News | March 7, 2024

PART 4 – Climate Update – The latest issues concerning pension scheme investment duties and decisions

  1. Financial Markets Law Committee (FMLC) paper: Navigating Sustainability and Climate Change in Fiduciary Decision-Making

The recent FMLC paper published on 6 February 2024 “Pension Fund Trustees and Fiduciary Duties – Decision-making in the context of Sustainability and the subject of Climate Change” throws a spotlight on a critical challenge for trustees today: balancing trustee fiduciary duties with the growing imperative to integrate sustainability and climate considerations into their investment strategies.

The paper highlights a number of key points around integrated risk management as regards climate change risks, in particular, since the advent of legislation introducing climate risk-related governance and reporting requirements. 

  • Trustee fiduciary duties under scrutiny: The paper clarifies that fiduciary duties remain paramount, requiring trustees to act in the best interests of beneficiaries.  The paper notes that these duties evolve with changing circumstances, and trustees must adapt and respond to these circumstances in accordance with their fiduciary duties.  Trustees should not rely alone on complying with legislative requirements, as this approach fails to address all risks. 
  • Climate Change as a Financial Risk: The paper states climate change presents real and material financial risks to investments, impacting asset values, company operations, and broader market stability.  Neglecting these risks could compromise returns and potentially breach trustee fiduciary duties. 
  • Integration, Not Exclusion: The paper advocates for integration of sustainability and climate factors into the investment process, not exclusion of specific assets.  The aim here is to ensure trustees remain focused on risk-adjusted returns whilst considering relevant environmental, social and governance (ESG) factors. 
  • Importance of Robust Frameworks: The paper highlights the need for robust frameworks and processes to support informed decision-making on sustainability and climate.  This includes comprehensive risk-assessments, clear investment policies, and effective engagement with companies. 
  • Collaboration and Guidance: The paper encourages collaboration between trustees, asset managers, and other stakeholders to share best practices and develop effective implementation strategies. 

Whilst not setting out all and every action trustee boards should take around climate risk, the following key areas are addressed as a potential way forward:

  • Trustee knowledge and understanding: Under the Pensions Act 2004, trustees have a fundamental duty to ensure they possess sufficient knowledge and understanding of the law relating to pensions and trusts, as well as the principles relating to the funding of occupational pension schemes and the investment of scheme assets. This includes trustee fiduciary duties towards pension scheme members.  The FMLC paper suggests trustees must address any gaps in their knowledge and understanding relating to the management of climate and sustainability risks.  Accordingly, upskilling on ESG integration and related risks is crucial. 
  • Investment strategy: The paper states: “It may be necessary to consider whether a strategy should reject shorter term gains because they create identifiable risks to the longer term sustainability of investment returns in the fund“.  Furthermore, the paper states: “The risks and uncertainty for pension fund trustees may be less if an investment strategy looks for investees who approach, or would as a result of investment approach, sustainability and the subject of climate change in a manner that supported the approach of the pension fund“. It is therefore imperative that trustees consider any investment strategy in the light of sustainability and climate considerations, striking a balance between risks and returns. 
  • Robust governance: The paper suggests that strong governance frameworks and processes are essential to ensure sound investment decision-making on sustainability and climate related matters. 
  • Engagement and collaboration: The paper states: “Pension fund trustees are able to discuss with their advisers and investment managers, whether there are appropriate, lawful, cost-effective steps available to be taken in collaboration and coordination with other pension funds“.  The paper notes the importance of contributions from advisers and investment managers.  Where trustees seek such guidance, it is likely beneficiaries will be even better served. 

The FMLC paper provides both a timely and valuable resource for pension trustees navigating the increasingly complex landscape of sustainability and climate change.  By integrating these factors into their decision-making processes and upholding their fiduciary duties, trustees can contribute towards a more sustainable future by adopting a proactive approach to integrating sustainability and climate factors into investment decisions and secure the long-term financial well-being of pension scheme beneficiaries.  The FMLC paper is clear that it is reasonable and appropriate for trustees to take climate change into account, as regards the financial position of a scheme. 

  • ClientEarth warns UK Pension Funds on Climate Risk

In December 2023, the non-profit environmental law organisation ClientEarth issued a letter entitled “Your bond investments and climate change” to the trustees of the UK’s 12 largest pension funds regarding their potential breach of their legal duties and obligations due to insufficient attention to climate risk.

ClientEarth’s letter focuses on a scheme’s bond holdings and states that, in line with their legal duties, trustees should take action to:

  • Cease providing capital through bonds to any energy sector company unless:
    • The company has a just and credible net zero transition plan – this includes specific targets ending use and support of fossil fuels in line with internationally agreed pathways; and
    • The bond documentation includes covenants requiring implementation of the transition plan (‘Bond covenants’)

These are known as the ‘Investment Conditions’.

