On 26th August 2020 the Government published a consultation on policy proposals to require trustees of the largest occupational pension schemes, and all authorised master trust schemes, to address climate change risks and opportunities through governance and risk management measures.
The measures must be in line with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD).
The idea is that these schemes will set a benchmark of good practice and that their market power will drive improvements in the flow of data necessary for high-quality climate risk governance.
Background
The Pensions Climate Risk Industry Group (PCRIG) is a group with representation from industry, civil society and government. It provides guidance for pension scheme trustees on integrating climate-related risk assessment and management with their decision-making and reporting.
It’s clear in its view that all schemes face climate-related risks, irrespective of the way they invest or the estimated duration of liabilities. Its view is that this applies “whether investment strategies and mandates are active or passive, pooled or segregated, growth or matching, or have long or short time horizons”.
Linked to this is the idea of measuring ‘portfolio warming’ or the ‘implied temperature rise’ (ITR) of investment portfolios. This is also sometimes referred to as ‘degree warming’, ‘temperature score’, or the ‘portfolio warming potential’.
The idea is that financial institutions can model the likely global average temperature rise above pre-industrial levels with which their holdings are consistent. The outcome of this modelling is a single metric, for example a portfolio may have an ITR of 3°C. Trustees can then compare this against current public policy measures aimed at limiting the global average temperature increase to well below 2°C.
The Government supports the PCRIG’s thinking and sees value in occupational pension scheme trustees taking steps to understand their portfolios’ ITR and making it public.
Proposals
Trustees of schemes with assets of £5bn or more (along with authorised master trusts and any new collective money purchase schemes) must put effective governance, strategy, risk management and accompanying metrics and targets in place for assessing and managing climate risks and opportunities from 1st October 2021.
They will then have to report on these in line with the TCFD’s recommendations by no later than 31st December 2022. This report will be included in the relevant Trustees’ Annual Report and Accounts.
This proposal dovetails with the Government’s Green Finance Strategy, and its expectations of large asset owners in relation to the TCFD. This obligation will be extended to schemes of £1bn or more in assets from 1st October 2022, with a report in line with the TCFD’s recommendations due no later than 31st December 2023. Once this is achieved, the DWP is clear that more than 75% of assets, and 80% of members, would be in schemes subject to the requirements.
The Government will then take stock in 2024 and consult on the extension to all other schemes. It has been clear that its view is that “no pension scheme is too small to make a difference” but it will take into account both the quality of climate risk governance and also the current and future costs of compliance.
Practicalities
The Government will only set out broad requirements in the regulations, with statutory guidance expected to list the steps that schemes are required to meet and the items they must report on.
Initially trustees will only be required to carry out scenario analysis, calculate metrics and report against trustee-set targets “as far as they are able”.
They will be required to obtain data from their asset managers and, in turn, from investee firms on emissions and other characteristics. There is the recognition that schemes may face difficulties in acquiring full data for their portfolio, at least in the early days.
Disclosure
Trustees will be required to publish their TCFD report on their own website (or the website of the scheme’s sponsor).
As these reports could be quite long and detailed, the proposal is that they don’t need to be presented in full in the Trustees Annual Report, but they will need to be referenced in it as a key financial disclosure.
Members are to be told that this information has been published and how they can find it in their annual benefit statements. Defined benefit schemes that may only produce such a statement on request will only be required to add a link to any that are issued to members.
Trustees will also be required to provide The Pensions Regulator with the address of the website that they have published their TCFD report on via the annual scheme return.
Penalties
A mandatory penalty will apply for a complete failure to publish any TCFD report.
Other penalties relating to failure to produce a report that’s fully compliant will be at The Pensions Regulator’s discretion.
Next steps
The consultation closed on Wednesday 7th October 2020 and the Pension Schemes Bill in Parliament contains provisions to legislate for this change in clause 124. Every indication that we have seen is that final regulations to set out the details will be drawn up early next year.
Capita comment
The fact that these requirements do not apply to many schemes, and are unlikely to for some years, may lead them to kick the issue into the proverbial long grass. This may be a mistake as it is clear that the Government intends to make changes, and they will already have provisions in their Statement of Investment Principles on financially material considerations that link to climate risk that they may have to report on. At the very least, therefore, it will be appropriate for trustees to review their knowledge and understanding around this issue and investments in general now.
Trustees of schemes that may be aiming to transfer their money purchase members to an authorised master trust should consider asking their candidate scheme or schemes what their plans are and what they may be planning in the future.
Please speak to your usual Capita contact if you would like assistance.