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Big Squeeze for UK Pension Schemes

Climate disclosure rules will stretch the resources and patience of mid-sized schemes, but October deadline is just the start.

For those responsible for preparing accounts for UK mid-sized and smaller pension schemes, life is about to become more complicated. That the threshold for climate-related reporting is due on October 1 to drop from £5 billion in assets under management to £1 billion has been known for a while, but less clear is what further changes are likely beyond that date.

“These new regulations are likely to be added to in the future,” said Simon Borhan, Managing Associate at Linklaters, the law firm. “The trend is towards requiring more and more detailed information.”

He added: “The aim is clearly a good one. That said, the regulations are detailed and it is going to be quite an uphill battle for smaller schemes to comply. There will be a challenge to find the time and resources.”

The requirements stem from the 2017 recommendations of the Financial Stability Board (FSB), a forum set up in the wake of the 2008 global financial crisis, and specifically the board’s Taskforce on Climate-related Financial Disclosure (TCFD).

The UK has been one of the fastest countries to adopt TCFD-based reporting into law, for corporates, regulated financial institutions and pension schemes. Regulators recently published results of their analyses of UK corporates’ 2021 filings on climate risks and governance.

Under the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021, large schemes have had to report climate risks in line with TCFD guidance since last October, ahead of some of their service providers.

Schemes are required to disclose four measures in their accounting: the total greenhouse gas emissions of the all the scheme’s assets; a measure of the intensity of such emissions per unit of currency; a measure of the trustees’ own choosing in relation to climate factors, and a measure of the extent to which the scheme’s investments align with the aim of the Paris Agreement to limit global warming to 1.5°Cabove pre-industrial levels.

Responsible stewards

This last measure has only recently become compulsory, because, according to the Department for Work and Pensions (DWP), “more work was needed to refine methodologies and ensure consistent, comparable, and robust reporting”. One result of the change has been to oblige trustees who previously used alignment with the Paris goals as their third measure to find a new one.

Speaking of the changes overall, DWP Secretary Therese Coffey said: “We understand we are asking a lot of occupational pensions schemes and wish to thank trustees for showing great leadership.

“We want to support trustees in their climate disclosures and hope we can count on the same constructive relationship with industry to help ensure these measures help trustees and savers.”

Nigel Peaple, Director of Policy and Advocacy at the Pensions and Lifetime Savings Association, said: “Striving to improve investment practices, and robust transparency standards across the investment chain, is an essential part of ensuring schemes can act as responsible stewards on behalf of millions of UK pensions savers.”

But he also emphasised the extent of pension scheme trustees’ reliance of climate-related data from third parties.

“As we enter the next phase of scheme reporting, it is important that the largest companies and asset managers meet institutional investors’ expectations, by enhancing their climate impact disclosure, as well as fully implementing their regulatory responsibilities within the TCFD regime,” added Peaple.

Failing to provide information

Will Martindale, Co-Head of Sustainability at Cardano, the investment management and advisory group, said that, from his firm’s perspective, there will be a huge increase on the number of pension scheme clients required to prepare TCFD reports. “We agree with the principle of starting with larger pension funds last year and moving on this year to the mid-sized operators.

“But it will be challenging for a number of schemes.”

One challenge is the ability of trustees to obtain the relevant information from asset managers. “This is not on the whole a problem in relation to listed equities and listed corporate credit. But it may be more of an issue in emerging markets and in relation to private asset classes, where there could, be fewer disclosures and concerns about confidentiality,” said Martindale.

This month, pensions and financial services consultancy Hymans Robertson reported that private markets managers are failing to provide their clients with the information they need effectively to manage climate risks.

Lower the thresholds

Hymans’ research aimed to assess the level of climate data asset managers could provide to pension scheme clients on their funds across four asset classes: private debt, private equity, real estate and infrastructure. The firm’s analysis bore out wider industry concerns about the incomplete picture facing trustees.

