What a difference a year makes. Twelve months ago, as bushfires raged in Australia and climate issues were central to the agenda of the World Economic Forum event in Davos, it was looking as though 2020 had the potential to be the year that climate change became the most important and pressing global crisis.
It didn’t turn out like that, of course. But while the world’s attention has been urgently turned to tackling the coronavirus pandemic, climate change continues to present a host of global risks that need increasingly urgent attention. Activist investors have continued to press for a realignment of companies’ priorities on climate change, resulting in notable changes at some major energy companies. One of the side effects of the pandemic has been a marked – although likely temporary – reduction in global carbon emissions1. One of President Biden’s first acts in office was to bring the US back in to the Paris Agreement, reversing the position taken by President Trump. Closer to home, the UK’s presidency of the UN Climate Change Conference in November 2021 (“COP26”) will continue to push climate change – and the UK’s response to it - up the agenda.
It probably hasn’t escaped the notice of anyone working in the pensions industry that, in the Pension Schemes Act 2021 (which received Royal Assent on 11 February), we have some freshly-minted climate change-related requirements for UK pension scheme trustees. This is a relatively new area for many. However, one of our recent surveys suggested that climate change, and its potential impact on schemes, is one of the areas where trustee boards anticipate they will require the most training and assistance. It is also the area that schemes expect to see impacting most on their governance processes in the coming years, and the requirements have already started to take shape.
From October 2021, trustees of schemes with more than £5bn in assets must have effective governance to manage climate risk.
In 2018 the Government proposed to require trustees to consider the impact of the ‘changing environment’ on their investments. The new Act continues in that vein. From October 20212, trustees of schemes with more than £5bn in assets must have effective governance, strategy, risk management, and metrics and targets to manage climate risk (in line with the Task Force on Climate-Related Financial Disclosures (TCFD)3), and must report on these by the end of 2022 (with fines for non-compliance). The requirements next cascade down to trustees of schemes with more than £1bn of assets a year later, and may well be extended further in the years to come. The regulatory direction of travel is clear, and it seems almost certain that the requirements will continue to expand in their scope over time.
Regardless of the evolving regulatory requirements, one should not lose sight of the risks that climate change may pose. Unmitigated climate change could see baseline global temperatures rise by more than 4°C4 from pre-industrial levels. This could mean heat waves, wildfires, drought, flooding, and sea level rises that threaten major population centres. Current global governmental policies to combat the effects are expected to limit the rise to 3°C, but still fall far short of the Paris Agreement-aligned 2°C rise. And all of these fall short of the Intergovernmental Panel on Climate Change’s (IPCC) ‘best case scenarios’ for a rise nearer to 1.5°C (noting that the IPCC sees a rise of 3°C as consistent with a world that is ‘no longer recognisable’5).
In short, there are physical risks to assets that trustees should be thinking about. And there are transition risks, too. If your star-performing asset is built on carbon emissions, there is a burgeoning risk that it could be regulated out of existence – or that the market does that job by itself – if there is a failure to adapt. The changes that we have already seen at some major energy companies are an early example. And what about the potential effects of climate change on human health and longevity?
We have already helped some pension schemes consider these risks, with our pioneering work being exemplified in the Government’s guide to aligning your scheme with TCFD, published by the Pensions Climate Risk Industry Group6. A truly integrated asset and liability climate study is a good place to start, and we draw on the sizeable research expertise and capabilities of Willis Towers Watson’s Climate and Resilience Hub7 to ensure that our work for trustees is aligned with our work for corporates.
No matter what size your scheme is, you can expect to hear more about climate change in 2021 as a top issue for trustees and sponsors of pension schemes to get to grips with. And even if you are not yet required by the regulations to report in respect of your scheme, climate change is such an important issue that it would be very sensible to ‘shadow’ the regulations anyway. Your members may well expect this, regulators and the Government are looking for this, and the scheme’s financial position may well thank you for it in future years, too.
Footnotes
1. Daily global CO2 emissions ‘cut to 2006 levels’ during height of coronavirus crisis
2. See anticipated regulations under the Act - Taking action on climate risk: improving governance and reporting by occupational pension schemes
3. See: Task Force on Climate-related Financial Disclosures
4. See, for example: Addressing global warming
5. The Intergovernmental Panel on Climate Change
6. Aligning your Pension Scheme with the TCFD Recommendations
7. Climate and Resilience Hub
