Part 2 – Pensions and Climate Change – a fair COP?

24 / 11 / 2021

Over the last two years we have witnessed significant climate change developments for UK occupational pension schemes. This has been driven by a desire to secure effective governance and reporting requirements with respect to the effects of climate change as well as promoting a “green” investment imperative for sponsoring employers, trustees and members alike. Please see two articles from Pensions Compass March 2021 and July 2021.

What is COP?

The 2021 United Nations Climate Change Conference or the 26th “Conference of Parties” – COP26 as its more commonly referred to, recently concluded in Glasgow. This annual meeting of governments who have signed up to the United Nations Framework Convention on Climate Change (UNFCCC) provides a forum for discussion, negotiation and most importantly reaching agreement on goals and targets as between the Parties in the global fight against climate change. The first COP meeting was held in Berlin in March 1995 with COP26 being delayed for a year because of the pandemic – early reports suggest that COP26 is a game changer.

Paris Agreement alignment

COP21 which was held in Paris in 2015 is notable because of the successful negotiation of the Paris Agreement which saw over 174 countries agree to (amongst other things) limit global warming to well below 2°C compared to pre-industrial levels and pursuing efforts to limit this temperature increase to 1.5°C. It is commonly accepted amongst scientists that the 1.5°C goal requires zero carbon emissions sometime between 2030 and 2050 (i.e. not adding to the amount of greenhouse gases in the atmosphere).

On 21st October 2021 the DWP launched a consultation seeking views on its policy proposals which will encourage trustees to align investment portfolios with the Paris Agreement. This appears to be a direct reaction to COP26 and will require trustees to devise and disclose such an alignment metric.

The consultation was accompanied by draft regulations, statutory guidance and non-statutory guidance explaining the DWP’s expectations on implementation statement reporting and the statement of investment principles (SIP). The proposals follow industry calls for “methodological flexibility” and the DWP said trustees will be supported every step of the way.

It’s early days in terms of the consultation process but generally alignment metrics are a very welcome and positive development in the role of pension schemes contributing and being accountable with regards to the UK achieving its net zero targets, particularly given their huge investing power.

Environment Social and Governance (“ESG”) Stewardship

The DWP has also produced draft guidance on stewardship, aimed at both financial and non-financial aspects that pension trustees are being encouraged to engage with. The consultation documents stated that, despite the rising prominence of ESG investing within pension schemes, SIPs are not showing the necessary levels of stewardship needed to deliver ESG targets. This is something which the DWP accounts to the “UK’s particularly fragmented pensions system”.

Member Engagement

The regulatory framework holds pension trustees accountable to their ‘green’ objectives. However, it is important that trustees also remain focused on their duties to members. COP26 and the green movement has seen a huge shift in the minds of individuals. From young protestors petitioning against the UN Secretary-General to the Extinction Rebellion movement, consumers are holding industries to account. Trustees should therefore take into account the members’ views and objectives on investment against the regulatory backdrop. Effective communication with members is one way that they can do this. Through communication trustees can show what they are doing in pursuit of ESG goals, but also help communicate with members who may be less ‘green’ conscious of the benefits of this shift in focus.

Of course, members will have different considerations and values when it comes to their investments. In making decisions trustees should therefore consider factors including the age of members, members appetite in ESG and the industry the principal employer operates in. DWP’s proposals on “mandatory” reporting will not guarantee a shift in investment focus alone – broader, intergenerational member engagement is needed to push through meaningful change. Of course the underlying duty of the trustees is to maximise the long term financial returns for members. The question is to what extent you can align this trustee duty with ESG considerations. As the green movement continues to grow, it seems likely that investment in the ‘green industry’ will also result in the best return to members. This will be a win-win for members allowing their ethical and financial goals to align and given the rhetoric flowing from COP26, it may not be too long before trustees’ green investment duties are hard-coded in legislation.

Another consideration is the extent to which trustees should align with the ESG values of the principal employer. Principal employers will have their own duties on tackling climate change, as well as reputational issues to consider.  

WB comment

Is this how our story is due to end? A tale of the smartest species doomed by that all too human characteristic of failing to see the bigger picture in pursuit of short term goals.”

David Attenborough, COP 26

The quote above doesn’t really need much explanation or commentary. The days of lip service to yet another reporting or governance regime are long behind us. Seismic movement is needed across all aspects of society if the damaging effects of climate change are to be reversed. More is needed but it seems that the UK pension industry is on the right track.