“The potential impact of climate change on investments should be considered at least on an annual basis”

Climate change has major implications for companies across sectors and markets, and by association, the pension funds that invest in them. Pension fund investors must use the influence they have as shareholders to ensure that their investee companies manage the impact of commitments to cut greenhouse gas emissions, the rapid development of green technologies and the physical effects of climate change on their business models.

All UN member states have now committed to the Paris agreement, aiming to limit temperature increases to 1.5 degrees Celsius above pre-industrial levels.

While US President Donald Trump’s stated intention of withdrawing from the treaty has led to suggestions that its ambitions will never be fulfilled, a network of nine states, 227 cities and counties and more than 1,600 businesses in the US have pledged to uphold commitments to the Paris deal.

Policy signals at international, national and local level, together with the rapid developments in green technologies accelerated by these signals, will have profound implications for companies across a range of industries including oil and gas, metals and mining, forestry, automobile, food production and retail sectors, plus the service industries, including banking and financial services.

Companies in each of these industries may have to make major changes to ensure that their business models are compatible with the reductions in global greenhouse gas emissions necessary to prevent environmental (and therefore social and economic) devastation.

Failure to do so could have serious consequences for companies and their investors – and not just over the decades-long timeframes across which the worst effects of climate change will be felt. While climate risk is commonly thought of as a long-term issue, potentially hitting global GDP by 50% by 2100, there is also a serious risk to pension fund’s investments in the short term.

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A report from Cambridge University suggests that portfolios with a similar make up to many pension funds could suffer permanent losses of more than 25% within five years, in the event of a climate-related market shock.

It is therefore critically important that companies – and the investors charged with overseeing their corporate governance – are alert to climate-related risks (and opportunities).

The PLSA last year published new guidelines for pension funds on measures they can take to manage risks and exploit opportunities from the major economic transition that climate change mitigation efforts necessitate. 

The guidelines are based on work already being done by PLSA members, as well as emphasising recent regulatory trends, including the Department for Work and Pensions’ response to the Law Commission report on pension funds and social investment, proposing clearer requirements on schemes to incorporate material environmental, social and governance (ESG) risks such as climate change into investment considerations. Our recommendations focus on good governance; engaged investment and stewardship practices; and clear communication to scheme members and other stakeholders.

On governance, it is firstly important that pension fund trustee boards and committees properly understand the significance of climate change as an issue with major implications for their investments. Some formal training for governance body members should be undertaken. The potential impact of climate change on the scheme’s investments should be considered at board meetings on at least an annual basis, and the work programme that pension funds set for their investment advisers should include time allocated to assessing climate-related risk and opportunity, and incorporating these considerations into the investment strategy.

In terms of investments, pension funds should pro-actively seek out low-carbon opportunities where they deliver comparable investment returns that would enhance the diversity of their portfolio. 

Those that outsource investment management to an external asset manager should quiz both current and prospective asset managers about their approach to climate change, and should consider the quality of their response when awarding mandates and monitoring performance. The PLSA stewardship survey of our pension fund members found that 71% of respondents already consider the quality of engagement and stewardship a factor when selecting their asset manager.

The selection and review process should include detailed questions about how they understand the climate-related risk in their portfolio – do they engage with companies with regard to their plans to make their business models compatible with the Paris Agreement targets, for example? Do they use their AGM voting rights to exert influence where private engagements fail to persuade companies to take climate change sufficiently seriously? The PLSA recently amended its corporate governance policy and voting guidelines to recommend voting against the chairs of boards that cannot demonstrate an appropriate strategy for their company in a de-carbonising economy.

It is important that managers are able to demonstrate not just policies in these respects, but also provide concrete examples of how they have put them into practice and achieved positive changes through engagement on climate-related issues.

Pension funds that follow these recommendations should also report on them. The Task-Force on Climate-related Financial Disclosure’s (TCFD) established by Bank of England governor; Mark Carney, and Mike Bloomberg have developed a framework that provides a useful template for reporting. 

The TCFD recommend clear, concise disclosure in relation to governance; strategy (for pension funds, this could mean investment and stewardship policies), risk management (how the governance body identifies and assesses overall climate risk to the portfolio), and metrics and targets (the data, such as the portfolio level emissions projections over a specified timeframe, used to manage climate-related risks and opportunities).

We hope that by following this suite of recommendations, pension fund governance bodies will give themselves a much stronger chance of delivering good outcomes for their members. While they might not know and certainly cannot control the precise impact of climate change, the success of the policies needed to mitigate it, or the way different markets will respond, pension funds can at least understand the broad inevitability of climate-related impacts on investment markets and position themselves accordingly. This is a preferable course of action to ignoring the issue in favour of shorter-term pressures, however appealing that may seem.

Luke Hildyard is the policy lead for stewardship and corporate governance at the UK Pensions and Lifetime Savings Association (PLSA)