Schemes do not have the data they need, but new reporting rules will drive “real world” change.
Alongside the flood of net-zero 2050 commitments from countries, investors and corporates, policymakers around the world have been moving climate reporting up the legislative agenda. As the host of COP26 this November, the UK is under pressure to lead by example and prove its commitment to addressing climate risk.
Last November, Chancellor of the Exchequer Rishi Sunak set things in motion, announcing that the UK would be the first country in the world to enforce mandatory reporting aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) by 2025.
Launched by the Financial Stability Board (FSB) to ensure standardised reporting of climate risks by corporates, banks, insurers and investors, the TCFD framework is made up of four pillars: governance, strategy, risk management, and metrics and targets.
Collectively managing around £2 trillion in total AUM, the largest pension schemes are expected to go first alongside premium-listed companies, followed by asset managers, life insurers, publicly-listed companies and pension providers from 2022. UK pension schemes with over £5 billion in AUM must begin finalising their first TCFD reports from 1 October, 2021.
To ensure there is as much transparency around climate-related risks as possible, the scope of corporates falling under TCFD should be widened, the Institutional Investors Group on Climate Change (IIGCC) has previously said. This was in response to a consultation on climate-related reporting requirements by the UK’s Department for Business, Energy and Industrial Strategy’s (BEIS), which closed last month.
“TCFD provides a very clear framework for reporting – identifying how a pension fund is governed, how it sets its strategy and how it incorporates climate into its risk management. It requires clear metrics and targets. It gives members transparency over the way the pension scheme is managed, which leads to change in the way assets are invested, ultimately resulting in real world changes,” says Mike Rogers, Paris Alignment Forum Lead at Pensions for Purpose, an organisation working with pension funds and asset managers looking to inject capital into impact investment projects.
A “hard slog”
As well as ensuring that TCFD-aligned reporting is a legal requirement for pension schemes, the Pension Schemes Act was passed in February to also strengthen the Department for Work and Pensions (DWP) regulatory powers, ascertaining that the DWP will be able to manage and enforce climate-related reporting requirements.
Ongoing challenges have made the preparation process a “hard slog”, notes Joe Dabrowski, Deputy Director of Policy for the Pensions and Lifetime Savings Association (PLSA). As a result, the first round of reports will be far from the finished article.
Not least because TCFD-aligned reports are not yet mandatory for a number of listed corporates, pension schemes have been struggling with the ongoing shortcomings in the availability and quality of relevant data, metric methodologies that can span multiple asset classes, and accurately modelling future projections according to different temperature scenarios.
More positively, the emphasis on TCFD-aligned reporting is accelerating pension schemes’ focus on decarbonisation, according to Charlotte O’Leary, Pensions for Purpose CEO.
“We believe that the next phase in climate reporting will be the establishment of net-zero targets. Many of the pension funds that we are talking to are actively exploring what it means to set a net-zero target. We are encouraged that this discussion goes well beyond a single 2050 target with pension funds keen to set interim milestones so that progress can be measured clearly,” she says.
Off to a slow start
The government’s roadmap initially outlined that occupational pension schemes with more than £5 billion in AUM would need to provide mandatory disclosures from early 2021.
However, UK Pensions Minister Guy Opperman extended the TCFD reporting deadline by seven calendar months from individual year-end dates, following pension funds’ requests for more time. This extension means that, while pension funds must begin preparing their TCFD reports from 1 October, they don’t need to publish those reports until seven months after their next year-end date. Therefore, the majority will actually be published in 2022.
The delay has been welcome, allowing schemes time to build up their resources for measuring and accounting for climate risk, some even conducting dry runs. Most, if not all, UK pension funds are in a strong position to produce TCFD-aligned reports, experts say.
Furthermore, a number of the largest UK pension funds with over £10 billion AUM are already voluntarily producing TCFD-aligned reports. For example, RPMI Railpen (£31 billion in AUM) published its first TCFD-aligned report back in 2018.
“Pension schemes over £5 billion are typically resourced sufficiently and we haven’t seen evidence that the reporting required this year is causing major difficulties – in fact the importance of the reporting seems to be widely recognised as outweighing any challenges around timing,” Rogers tells ESG Investor.
“Our sense is that preparation for TCFD reporting is more challenging for pension schemes which are smaller scale and less well internally resourced. That said, if a pension fund is struggling even to produce a report, members might question whether the fund is adequately resourced to manage their pensions,” he adds.
Funds large and small have faced resourcing challenges, with some needing training, says Will Martindale, Group Head of Sustainability for pensions risk and investment management provider Cardano Group.
“Trustees are engaged and working hard to make sure that they understand the metrics they need as part of their TCFD reports,” he says.
Regarding the Financial Conduct Authority’s (FCA) recent consultation for the introduction of TCFD reports and guidance for asset managers, life insurers and FCA-regulated pension providers, Martindale previously told ESG Investor that UK asset managers should also be subject to the TCFD mandate at the same time as pension funds. This would improve the level of detail included within pension schemes’ own reports more quickly, he said.
The dreaded ‘D’ word
Despite the delay, seven additional months isn’t enough time to address the gaps in the required climate-related data, experts warn.
