A changing climate for pensions
We have been hearing a lot lately about ‘Net Zero’ and the Government pledge to achieve this by 2050. You may ask what does a pledge to reduce carbon emissions have to do with pensions?
Actually quite a lot as:
on 31 May 2021 regulations brought into force section 124 of the Pensions Scheme Act 2021 which creates regulation–making powers allowing the Government to impose governance and disclosure requirements on pension trustees concerning the climate change risk; and
the Pension Regulator (TPR) has decided to tighten up on its Environmental, Social and Corporate Governance (ESG) policy as it affects pension schemes.
The proposal currently on the table, planned to come into force ahead of the UN Climate Change Conference COP26 (which begins on 1 October 2021), is that:
trustees will be required to secure the effective governance of the pension scheme with respect to the effects of climate change;
the scheme statement of investment principles (SIP) must disclose the trustees’ policy on ESG issues adding to the already heavy burden for trustees on what the SIP must contain; and
schemes must comply with these requirements and provide for the Pensions Regulator to issue notices to trustees, including a penalty notice for non-compliance.
The Pensions Regulator holds that the drivers for this is not just Government policy but rather the demand of scheme members to know where their hard-earned pension funds are being invested. This is probably particularly so with Defined Contribution Schemes although Defined Benefit Schemes are also in the mix. Whilst many members may not care whether their scheme invests in Shell or BP as long as they get a good pension when they come to retire, research has suggested that increasingly members are more likely to have views once the effect of climate-related financial risks is pointed out to them.
From later this year, the SIP will have to include an implementation statement describing whether certain policies in the scheme’s SIP have been followed, and the trustees’ voting behaviour. An implementation statement may be used to show how trustees have held their investment managers to account, explaining how they have engaged with, influenced and challenged investment service providers where necessary. Trustees could also explain how they have embedded their principles in service agreements and checked these have been upheld. This statement offers trustees the opportunity to demonstrate the work they are undertaking on members’ ’behalf, as well as reflecting on areas for improvement or change. It will have to be made publicly accessible and so savers will have the chance to examine how the intent stated by trustees in scheme policies translates into action.
Holding the investment manager to account may not be that straightforward where the trustees invest in pooled funds (as so many, particularly smaller schemes do). Not all investment managers may initially be willing to listen. But of course, their behaviour will inevitably change.
There has been much discussion about the fiduciary responsibilities of trustees and the ‘old’ adage that this involves achieving the best return for members irrespective of investment vehicle. Surely this must conflict with the ESG principles as a share in (say) tree hugging is never going to be as good as a share in a lovely profitable oil company? Again investment managers have conducted extensive research to prove that their ESG funds provide just as good an investment return as non-ESG investment strategies so why not? It certainly seems that TPR have thrown out the short-term, best return principle in favour of sustainability over the long-term, so trustees will ignore it at their peril.
As David Fairs Executive Director of Regulatory Policy at TPR said late last year “This is no passing fad. It’s fundamental, given the long-term nature of pension schemes climate change will be a fundamental consideration. Trustees must take account of long-term risks and opportunities to deliver the pensions people will need in the future. And that may be in an environment very different from today’s.
So, my advice to trustees? Build capacity in this area if you haven’t already. You’ll be better placed to understand what climate-related issues mean for your scheme – and better able to make decisions that contribute towards good savers outcomes.”
I would not dream of advising my clients otherwise!