three metrics, they will now need to come up with a new “other metric”. Alternatively, for those trustees who have not considered portfolio alignment previously, they will now need to consider this in addition to their current metrics.  

Either way, schemes that have already published their first report on climate change risks and opportunities for their scheme as they fell within scope in 2021 (such reports often referred by the jargon “TCFD reports”) will need to include the additional requirement in the second year’s process, and schemes that will come within scope for the first time in October 2022 will now have four metrics to consider. 

The government has issued draft updated guidance to allow for the inclusion of a compulsory portfolio alignment metric. The guidance lists the following as potential alignment metrics which trustees can consider: 

  • binary target measurements: where the assets are assessed to see what proportion of the assets have declared a net zero target or are already net zero; 
  • benchmark divergence metrics: where a tool is used to assess the performance of assets against one or more benchmarks based on climate scenarios; or 
  • an implied temperature rise model: where a tool is used to assess the consequences of alignment in the form of a temperature score. 

Trustees should try to choose the same metric across their portfolio, irrespective of asset classes, sectors or geographies.  

However, the draft guidance does recognise that may not be possible or that there may be good reason for using alternative metrics in a specific set of circumstances. If this approach is taken, trustees will need to explain that difference in approach in their report. 

The guidance is clear that trustees will need to monitor the portfolio alignment metric in the same way as they do other metrics to determine whether they remain appropriate for the scheme. It also recognises that certain assets classes, such as derivatives, may prove problematic. In that case, the government highlights in the guidance that the requirement is simply to report “so far as trustees are able” and so there should be a degree of flexibility if trustees are unable to report on the new measure. 

Finally, the draft guidance also extends the choices available for the optional metric. These now include a metric related to assets which are materially exposed to climate-related physical risks, and a metric related to assets which are materially exposed to transition risks. 

The guidance is clear that it is the responsibility of trustees to ensure that they understand the assumptions underlying the chosen metrics. However, given the complexity, trustees will need to ensure that they have taken detailed professional advice when choosing appropriate metrics for their schemes.  

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