Pensions first in move toward UK mandatory climate risk reporting

And it is the government pensions department – the Department for Work and Pensions (DWP) – that made the move in August, launching a consultation on proposals targeting “taking action on climate risk” by occupational pension schemes.

Indeed, although many reports on the consultation focus on the mandatory reporting aspect as a convenient shorthand for its content, the reporting requirements are in a way secondary to the expectations relating to risk management and governance. 

In one part of the consultation document, the DWP puts it this way: “We consider the adoption of effective climate risk management, comprehensive governance processes and techniques such as scenario analysis and calculation of metrics to be as integral to the implementation of the TCFD recommendations as the disclosures themselves.”

Claire Jones, partner and head of responsible investment at pensions and investment consultancy LCP, says trustees “shouldn’t be fooled by the words ‘governance’ and ‘reporting’ in this consultation. This consultation is about action.”

Jones was one of several advisers reacting positively to the consultation on the day of its launch. 

“We know that climate change is a huge risk for pension schemes and the DWP has reached the conclusion, which I agree with, that schemes are not yet acting fast enough, given the severity of the threat,” she tells IPE.

“It’s going to be mandatory for the larger schemes if the proposals go through as planned, but I think it will have a really significant influence on pension schemes of all sizes because it will set clear expectations in terms of what schemes should be doing.”

The Pensions and Lifetime Savings Association (PLSA) has been doing a lot of work on climate change-related investing this year. Joe Dabrowski, its head of DB, LGPS and standards, says the association is “overall quite supportive of the direction of travel”. By this he means the move towards a clear and common framework and “a more settled way of doing things”.

From the PLSA’s perspective, a key point is that there should be a common reporting framework across the investment chain. 

“The industry is very clear that it is keen to demonstrate that it is actioning the climate change challenge,” says Dabrowski. “It isn’t a simple solution, and pension schemes are only part of the overall picture and the landscape they’re operating in is heavily intermediated.” 

He notes that there are no TCFD-based reporting obligations for asset managers and that “there’s some optionality coming through” in Financial Conduct Authority consultations on climate-related disclosure requirements for listed companies.

At responsible investment campaign group ShareAction, UK policy manager Rachel Haworth says the DWP has shown leadership as the first government department to require entities within its remit to report publicly on how they are managing the financial risks associated with climate change. But she adds a caveat. “For this proposal to be fully effective, pension funds will need the companies in their portfolios to report climate-related financial information,” she says. 

“We expect other government departments to follow DWP’s example within the shortest realistic time frame and introduce legislation that will require all other market participants to report against TCFD.”

What do the proposals imply in terms of reining in global warming to Paris Agreement levels? 

It should be said that this is not the DWP’s aim, at least according to the policy objective stated in its impact assessment document accompanying the consultation.

“The policy objective is to ensure effective governance of climate change as a financially material risk and opportunity to pension schemes and their members’ savings,” it states.

“The intended effect is a UK pensions system that has resilience to both transition and physical climate risk, in the same way that interest rate or inflation risk are embedded in decision making processes.”

On the other hand, when unveiling the DWP’s proposals in a speech in Glasgow, work and pensions minister Thérèse Coffey appeared to make a link to the fight against climate change itself. She said the consultation “marks one of the most significant steps to date in the UK’s pioneering progress on tackling climate change”.

And in explaining why the DWP was not calling for “complete divestment”, she said “we see this overly simplistic approach actually making it harder to achieve net zero”.

Asked what the consultation proposals mean for the fight against climate change, LCP’s Jones says they would “help to an extent” and that if they didn’t do more, then it would be for reasons consistent with the DWP’s approach of not directing how pension schemes should be investing.

“Pension scheme trustees will take more action than they otherwise would have done but, because not only is there no requirement to align with the Paris Agreement but there isn’t even a specific requirement to comment, it seems unlikely it will go far enough to achieve that alignment in the first place,” she says.

The DWP has been looking into the issue of reporting on alignment with the Paris Agreement. However, it said it was holding off on consulting on this until “the near future” when better methodologies are likely to be available which would be more useful for trustees. 

At the same time, the DWP has said its current consultation would “signal an intent” that schemes report on the extent to which their portfolios were aligned with the Paris Agreement. 

For some people, this is good news. “If they’re keeping that open, then I think that’s exactly the direction they should go in and, of course, COP26 provides this wonderful moment to go a bit further and a bit more quickly,” says Ben Caldecott, founding director of the Oxford Sustainable Finance Programme and COP26 strategy adviser for finance at the UK cabinet office.

LCP’s Jones says qualitative reporting on alignment would be helpful but a move to mandate that brings into focus potential conflicts in objectives.

“On the one hand, the government has the objective to meet its Paris Agreement targets that’s set out in law, but on the other, pension schemes have a duty to deliver pensions for their members and within that framework it’s not necessarily clear you would deliver the best outcome for members in a narrow sense by aligning with the Paris Agreement, especially if you’re a pension scheme with a short time horizon,” Jones says. “So there is a tension there.”