Climate Risk for Pension Schemes – the regime from October 2021
22 / 03 / 2021
After several years in the making, the Pensions Schemes Act 2021 (the “Act”) has finally received Royal Assent. Whilst much has been written about “beefing up” of the Pension Regulator’s moral hazard powers, another key aspect of the Act concerns climate change and pension schemes. Under the Act, regulations will impose new requirements on trustees “with a view to securing that there is effective governance of the scheme with respect to the effects of climate change.”
Two broad requirements
The Act has introduced two broad sets of requirements relating to the effect of climate change on schemes – governance (including strategy, risk management, scenario analysis, metrics and targets – see below) and reporting (to produce and publish (on a publicly available website) a report on how they have done so). This follows on from the Department of Work and Pension’s (“DWP”) August 2020 consultation, which sought pension industry views on climate risk reporting in line with recommendations of the Taskforce on Climate-related Financial Disclosures (“TCFD”).
Two sets of draft regulations and draft statutory guidance were published on 27 January 2021 and it is expected that these will come into force later in 2021.
TCFD recommendations – a reminder
In 2017, the TCFD published 11 recommendations for all organisations, aimed at identifying, assessing, managing and disclosing climate-related financial risks and opportunities. At their core, these recommendations are focussed on accelerating the world’s transition to a low carbon future.
The regulations under the Act will require trustees to satisfy the 11 recommendations of the TCFD, and to report on how they have done so. When meeting certain of the requirements, trustees must have regard to guidance, with any deviations explained in the report.
The regulations will require trustees to comply with the following areas:
Governance – to establish and maintain oversight of the climate-related risks and opportunities which are relevant to the scheme;
Strategy – trustees must, on an ongoing basis, identify climate-related risks and opportunities which they consider will have an effect over the short term, medium term and long term on the scheme’s investment strategy and where the scheme has a funding strategy, the funding strategy;
Scenario analysis – undertake scenario analysis assessing the impact on the scheme’s assets and liabilities, the resilience of the scheme’s investment strategy and (where it has one) the scheme’s funding strategy for at least two scenarios – one of which corresponds to a global average temperature rise of between 1.5 and 2°C inclusive on pre-industrial levels. This analysis must be carried out in the first year in which the requirements apply to the scheme and at least every three years thereafter. Where a scheme has both DB and DC sections, separate scenario analysis will be required for both the DB section(s) and the DC default fund(s);
Risk management – trustees must establish and maintain processes for the purpose of enabling them to identify, assess and manage climate-related risks which are relevant to the scheme. Trustees must also ensure that management of climate-related risks is integrated into their overall risk management of the scheme; and
Metrics and targets – trustees must select a minimum of one metric which gives the total greenhouse gas emissions of the scheme’s assets, one metric which gives the total carbon dioxide emissions per unit of currency invested by the scheme plus an additional climate change metric. Trustees must also obtain the data necessary to measure their chosen metrics and review their selection from time to time as appropriate to the scheme. Trustees must set a target for the scheme in relation to at least one of the metrics which they have selected to calculate.
As outlined in the DWP’s August 2020 consultation, a phased approach is being employed – schemes with “relevant assets” equal to or more than £5bn together with authorised master trusts and collective money purchase schemes must comply from 1 October 2021. Schemes with £1 billion or more of assets will be in scope from the following year.
The position for smaller schemes will now be reviewed in the second half of 2023, with proposals to be published in early 2024.
Failure to publish a report could result in a minimum mandatory penalty of £2,500. The maximum fine for breach of any of the other requirements would not exceed £5,000 for an individual trustee, or £50,000 for a corporate trustee. This regime will be overseen by, and operated at the discretion of the Pensions Regulator.
The new requirements are not just about reporting and disclosure. They offer more than mere lip service to climate change. Trustees must adopt effective governance systems so they can properly assess and understand what climate change actually means for their particular scheme. This is a real game changer in terms of the UK Government’s efforts in fostering a culture of responsibility and accountability around the subject of climate change. The larger schemes, which will have to comply first, will be able to use their market power to drive best practice from asset managers and advisers, and will make it easier to roll out the requirements to smaller schemes in due course.
However, given the onset of ESG investing we believe that all trustee boards should begin to engage with their advisers on what the new regime could mean for them and how the transition could be managed.