Climate risks and opportunities not yet a priority for trustees despite incoming regulation.
Defined benefit pension schemes with under £1 billion in assets risk being left behind the rest of the UK market, according to a new report, Climate Change: Risks and Opportunities for Pension Schemes, by investment consultants Willis Towers Watson (WTW).
WTW said laggards in the pension funds market risk their futures by not keeping up with transition requirements around climate change such as reporting and managing risks in line with the Task Force on Climate-related Financial Disclosures (TCFD).
The UK requires climate risks to be considered and reported on by pension schemes under the Pension Schemes Act. Schemes with £5 billion in assets must already comply, with those managing £1 billion in assets liable from October 2022. Trustees and sponsors of large schemes – those with assets over £1 billion – need to act now, says the WTW report. The requirements for large UK pension schemes are based on a framework developed by the TCFD.
“While schemes with assets between £1 billion and £5 billion do not view climate change as a priority over the next 12 months, they do see it as a top five issue over the next three years.” the report said. “However, it was not a priority at all for schemes with under £1 billion in assets under management.”
The WTW report added that funds with £5 billion or more in assets under management identify climate change as a top five priority over the next year and their number one priority over the next three years.
Research from The Pensions Regulator (TPR) said UK pension schemes were currently not doing enough to adapt to the risks posed by climate change, according to a report in October.
Only 43% of defined contribution schemes accounted for climate change when formulating their investment strategies and approaches last year, according to the report. Further, 51% of defined benefit schemes had not allocated time or resources to assessing any climate-related financial risks and opportunities in their investment strategies, TPR said.
From April 2022, some of the largest UK-registered companies and financial institutions will have to prepare TCFD-aligned disclosures. Premium listed companies are already required to report in line with TCFD and More companies and institutions will come into scope through to 2025.
In October, TCFD updated its implementation guidance for the first time since 2017. A revised annex included supplemental guidance on decision-useful disclosures by the financial sector across TCFD’s four reporting pillars – governance, strategy, risk management, and metrics and targets – and updated universal and sectoral reporting requirements.
Physical and transition risks
Willis Towers Watson said trustees of defined benefit schemes need to take account of transition risks associated with climate change as well as physical risks.
“If your star-performing asset is built on carbon emissions, there is a risk that it could be regulated out of existence – or that the market does that job by itself – if there is a failure to adapt,” said the report.
The report added climate change posed material risks to all pension schemes regardless of their size but also provided opportunities for all schemes – if they look for them.
“Perhaps it is not surprising that it is an issue of more pressing urgency for larger schemes,” said Edwin Sheaf, Senior Director, WTW. “But dealing with the impact of climate change shouldn’t just be a regulatory tick-box exercise. It is something that all schemes can benefit from.”
Experts across the investment industry have acknowledged that the higher stewardship standards involved in management of climate risks can pose challenges for smaller pension schemes. Catherine Howarth, CEO of sustainable investment NGO ShareAction, said outsourcing and consolidation could both increase, speaking to ESG Investor earlier this year.
Earlier this year, research published by Make My Money Matter and sustainability research house Route2 stressed that UK pension schemes currently enabled more than 330 million tonnes of carbon emissions every year.
“There is a danger that while schemes subject to the TCFD requirements will look at these in detail, other schemes will continue to focus elsewhere and so may ‘miss the boat’ on taking advantage of the available opportunities,” the report added.