  • Exercise effective stewardship in relation to the implementation of the transition plans of investee energy sector companies; and
  • Communicate the Investment Conditions to all current and prospective investee energy sector companies. 

ClientEarth has argued that neglecting climate change exposes pension fund trustees to significant financial risks, potentially breaching their duties to act in the best interests of beneficiaries.  In particular, the warning addresses three key issues, as foundations for the above requested actions: (1) legal duties of trustees; (2) risk posed to the pension scheme by investing in fossil fuels; and (3) tools for mitigating climate risk through debt portfolios.   

So far, the issue with ClientEarth’s arguments has been the potential friction between ensuring that investments are in sustainable risks, without sacrificing returns for beneficiaries.  Commentators have also taken issue with ClientEarth’s wide interpretation of the legal and fiduciary duties of trustees as regards the global financial system rather than the narrower interpretation concerning the investments held for the benefit of pension scheme beneficiaries. 

Nevertheless, ClientEarth’s ‘preferred approach’ for pension scheme trustees going forward involves the following aspects:

  • Active Engagement with Fossil Fuel Investors: The letter notes that “continued investment in bonds issued by companies involved in fossil fuel projects… poses significant financial, legal and reputational risks to the scheme“.  The letter suggests pension fund trustees should utilise their bond investments to push companies towards credible climate transition plans through active engagement strategies. 
  • Developing Effective Climate Engagement Strategies: Trustees need to establish robust systems for assessing and managing climate risks, including clear policies and effective engagement approaches with investee companies. 
  • Transitioning Portfolios Towards Net Zero: ClientEarth urges pension funds to align their investments with a net-zero emission future, gradually divesting from high-carbon assets and prioritising sustainable alternatives. 

It remains to be seen whether ClientEarths plea to the trustees of these pension funds leads to any material change in approach to transitioning scheme investments to net-zero and scheme climate strategies, or whether investment strategies will pursue the same cause with a focus on gradual, rather than fundamental, change.    

  • TPR Blog: Trustees to  “take stock and plan for wider ESG risks and opportunities” (21/02/24)

TPR has recently published a blog post urging pension scheme trustees to:

  • Take stock” and consider expanding their approach to managing ESG factors, which go beyond climate change to encompass nature related risks and disclosures, together with social factors.
  • Integrate ESG considerations into core governance operations.  This means considering ESG risks and opportunities in investment decisions, risk management, and member communications. 
  • Develop transition plans to address climate-related risks and opportunities, and potentially nature and social factors where they are material. 

The blog sets out a number of key legal aspects relating to ESG factors:

  • The importance of the trustee duty act in the best interests of scheme members.  This includes considering ESG factors, as they can have a significant impact on the long-term sustainability and returns of investments. 
  • Regulatory requirements for ESG reporting are expanding.  Failure to account for material ESG risks and opportunities could put savers at risk and lead to regulatory action. 
  • There is no one-size-fits-all approach to ESG.  Trustees should consider the specific circumstances of their scheme and members when developing their approach. 

Before considering the various action points set out in TPR’s blog, trustees may wish to consider taking the following preliminary actions as part of ensuring their governance processes are fit for purpose when considering ESG factors:

  • Reviewing existing ESG policies and procedures.
  • Assessing the materiality of ESG risks and opportunities for the scheme.
  • Developing an ESG implementation plan, including specific objectives and targets.
  • Seek professional advice and training on ESG issues if necessary.
  • Engage with members and stakeholders on ESG matters.
  • Monitor and report on progress regularly. 


A recent surge in commentary and guidance underscores the growing significance of environmental, social, and governance (ESG) factors, particularly climate change, in pension scheme investment decisions. The Financial Markets Law Committee (FMLC) paper and The Pensions Regulator (TPR) guidance emphasise the need for trustees to navigate this evolving landscape by balancing their fiduciary duties with these considerations. This includes integrating ESG factors into core governance practices, potentially developing transition plans, and seeking professional advice to ensure informed decision-making.

While ClientEarth advocates for divestment from fossil fuels and stricter climate transition plans, their approach faces potential tension with maximising returns for beneficiaries. Consequently, navigating this complex environment necessitates careful consideration of the legal aspects, engagement with relevant stakeholders, ongoing monitoring of progress towards achieving a sustainable and responsible investment strategy and obtaining and considering advice as appropriate in these areas.

The 6th March 2024 Budget proposals re DC schemes (see the Introduction to this Pensions Compass) potentially up the stakes in this area.