In the major financial markets, trustees and managers of occupational pension funds are facing new legal and regulatory requirements to take full account of the impacts of climate change on their investments. These developments will have a significant impact on the investment policies of trillions of dollars worth of assets, and this will, in time, make a major difference to the energy transition, the context for investment in fossil fuels as against renewable and sustainable technologies and thereby climate change itself. In the short term these new and important responsibilities are a matter of high priority for trustees and managers.
Even if they wanted to, trustees and managers of pension funds are now not legally able to ignore the climate changes in the world outside.
In the United States, for example, Trump Administration Executive Orders severely restricted the scope of pension fund managers to take account of wider Environmental, Social and Governance ‘ESG’ issues in selecting pension plan investments. These rules were comprehensively reversed on 20 May 2021 by a Biden Administration ‘Executive Order on Climate-related Financial Risk’. This will include obligations on the Secretary of Labor to conduct specific reviews of U.S. ERISA pension fund legislation and similar laws applying to Federal employees retirement savings, with a view to protecting these savings and pensions from climate-related financial risk.
In the UK, section 124 of the new Pension Schemes Act 2021 will place new legal obligations concerning climate change on the trustees and managers of occupational pension schemes. The section allows for regulations to set out legal requirements to ensure that schemes have effective governance with respect to the effects of climate change. Trustees and managers will need to address both the risks and opportunities of climate change, to make detailed provisions about this in the governance of their schemes and to be able to publish information on the steps taken.
The UK government expects trustees and managers to be in a position to make disclosures in line with the Task Force on Climate-Related Financial Disclosure (TCFD) and the government’s Green Finance Strategy. The TCFD requires accurate and full information on climate impacts and climate risks, under the headings of GOVERNANCE, STRATEGY, RISK MANAGEMENT and METRICS AND TARGETS, with the underlying aim of ensuring that climate risk is properly factored into every financial decision. It is likely that final regulations under the Pension Schemes Act 2021 will follow the same model.
Explanatory Notes to the new legislation state that –
…”regulations may require that trustees or managers take into account the different ways in which the climate might change and the steps that might be taken as a result, including with regard to climate change goals such as the goal in Article 2(1)(a) of the Paris Agreement of holding the increase in the average global temperature to well below 2oC above pre-industrial levels…”
The Pensions Regulator will be given new enforcement powers to address compliance with these expectations. The Notes make clear that the long term objective is to protect scheme members’ benefits against the physical risks of climate change, and to ensure that proper account is taken of the real risks and opportunities involved in the transition to a lower-carbon economy.
This is a very different and much wider view of the full fiduciary duties of trustees and managers than before.
However, this wider view of their responsibilities was underlined by The Pensions Regulator on 7 April 2021 in its “Climate change strategy” document. This sets out a number of Objectives, including the expectation that schemes will publish their statement of investment principles implementation statement and “for those in scope their TCFD report”. Obligations will apply first to the largest schemes, but quite soon to smaller schemes. The Pensions Regulator will be issuing guidance on its approach to TCFD regulations, and, before the COP26 climate negotiations in November, its own Climate Adaptation Report. As it states –
“The world of green finance is moving incredibly quickly and debates around divestment versus engagement, ‘greenwashing’, standards and metrics are real and complex. Savers are increasingly showing that they too are interested in understanding where their pension savings are being invested and the impact of these investments.”
Let us step back for a moment from the detailed regulatory advice, but hold onto to the idea that trustees and managers of pension funds have new and much wider legal responsibilities to factor in a wide range of climate change risks to their schemes and investments. Then consider four facts.
First, Mark Carney as Governor of the Bank of England, and now UK and UN Climate Envoy has specifically warned that as much as 80% of investments in coal and 50% of investments in oil could become “stranded assets” if Paris Agreement targets are enacted and met.
Secondly, the International Energy Agency ‘IEA’ in its May 2021 report ‘Net Zero by 2050’ concluded that net zero would only be reached by an immediate cessation of all further development of coal mines, coal mine extensions and exploration and development of oil and gas.
Thirdly, the Intergovernmental Panel on Climate Change ‘IPCC’ report of August 2021 on the physical science basis for climate change was described by the UN Secretary General Antonio Guterres as “code red for humanity” and he declared that it should sound the death knell for fossil fuels and called for an end to investment in coal, oil and gas.
Fourthly, on 21 April 2021 Mark Carney, with support from US Climate Envoy John Kerrey, US Treasury Secretary Janet Yellen, UK Chancellor of the Exchequer Rishi Sunak, launched the Glasgow Financial Alliance for Net Zero (GFANZ), with 160 firms responsible for assets in excess of $70 trillion becoming accredited to the UN Race to Zero campaign, allied to the Net Zero Banking Alliance and the Net Zero Insurers Alliance.
In the past, trustees and managers of pensions funds might have noted these scientific, economic and political developments as “noises off”, and continued to apply their own view of their fiduciary duties as requiring them to maximise the return on their investment. But now they surely cannot ignore the “world outside their door” or their own legal responsibilities to reflect these climate risks (and opportunities) in the management of their schemes, for example when considering investments in the continued production of fossil fuels.