What does the climate transition plan craze mean for pension funds?

Transition plans are confusing investors. That’s the message from think-tank Carbon Tracker, which has just issued a guide to evaluating companies’ climate strategies.

“Throughout 2024, our meetings with the financial community consistently highlighted a common theme,” said Mike Coffin, Carbon Tracker’s head of oil, gas and mining research.

“Investment teams were growing increasingly perplexed by the multitude of transition assessment methodologies claiming superiority over the other.”

He added that there was no “silver bullet” for companies when it came to explaining how they were managing the shift to net zero. Things may get simpler once the rules for what should be disclosed in a transition plan are formalised in legislation.

European Union advisors are expected to consult on proposals for what should be included in transition plans under the Corporate Sustainability Reporting Directive (CSRD) later this year, for example.

The European Financial Reporting Advisory Group (EFRAG), which helps steer the European Commission’s thinking on sustainability reporting, is currently working on draft recommendations that are likely to be based on expectations already set out by the UK’s Transition Plan Taskforce (TPT).

TPT was set up to support the Financial Conduct Authority’s (FCA) efforts to bolster its requirements for such plans as part of broader sustainability disclosures.

While the UK has so far failed to adopt any of its guidance, TPT was recently absorbed by the IFRS Foundation, meaning its recommendations are set to become the global baseline for transition plans under the International Sustainability Standards Board, which IFRS oversees.

Insiders have suggested that EFRAG will build on them in order to produce transition plan standards for the EU that are compatible with emerging global expectations, but take a more explicit approach to double materiality, in accordance with the objective of CSRD.

Pension fund transition plans

While many financial institutions are covered by CSRD, it’s unlikely that any occupational pension schemes will fall into scope – the rules only apply to schemes registered as public companies, and even they have to meet other criteria, including significant employee thresholds.

So EFRAG’s guidance will only have indirect implications for pension funds, forcing their portfolio companies to explain if and how they plan to manage the climate transition and align with net zero by 2050.

Given that pension funds were also removed from the Corporate Sustainability Due Diligence Directive (CS3D) at the last minute, there are no EU-level requirements for schemes to produce climate transition plans.

The EU’s Platform on Sustainable Finance, which advises the Commission on its sustainable finance agenda, is due to publish recommendations for finance-sector transition plans next month, seeking to clarify expectations and map existing efforts in the space.

It’s unclear whether pension funds will be addressed as part of that initiative.

Elsewhere, the UK’s Department for Work and Pensions (DWP) is expected to launch a long-awaited review on the effectiveness of its broader climate reporting rules by the end of the year, which observers say will explore whether they should be extended to cover smaller schemes and whether they should have stronger requirements for transition plans.

The newly-elected government said in its manifesto that it would set to work “mandating UK-regulated financial institutions – including banks, asset managers, pension funds, and insurers – and FTSE 100 companies to develop and implement credible transition plans that align with the 1.5°C goal of the Paris Agreement”.

If it executes on this promise, it would mean transition plans would become more than a disclosure requirement – there would be rules to ensure they were enacted.

This evolution tracks what’s already started in Europe: CSRD requires entities to be transparent about their climate plans, but those covered by the CS3D must also demonstrate that they are achieving them.

A spokesperson for the UK Pensions Regulator (TPR) told IPE: “We are aware of the manifesto commitment and that government is exploring requirements in relation to transition plans for listed companies and financial institutions, including pension schemes.”

“This underscores the importance of effective transition planning in the achievement of the UK’s net zero ambitions and the management of climate-related financial risks. Government will provide further information about its plans in due course.”

There are currently no legal requirements for pension scheme trustees to produce transition plans, but Mark Hill, TPR’s head of climate and sustainability, published a blog earlier this year encouraging trustees and their advisors to familiarise themselves with the guidance published by TPT.

Pension plans regulated by the FCA (as well as asset managers and life insurers) must already disclose information in line with the recommendations of the Taskforce on Climate-related Financial Disclosures, which include some minimal references to transition plans.

It is expected to strengthen these expectations once the UK government officially endorses the ISSB – slated for 2025 – at which point it will be free to undertake a broader update to its sustainability disclosure rules.

Stuart O’Brien, a partner at London-based pension law firm Sackers, describes the UK’s current climate reporting requirements as “a force for good”, but warns that ramping them up too much more could turn them into a box-ticking process.

To avoid this, he suggests regulators should consider replacing some of the existing metrics “that may be quite arbitrary for very mature DB schemes with large allocations to LDI” with an obligation to explain the broader transition strategy.

“There might be some merit in swapping over to something that captures climate risk management better,” he said. “But if they just put transition plans on top of everything else, I don’t think that will be particularly welcomed.”

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