With the onset of Spring, the environmental social and governance (“ESG“) landscape for pension scheme sponsors and trustees continues to change. In this update, we have provided a brief roundup of four key ESG developments and provide some insight into where these developments may lead to for the remainder of 2023 and beyond.
1. The Pensions Regulator’s (TPR) review of Pension Schemes’ Climate Reports (23 March 2023)
TPR has published a review of a selection of pension schemes’ annual climate reports. The review has revealed some good practice on the one hand and several areas for improvement on the other.
Since 1 October 2021, the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021, SI 2021/839 require trustees of all authorised master trusts and larger DB, DC and hybrid schemes with relevant assets of £5 billion or more to report on various climate-related matters. From 1 October 2022, DB, DC and hybrid schemes with assets worth more than £1 billion are also required to report on such matters. The requirements have been brought in because, according to the report, “There is no doubt that climate change will continue to pose a core financial risk to business, the economy, and markets for some time to come“.
The Government has said it will consider whether to extend the rules to smaller schemes from late 2024/early 2025.
As a result of the review, TPR identified the following positive examples of trustees taking appropriate action:
- preparing climate and sustainability training for trustees and others involved in scheme governance about climate-related risks and opportunities;
- developing a trustee policy on investment beliefs in relation to climate change;
- working with investment managers to obtain better data;
- allocating more funds to sustainable investments;
- using stewardship to manage climate-related risk; and
- switching to climate-tilted pooled funds.
TPR also found that 43 of the 71 reports analysed had also set a formal net-zero emissions target.
Conversely TPR identified some common areas for improvement:
- a lack of sufficient background information on the scheme, meaning disclosures were difficult to interpret;
- some disclosures of strategy, scenario analysis and metrics activities not having the appropriate level of detail, as set out in the Department for Work and Pension’s (DWP’s) statutory guidance; and
- various accessibility issues that could make it difficult to find reports online, including long or complicated web addresses and use of PDFs that are not compatible with reader accessibility software.
Some reports missed the disclosures required by DWP’s statutory guidance. TPR has recognised that this is new territory for trustees but warned that it will consider enforcement action if these problems crop up in the next round of reporting. Trustees of appliable schemes who fail to publish their climate report are subject to a mandatory fine of at least £2,500. If it is clear that the trustees have not complied with the regulations in preparing their climate report there may be a discretionary fine of up to £5,000 for individual trustees and up to £50,000 for corporate trustees.
2. TPR launches regulatory initiative on monitoring climate and ESG non-compliance (TPR statement, 22 February 2023)
As a further measure, TPR is launching an initiative to ensure trustees are publishing important data on ESG. Trustees of schemes with more than 100 members (unless exempt) must publish a statement of investment principles (“SIP“) and an implementation statement (“IS“). A SIP details the policies dictating how a scheme invests, including consideration of financially material ESG and climate factors. An IS shows how the principles in the SIP have been implemented. TPR is analysing data contained in Scheme Returns to monitor compliance.
TPR’s initial analysis of the 2022 results show that a number of schemes did not provide valid website addresses of the SIP and IS statements. Nicola Parish (Executive Director of Frontline Regulation at TPR) has said: “Trustees who fail to comply risk us taking enforcement action against them and I expect to see an improvement in compliance levels”. TPR has the power to impose fines of up to £50,000 for breaches (where the trustee is a corporate body).
A review of a cross-section of SIP and IS statements will follow in the summer, the outcome of which will be shared with the industry to highlight good practice.
3. Pension investors support for ClientEarth’s Court proceedings v Shell PLC
The environmental law charity and Shell PLC (“Shell“) shareholder, ClientEarth, has filed a Part 7 claim in the High Court against against the Board of Directors of Shell. As part of the claim, ClientEarth alleges that Shell’s board of directors are in breach of their fiduciary and legal duties under the Companies Act 2006 in respect of Shell’s climate strategy, which ClientEarth states is inadequate in meeting climate targets. ClientEarth also alleges that Shell’s energy transition plan does not align with the targets set out in the Paris Agreement (which sets a goal of keeping global warming below 1.5C).
Shell has publicly announced that it does not accept the allegations, alleging that its directors have acted in accordance with their legal duties.
On 8 November 2022, NEST Corporation published a letter in support of ClientEarth’s anticipated claim against Shell in respect of their alleged failure to manage the “material and foreseeable risks posed to the company by climate change“. As a UK DC scheme with over 11 million members and assets of over £25 billion, NEST’s letter refers to the fact that the board of directors should consider their “fiduciary duty to act in the best interests of our members when making investment decisions“. The letter is critical of Shell’s management of climate related risks, the current lack of effective action to seriously transition the business away from fossil fuels and casts doubt on Shell’s ability to get on track to achieve the goals set out in the Paris Agreement by 2050 or earlier.
Alongside NEST, London CIV (which manages the assets of the London Local Government Pension Scheme) has also voiced support for ClientEarth’s claim against Shell, citing that Shell has failed to adopt a reasonable or effective strategy in managing climate risks affecting the company.
4. TPR publishes blog on expectations around ESG and climate change reporting (14 April 2023)
Nicola Parish has explained in a blog why TPR is placing so much emphasis on compliance with ESG duties in 2023. TPR is of the opinion that ESG factors, including climate change, will affect the performance of a pension scheme’s investments in the years to come. TPR have stated that failure to comply with ESG and climate reporting duties ultimately places savers’ pensions at risk. The blog encourages trustees to step up and demonstrate they are taking proper and appropriate steps to safeguard savers’ pensions.
TPR is looking to improve the quality of trustees’ governance and reporting of climate-related risks. TPR expects trustees to have regard to the DWP’s guidance, report on a new portfolio alignment metric and (for trustees that are reporting for the second time) consider scope 3 emissions.
TPR is also keen to see trustees participate in the debate around climate change and wider sustainability reporting. To that end, TPR has stressed that reporting shouldn’t be seen as the end of the matter, for instance trustees should consider developing a climate action plan to focus and inform scheme members.
TPR has called on trustees to ensure that they are aware of TPR’s expectations and have stressed that they have the power to fine those who fall short of compliance.
WB comment
It is clear there may be further challenges to companies (and their respective Boards) following ClientEarth’s claim against Shell. With the introduction of the Pension Schemes Act 2021 and TPR taking a tougher stance on schemes who do not adequately prepare for a switch-over towards a lower carbon economy, both pension scheme trustees and sponsors must adequately plan for this transition, ensure robust processes are in place for doing so and seek professional advice to the extent there are any uncertainties around their ESG obligations.