The inconsistencies and unreliability of ESG-related data is a sore point for managers, investors and pension trustees alike, making it difficult to secure the relevant information they need to ensure transparency, let alone being able to quantify and compare data reliably.
This issue is bleeding through into TCFD-aligned reporting. After all, for climate-related financial disclosures to be considered comprehensive and accurate, data needs to back up every claim.
Sourcing climate specific data is still a relatively new concept, Pension for Purpose’s Rogers says, and that data “is not yet fully available for all asset classes”.
But pension schemes’ TCFD reports are heavily reliant on that data being available, particularly when it comes to risk management, metrics and targets.
“They hold bonds and equities issued by companies, and they need those companies to be providing the relevant information in order to aggregate across their portfolios,” explains Simon Robinson, Director of Product Management at Moody’s Analytics.
Measuring Scope 1 carbon emissions (direct emissions) and Scope 2 (indirect emissions through purchase) across asset classes can be complicated, he notes, requiring careful consideration of methodology.
While listed equities are usually the easiest to source climate-related information for, Robinson says that these are making up a smaller proportion of pension schemes’ portfolios over time.
Instead, the general trend is to “look more at fixed income or the private asset world – private credit, or infrastructure and property-based assets – which are delivering the sorts of financial characteristics that are needed. But sourcing emissions data on these asset classes is harder,” he says.
UK pension schemes investing in overseas assets will also find it more challenging to improve visibility of their carbon emissions, Martindale adds. However, as international policymakers move towards climate reporting, in tandem with the UK, there will be an “international consensus around the importance of these metrics in the next couple of years”, a change that will eventually be reflected in higher quality TCFD reports.
Strong signal to managers
The more UK corporates and asset managers’ produce TCFD-aligned reports, and therefore include the relevant information asset owners need to inform their own reports, the more accurate pension schemes’ TCFD-aligned disclosures will be, according to the UK’s Universities Superannuation Scheme’s (USS) 2021 Stewardship Code Report.
Managing £79 billion in AUM, USS said that this was a point it raised with both the BEIS and DWP during public consultations, emphasising the importance of “sequencing the introduction of reporting requirements”.
To get hold of the information it needs, USS asks its managers to “commit to responding to ad-hoc data requests on ESG or stewardship to support USS analysis or scheme reporting”.
“Whilst we have not always been successful in achieving the proposed [TCFD] template wording, our negotiations and starting position sends a strong signal to managers, emphasising the importance placed on responsible investing considerations at the scheme,” USS said.
In the long term, a lot of work needs to be done to ensure that corporates have “more investable assets” that are carbon-free, Dabrowski says. “But we’re not there yet. We’re very much in a transitory period.”
Right now, it’s not essential that their first reports get everything completely right, Moody’s Robinson adds, as the government is “cognisant that some of the reporting requirements will be more challenging than others”.
“What they’re really looking for is for pension schemes to make a good start, get climate-related reporting on their agenda and get the process rolling as much as possible. It’s going to evolve over time,” Robinson says.
Measuring by degrees
The difference between 1.5°C, 2°C and 3°C may once have seemed minuscule, but investors are painfully aware that each temperature increase introduces a raft of more damaging changes to our world. It’s vital that we have a concrete understanding of how different temperature scenarios may impact both the environment and our economies.
Scenario modelling is a key part of TCFD’s 11 reporting recommendations and UK pension funds will be expected to outline how their exposure to climate-related risks changes across these temperature scenarios.
“Thinking about risk management and economic planning isn’t new to large pension schemes. But bringing this into a climate context is new for the vast majority,” according to Robinson. “Pension schemes need to understand how these scenarios may impact their assets going forward; what are the implications for their funding policy?” he asks.
A number of bodies are looking into this area and formulating guidance. For example, the Network for Greening the Financial System (NGFS) recently updated its climate scenarios with more granular data, incorporating countries’ commitments to net-zero and examples of coherent transition pathways.
Furthermore, perhaps too late for the first round of UK TCFD reports, the TCFD has launched two consultations. The first proposes updates to existing guidance on climate-related metrics and data, including specifically asking for Scope 3 emissions (indirect emissions throughout the value chain). The second consultation is an assessment of the current market developments for future-looking metrics, which may also offer pension funds more clarity when mapping future projections for their portfolios. The TCFD will publish finalised guidance this autumn, so it will be to hand for UK pension schemes.
However, while additional guidance is always helpful, Dabrowski warns that the UK government shouldn’t be prompted to change existing legislative reporting requirements too soon, such as introducing Scope 3 reporting on a mandatory basis.
“Otherwise, it will be difficult to keep up. Pension funds don’t want to have to constantly amend their strategies,” he says.
Spotlight on UK pensions
1 October, 2021, only marks the beginning of mandatory TCFD-aligned disclosures for the UK, and everyone else waiting in line will be watching pension schemes closely as they publish their reports.
Pension funds may be the first, but they’ve been gifted something of a soft landing by the government, with their ‘do as much as you can’ stipulation. It remains an uphill battle to improve upon their first reports in the coming years, experts say.
And pressure on UK investors, funds and corporates will only increase when COP26 rolls around, O’Leary warns.
“COP26 will put UK pension funds under the spotlight and managers should expect to see significant member pressure for action in this area, regardless of whether they are required by legislation to report this year, next year, or are currently exempt,” she says.