The ESG Interview: “Working toward the same goal”

Katharina Lindmeier, Responsible Investment Manager at Nest, sets out the scheme’s climate policy and looks forward to a year of change.

What is the biggest challenge faced by asset owners attempting to chart a successful course to net-zero emissions from their portfolios by 2050?

Few peers will be surprised to know ‘data’ is front and centre for Katharina Lindmeier, Responsible Investment Manager at Nest, the UK-based defined contribution workplace pension scheme. Equally, they will recognise the desire for the emergence of standards and best practice.

“Data is probably the biggest one,” she says, “Also, there are still no generally accepted methodologies for what a Paris-aligned portfolio looks like for all asset classes.”

As author of Nest’s climate change policy, Lindmeier knows the limitations of available data better than most.

“The most widely used data points, including for carbon emissions, are backward looking,” she says, acknowledging that investors are being asked to make investment decisions related to future emissions based on forward-looking statements from issuers. “There is an element of good faith in terms of whether you believe a company is going to meet its targets.”

The National Employment Savings Trust, to give the scheme its full name, was established by the UK Pensions Act 2008, to facilitate automatic pension enrolment and already has nine million members, making in the largest scheme by membership in the UK.

The trust published its climate change policy in July last year. The scheme had already started to invest on a climate-aware basis, via a developed market equity fund co-created with UBS Asset Management, in 2017. The UBS Life Climate Aware World Equity Fund tilts away from companies which are highly carbon intensive and toward those better placed for the transition to a low-carbon economy.

Accompanied by the unarguable but stark assertion by CIO Mark Fawcett that “No one wants to save throughout their entire life to retire into a world devasted by climate change”, the policy commits Nest to investing £5.5 billion into climate-aware strategies, representing 45% of Nest’s entire portfolio.

The policy also obliges the trust to divest ownership of firms involved in thermal coal, oil sands and arctic drilling, a process due to be completed by 2025 if not before, unless the firms in question propose a credible plan to phase out such activity by 2030. In parallel, Nest is directing more investment toward green infrastructure and other renewable projects.

Lindmeier acknowledges that a key priority for the whole of the industry is the setting of credible milestones on the path to net zero. Nest is a member of the Institutional Investor Group on Climate Change, which last year published a net-zero framework to help investors set targets.

Nest’s interim targets on its path to net zero include a goal of halving emissions by 2030. “There are different ways of reaching that goal. Ours is a combination of driving change directly with companies to drive down real world emissions, while also making changes to asset allocation,” she explains.

A holistic approach

Joining Nest in October 2019, Lindmeier had a remit to draft a “holistic” climate change policy across all asset classes. To this end, she consulted with peers and providers, ascertaining best practice, while bearing in mind Nest’s existing exposures. The scheme-wide policy was put together with oversight from Nest’s investment committee.

The policy is informed primarily by the goal of limiting climate change to 1.5 degrees Celsius above pre-industrial levels, as set by the UN’s Intergovernmental Panel on Climate Change. This means taking meaningful steps now to avoid a disorderly transition later. “The risks from a gradual transition are going to be more manageable,” observes Lindmeier, “compared with either the physical risk of runaway climate change not meeting either 1.5 or 2 degrees or the transition risk of a sudden policy shock if we start at a later point.”

Reviewed and updated annually, progress against the policy’s objectives is reported every year in Nest’s responsible investment reports. The scheme reports annually against the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), and is expecting to publish a progress report in line with TCFD recommendations to mark the first year of its climate change policy.

Two sides of one coin

The policy covers four key areas: asset allocation; manager selection; engagement; and advocacy. These can be characterised as two sides of one coin, with asset allocation and manager selection largely focused on the content and management of Nest’s portfolios, while engagement and advocacy deal more directly with reducing emissions levels.

On the asset allocation front, Nest’s policy orientates investment toward renewables and infrastructure. In December, it launched a climate-aware emerging market equity fund in collaboration with Northern Trust Asset Management. The new fund doubles Nest’s investment in emerging markets to £930 million (6% of its overall portfolio), tilting to energy efficiency, alternative energy and green building.

As noted above, Nest’s policy entails exclusions, but these are more the exception than the rule.

“There are other areas [of industry], where there is scope for transition so our approach there is to look for best-in class-companies. Using the tilting approach, we will look at companies that are well-prepared for transition and can make a positive contribution, then reinforce using engagement,” explains Lindmeier.

Although Nest has to date announced climate-aware equity funds, its ambitions to reduce emissions run across asset classes. Lindmeier admits that ensuring every mandate contributes to meeting its net-zero target is a challenge.