“It revealed a worryingly low level of engagement from some asset managers with just over two-fifths (42%) of managers providing data on all funds and a further 14% of managers providing data on some of their funds. Nearly half of managers (44%) approached did not respond, raising concerns as to whether managers are prepared to meet expected requests for climate information.”

Hymans added that the research highlighted the significant variation in the depth of information disclosed by respondents, with the reporting of carbon emissions data not yet commonplace. It said: “Managers of property and infrastructure funds are better prepared with just under half – (44%) for property and 48% for infrastructure – providing data on carbon emissions. In contrast, private equity and private debt managers were able to report significantly less information on climate issues – no private debt managers in the survey provided carbon emissions data.”

Looking to the future and the question of whether the £1 billion limit is permanent or could be lowered further, Martindale said: “The DWP has said it will review the thresholds. Would it be desirable to lower them further?

“You could argue that it would be, given that, if you’re a pension saver your scheme, large or small, should measure climate risk. Alternatively, it could be said that this would involve a disproportionate use of resources for smaller schemes.”

“Ignoring a major risk”

Reporting in line with the TCFD framework, which measures financial risk linked to climate change, ought not to be the full story for pension schemes, added Martindale. “The other side of the coin is to look at ways the financial sector can support moves towards net zero. We suggest further attention on stewardship and engagement.”

Borhan at Linklaters warned that some schemes would simply find it impossible to comply with climate-related reporting requirements in the early years, and he expected the regulators, rather than responding heavy-handedly, would require trustees to explain any gaps in information and detail the steps they were taking to remedy the situation.

He warned: “Some people see TCFD reporting as just a once-a-year exercise. But I’m not sure it is going to be quite so straightforward. There are on-going requirements as to what trustees need to do.”

In extreme cases, he said, firms refusing to supply trustees with TCFD information would have to be divested from the portfolio in question.

The extension of TCFD reporting is part of a wider climate-change strategy outlined last year by the Pensions Regulator. Chief Executive Charles Counsell said: “I believe that, wherever the focus lies for trustees, it is absolutely the case that any scheme that does not consider climate change is ignoring a major risk to pension savings and missing out on investment opportunities.”

More efficient allocation of capital

Counsell added: “Regulators across the entire UK investment chain are committed to disclosure of climate information and the government is making plans to achieve its target of net zero carbon emissions by 2050. This means a landscape of resilient pension schemes that protect savings from climate risk is entirely within reach.”

The DWP has advised pension trustees, in the context of climate-related activity, to focus on three “core duties: first, the exercise of investment powers for their proper purpose, adding “the consideration of climate-related risks and opportunities should take place in this context”; second, the taking account of material financial factors (“When considering the financial implications of climate change, trustees should consider both transition risks and physical risks”); and third, the need to act in accordance with the “prudent person” principle. “Trustee investment powers must be exercised with the ‘care, skill and diligence’ that ‘a prudent person would exercise when dealing with investments for someone else for whom they feel morally bound to provide’.”

On this last point, the DWP added: “Standards are evolving in this area and what may be considered ‘prudent’ in relation to climate-related risks today might no longer meet that standard in the future.”

The FSB has emphasised the evolutionary and holistic nature of climate reporting in its rationale for establishing the TCFD framework: “Through widespread adoption, financial risks and opportunities related to climate change will become a natural part of companies’ risk management and strategic planning processes.

“As this occurs, companies’ and investors’ understanding of the potential financial implications associated with transitioning to a lower-carbon economy and climate-related physical risks will grow; information will become more decision-useful; and risks and opportunities will be more accurately priced, allowing for the more efficient allocation of capital.”

While it is little comfort to pension scheme trustees facing gaps in their climate reporting in the coming months, the flow of decision-useful information is set to be increased by the completion and adoption of new climate reporting standards by the International Sustainability Standards Board (ISSB), which build on the TCFD framework. The UK government has committed to promptly implementing the ISSB’s standards.

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