I’m a trustee of a small defined contribution pension scheme and I’m acutely aware of the growing challenge of climate change and the risks that it can potentially create for my scheme’s investments, which will ultimately impact members.
Why should we care?
In August, the Intergovernmental Panel on Climate Change (IPCC) released its Sixth Assessment Report on the science of global warming, and the first report published since 2013. Some of the key findings of the report made for disturbing reading, and the United Nation’s (UN) Secretary-General, António Guterres, called it a “code red for humanity”. The findings were reviewed by representatives from 195 countries, and will form the basis for negotiations at the UN’s Climate Change Conference, known as COP26, taking place in Glasgow in November. The biggest single takeaway is the significant climate change that’s occurring in our lifetime, and urgent steps need to be taken to limit the effects.
IPCC scientists believe it is now “indisputable” that human activities are causing the climate to change dramatically, and that people are responsible for the world warming up by 1 degree Celsius (C). Scientists also believe almost all emissions of greenhouse gases comes specifically from the extraction, transport and use of fossil fuels, as well as from agriculture and farming.
The report suggests weather-induced disasters are likely to become more severe, as each fraction of temperature warming brings greater rainfall and rising sea levels, as well as intensifying droughts and wildfires.
This creates challenges for pension schemes. The physical risks posed by climate change, such as extreme weather events, is leading to global policy response, which in turn is creating transiton risks, as companies have to reduce their carbon emissions. The effects of this transition away from carbon intensive sectors, and overall decarbonisation will impact a large majority of a pension scheme’s funds and constituent holding companies or issuers.
The power of pension schemes
I believe that UK pension schemes are in a unique position to drive change, whilst also focussing on the risks of climate change to their investments. The UK pensions market is the third largest in the world, overseeing over £2.5 trillion of assets. This is a tremendous responsibility and collectively gives pension schemes the power to make a real difference in driving the climate agenda with their asset managers.
In October this year, pension schemes over £5bn in size, and all master trusts, have to report on their climate risks in line with the Task Force on Climate Related Financial Disclosures (TCFD). These rules apply to all schemes over £1bn in size from October next year. However, this has created a misalignment between pension schemes and asset managers. For me, this reinforces the importance of pension schemes creating their own independent viewpoint of how their investments are impacted by the physical and transition risks of climate change.
Climate change will continue be high on the regulatory agenda and likely to be more so as the UK hosts COP 26 this year.
Steering a path to independence
Managing the risks of climate change will be a critical factor for UK pension schemes, especially to protect member pensions pots. They will need access to good quality data on the environmental impact on their investments, including scope 1, scope 2 and scope 3 carbon emissions for both pooled funds and segregated mandates. Once schemes can measure their carbon footprint, and understand other environmental factors, they can then address their exposure to the risks of climate change.
Staying on the theme of independent data, I think it’s important that pension schemes develop an independent viewpoint of their climate risks that’s separate from their asset managers. This creates the conditions for stronger stewardship and engagement between a scheme and its asset managers on the topic of managing climate risks.
Climate knows no boundaries
In a nutshell, climate change risks know no boundaries and will impact schemes of all shapes and sizes.
As a trustee, taking action to address climate change challenges of the physical and transiton risks from my scheme’s investments will be key to protecting my members pension pots. That’s because the risks of climate change are real - through rising heatwaves, droughts and flooding in different parts of the world, creating real impacts for companies and their supply chains, not to mention the challenges and investment that companies face when transitioning from fossil fuels to renewables. There will be winners and losers.