“It’s important to bear in mind that different asset classes have different pathways to get there,” she says. “We’re working closely with fund managers on how we can align portfolios and we recognise that it’s going to look different across asset classes. But we’re deliberately looking at all the building blocks of our funds rather than looking at a top-down level and offsetting emissions from different parts of the portfolio.”

Again, the question of data availability plays its part. “In other asset classes, there is not even that data coverage on Scope 1 and 2 emissions. One of the first things you have to do is try to get issuers to disclose their Scope 1 and 2 emissions, with Scope 3 being somewhat aspirational.”

Engagement tactics

The successful implementation of Nest’s climate policy requires significant support from managers. The scheme sets different objectives and benchmarks for managers suited to their remits, but has developed three key expectations.

First, managers must report climate-related risks and opportunities in their portfolio in line with the TCFD framework. Second, they must develop strategies to align the portfolios they manage for Nest with its 1.5 degree limit. Finally, managers are expected to use their voting rights and engagement resources to influence investee companies to transition to a low-carbon economy.

This latter point means Nest employs a variety of engagement tactics, engaging either directly or via managers, for example. “Equally, advocacy is a mix, including working with peers to develop methodologies for portfolio alignment, for example,” says Lindmeier.

Any direct engagement with an investee company is informed by Nest’s voting and engagement policy. This will typically focus on strategically important areas to the scheme, not just climate exchange but also workplace issues, or topics on which managers have not already engaged.

Alternatively, Nest will let a manager take the lead if a topic or theme is already included in its existing engagement priorities. “Every year we engage with our fund managers on their policies. In equities, typically we look for managers with very strong corporate governance practices,” observes Lindmeier.

Policies differences do arise. Lindmeier says Nest can override the managers of their segregated mandates – both developed and emerging equities – if they deem it necessary.

Individual and collaborative

Nest updates its voting policy every AGM season, and this year it has already been strengthened to fully reflect the climate change policy. “We tend to support shareholder resolutions on climate change asking for additional disclosures,” says Lindmeier, noting that Nest will occasionally pre-disclose its voting intention, as this tactic can increase leverage for change.

According to Lindmeier, both individual and collaborative approaches to engagement can be effective in driving change on climate issues.

“Generally, we think it’s really powerful when investors come together and engage as a group. But we also often have individual engagement with companies, usually on voting issues. Off the back of the AGM season, we then usually engage with a number of companies where we have voted against management to discuss our key concerns, which could be a classic corporate governance topic like board remuneration, but it could be on climate change.”

But she says joint action has been highly persuasive for climate-related engagement, noting the success of the ClimateAction 100+ investor group in encouraging large corporates to commit to net-zero targets and developing science-based targets. “The value of collective investor engagement really cannot be underestimated,” she says.

Right to a ‘say-on-climate’ vote?

Discussion of climate change topics are widely expected to be lively in the UK 2021 AGM season, particularly since The Investor Forum called on the UK government to consult on the giving investors a ‘say on climate’, which could lead to automatic right for shareholders to hold a specific vote at AGMs on a company’s climate policy.

Lindmeier points of that there already a number of mechanisms shareholders can use to register their views on firm’s climate change policies, from specific shareholder resolutions to votes on the report and accounts, the re-election of board directors and approval of remuneration packages.

“This could be a way of getting a more specific item about climate change onto the ballot,” she says. “It needs to be considered by all companies because it is a systemic risk. It will affect different companies to a different extent, but it affects the whole economy.”

She also suggests that a specific vote on climate change policy would send an unambiguous and public message to the company about shareholder views on the subject, rather than voting against a particular director, which might then only be fully understood via a follow-up meeting with investors.

No silver bullet

From one-on-one discussions to sector-wide initiatives to global climate diplomacy, no aspect of the migration to a net-zero society is a solo endeavour.

Nest was supportive of the recent changes to the UK Pensions Schemes Bill, with respect to reporting and governance on climate change risk, partly due to the network effect across the finance sector. “This will feed through the financial system with asset owners asking asset managers for this information, they in turn will ask companies which they invest in,” says Lindmeier.

With COP26 on the horizon, scheduled to be held in Glasgow in November, political developments related to climate change will continue to dominate headlines. Lindmeier hopes for ambitious and credible commitments from governments, but also the certainty that the finance sector needs in order to allocate capital with conviction and confidence.

“As a UK pension scheme, we’re hoping that COP26 will be a success and ambitious policies will be announced. But it’s not just about government policy, of course. We need different parts of the financial system to be working toward the same goal.”

Whether negotiating global commitments or working in close collaboration with fund managers and investee companies, “There’s no silver bullet,” Lindmeier observes.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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