New Climate Rules and Guidance for UK Pensions

Government plans to ease access to illiquid assets, but expects more robust stewardship.

UK pension schemes will be required to demonstrate alignment with the Paris Agreement from October, but will also be given greater flexibility to make climate-positive investments as well as new stewardship guidance, Work and Pensions Secretary Therese Coffey confirmed today.

“We are giving schemes greater flexibility to invest in productive finance – in real assets like infrastructure and innovative businesses of tomorrow,” Coffey told the Pensions and Lifetime Savings Association’s (PLSA) digital ESG Conference 2022.

Coffey said the UK government would bring forward legislation “shortly” to remove barriers currently preventing schemes from investing in illiquid assets.

Last November, the Department of Work and Pensions (DWP) consulted on proposed changes to the regulatory charge cap for defined contribution pension schemes to enable investment in a broader range of asset classes.

This followed the final report of the Productive Finance Working Group, formed by HM Treasury, the Bank of England and the Financial Conduct Authority to encourage more investment in long-term less-liquid assets, widely seen as offering a wider range options for investors looking to support the low-carbon transition.

Paris alignment

Coffey also confirmed the introduction of new rules requiring pension scheme trustees to report on the alignment of their portfolios with the goals of the Paris Agreement, taking effect from 1 October.

The DWP issued a consultation last October on proposed changes to the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021 to require trustees to calculate and disclose a portfolio alignment metric to show alignment with the goal of limiting climate change to 1.5 degrees Celsius.

Coffey said pension schemes would be free to select portfolio alignment tools best suited to their investment strategy and governance capacity. She also said limits to data coverage meant trustees would only be required to report on a best efforts basis.

“These new requirements are part of a bigger push right across the economy for new standards on environmental reporting to weed out greenwashing and support our transition to a net zero financial system – for example, through our new Sustainability Disclosure Requirements,” she said.

The DWP consultation followed updated guidance by the Task Force on Climate-related Financial Disclosures (TCFD), which said financial institutions should describe the Paris alignment of their activities. The largest UK pension schemes have been reporting on the financial risks of climate change in line with TCFD recommendations since October 2021.

Increasing numbers of UK pension schemes have adopted net zero commitments and aligned their strategies toward investments in people and planet. Larger UK schemes are using frameworks provided by the UN Net Zero Asset Owners Alliance and the Net Zero Investment Framework. But an analysis by campaign group Make My Money Matter reported in October that 70% of UK schemes had not made credible commitments.

More than 50% of UK pension funds already hold some kind of impact investment, according to a new survey by Pensions for Purpose and Big Society Capital, which also found that 90% of schemes are looking to make impact investments in the UK. All surveyed schemes, collectively representing £150 billion AUM, said they were targeting UN Sustainable Development Goals relating to climate action.

 “Walking the walk”

Coffey said the DWP will publish guidance on Paris alignment in the coming months as well as on the stewardship role of trustees, warning that they could not “just passively report on and tick-box their way through climate change risks and to net zero”.

Trustees should exert their influence over asset managers and investee companies to ensure they are “walking the walk” in terms of adapting their business models to net zero objectives, she said, including encouraging managers to sign up to the UK Stewardship Code.

According to recent study of 650 UK occupational pension funds by investment consultants Mercer, only 35% of schemes conduct a stewardship assessment of investment managers at least annually.

The Financial Reporting Council reported that almost 200 organisations have signed up to the UK Stewardship Code, which commits signatories, including asset managers with a combined £33 trillion AUM, to demonstrating adherence to a set of 12 principles.

“Our approach is about better information and empowerment, not about divestment or directly penalising today’s high carbon emitters. High emitters – like fossil fuel companies – should be supported in their transition to Net Zero and we need them to invest in green technologies,” said Coffey.

“This is about enabling pension schemes to distinguish between the leaders and the laggards based on the ambition of those companies so that investment does not shift if they have a credible net zero plan.”

The DWP has already consulted on updating its guidance on stewardship requirements, but has not yet set a date for when it will come into force.

The DWP and The Pensions Regulator (TPR) already provide guidance to large UK pension schemes on compliance with climate-related governance and reporting requirements. In February, the Pensions Regulator also published further guidance, which provides a step-by-step worked example of compliance with climate-related rules by a fictitious pension scheme.

“One of the things that isn’t fully appreciated is responsibility for climate is very much with a trustee board, even though certain duties may be delegated to sub-committees. The whole trustee board must be involved with climate-related decisions,” said Brendan Walshe, a member of the TPR’s investment consulting team, also speaking at the PLSA event.

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