There is a legal and financial imperative to align with the Paris Agreement. Trustees who ignore it risk legal action.


Climate change is happening now

The Intergovernmental Panel on Climate Change (IPCC) has reported that man-made warming has already exceeded 1⁰C since pre-industrial times, and is increasing by 0.2⁰C per decade. The impacts of this warming are being felt in devastating hurricanes, droughts, wildfires, sea level rise, and in catastrophic ecosystem and biodiversity losses.

The majority of the British public (63%) think the planet is in a ‘climate emergency’, with 76% saying they would vote differently to protect the planet and climate. And, importantly, the world’s politicians have made commitments: the 2015 Paris Agreement binds the world’s leaders to limit global warming to well below 2⁰C.

While this may all seem many miles from pension scheme portfolios, it is crucially important for one simple reason:

Climate change is a material financial risk, and trustees and other fiduciaries could face legal action if they fail to consider, and effectively manage, the risk it poses.

Climate change is financially material

We are not talking about ethical considerations here. Bank of England governor Mark Carney has been spearheading regulatory action on climate change since 2010. Investment consultant Mercer has modelled its impacts since 2005. The Institute and Faculty of Actuaries has issued a Risk Alert. Ever more asset owners and managers – including NEST, HSBC Bank’s UK Pension Scheme, LGIM and BNP Paribas Investment Management – are setting out their own approaches to dealing with the risks and opportunities associated with climate change.

Unsurprisingly, discussion around climate can focus on risks. But there are also enormous investment opportunities in the transition to a low carbon economy. There is no inverse relationship between sustainability and return. Evidence over the last five years for MSCI indexes, which exclude all companies with coal or fossil fuel reserves, outperformed the benchmark, while significantly reducing associated carbon emissions. Many investors now see such investments as a ‘free hedge’ against climate change transition risk.

Attention from regulators and members is increasing

Trustees cannot afford to ignore climate risk. Their legal duties have been strengthened even in the past few months: schemes must update their Statement of Investment Principles (SIPs) by October 2019 to include their policies in relation to financially material considerations (defined to explicitly include climate change) and undertaking engagement activities. DC schemes must publish SIPs on a public website and, from October 2020, publish a report detailing their implementation of the policies in their SIP.

Governance must improve and schemes must be transparent. This may make those schemes that are yet to seriously consider the impacts of climate risk feel uneasy.

And for good reason; their action (or lack of it) will be published for all to see. This will be of interest to climate conscious members and regulators alike. The Pension Regulator’s (TPR) investment guidance already signposts that climate change is a material financial risk and, along with the FCA, it has committed to reporting on the adaptation of their respective sectors to climate change under the third round of the Adaptation Reporting Power. This work is likely to result in increased scrutiny of climate risk management from regulators.

The financial imperative to align portfolios with the Paris Agreement

Trustees are investing for their beneficiaries’ retirement. Unmitigated climate change will result in losses throughout the economy, so beneficiaries’ interests will clearly best be met (and therefore fiduciaries’ duties best discharged), through efforts to ensure that warming is kept to a minimum. For well informed fiduciaries, this should be understood as effective risk management.

Indeed, a key conclusion from Mercer’s Investing In A Time Of Climate Change: The Sequel report (released in April 2019) is that investing for a well below 2⁰C scenario is an imperative as well as an opportunity: for nearly all asset classes, regions and timeframes, a 2⁰C scenario leads to enhanced returns versus 3⁰C or 4⁰C, and is therefore better for investors.

The legal imperative is also clear: if it is in beneficiaries’ best interests that catastrophic global warming is avoided, those beneficiaries will expect fiduciaries to exercise their investment duties to further that objective where there is a clear route to doing so. While market practice is developing remarkably quickly, there is a strong argument that forceful stewardship demanding action is already in that category.

A blueprint for trustee action on climate risk: you can’t leave it to your asset managers

Managing climate risk need not be difficult, though it will need appropriate resources. Think of it as a project, and resource it accordingly. Here are six steps to help get trustees on the road to becoming climate competent:

1/ Understand the risks associated with climate risk
Don’t take my word for it, do your homework. Mercer’s report (see above) is a good starting point. The Financial Stability Board’s (FSB’s) Taskforce on Climate-related Financial Disclosures (TCFD) offers a reading list. The Environment Agency Pension Fund (EAPF), whose trustees understand climate change more than most, provides an example of good practice. Once you have done some initial reading, consider whether you need additional advice.

2/ Establish investment beliefs
Consider articulating the core investment beliefs held by the trustee board which will shape the integration of climate risk into investment strategy, including practical decision making on asset allocation, performance objectives and selection and retention of asset managers.

Your investment beliefs around climate change could refer to trustees’ investment duties, as the EAPF’s do.

3/ Review your advisers’ and investment managers’ capabilities
Ensure new and existing mandates with professional advisers, including consultants, auditors, actuaries and accountants, require that appropriately qualified advice will be given on climate risk exposure.

4/ Assess your scheme’s exposure and update strategies accordingly Analyse the fund’s exposure to physical and transitional risks in relation to the fund’s assets and the sponsor’s employer covenant. Enlist experts’ help to conduct forward looking climate change scenario analysis consistent with the TCFD recommendations and consider political and regulatory developments. Findings should inform your investment strategy.

5/ Reallocate assets in line with investment beliefs
Instruct investment managers to reallocate capital and stop investing new capital into risky fossil fuel assets. Move the scheme’s passive investments into products tracking low carbon indices and seek out investment opportunities in low carbon sectors, including in real assets, infrastructure and private equity. Monitor emerging climate benchmarks and plan to invest for a well below 2⁰C scenario.

6/ Pursue active stewardship and engagement
Effective engagement with governments and regulators, as well as companies, is required to mitigate the systematic risks associated with climate change. Alongside company level engagement requesting well below 2⁰C business plans and reporting in line with the TCFD recommendations, make a commitment to investor networks on climate change and support investor action on climate change.

7/ Report
Report in line with the TCFD recommendations.


Megan Clay
Climate Finance Lawyer – ClientEarth

Leave a Reply

Your email address will not be published. Required fields are marked *
You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

This site uses Akismet to reduce spam. Learn how your comment data is processed.