Consultation launched on guidance for trustees on climate-related risks

Pensions expert Michael Jones of Pinsent Masons, the law firm behind Out-Law, said the new guidance represented a significant shift to the way in which pension schemes need to start thinking about climate change.

The guidance document (104 page / 1.3MB PDF), which is now open for consultation, follows the announcement of the government’s green finance strategy last year. That set an expectation that all large asset owners, including pension schemes, would be disclosing in line with TCFD recommendations by 2022. Earlier this year an amendment to the Pension Schemes Bill also set out a proposal for large UK occupational pension schemes to be required to assess the impact of climate change on their investments and report that information to scheme members.

The TCFD, which is chaired by Mark Carney of the Bank of England, has developed a set of climate-related financial disclosures on governance, strategy, risk management and metrics and targets, which firms can adopt on a voluntary basis.

The new guidance sets out a proposed framework for TCFD-aligned disclosure, which is designed to help trustees evaluate the way in which climate-related risks may affect their strategies and plans.

Jones said the guidance was closely aligned with the amendments to the Pension Schemes Bill, and recommended scenario analysis as a key tool for testing resilience of a pension scheme to different future plausible climate states.

“This type of ‘stress-testing’ assessment of investment risk resonates very closely with the Pensions Regulator’s consultation on the principles underpinning the defined benefits funding code, and shows significant alignment from government, the Pensions Regulator and industry bodies in different aspects of policy-making in the new decade,” Jones said.

The guidance is split into three sections, firstly introducing climate risk as a financial risk that could affect pension schemes and trustees’ legal requirements, and laying out the TCFD recommendations. It provides background for trustees on both transition risks and the physical risks of climate change, and notes that trustees should consider whether a particular factor is likely to increase or reduce risk – and that this is as important as whether a factor is likely to contribute positively or negatively to investment returns.

The document sets out a suggested approach for the integration and disclosure of climate risk within the typical governance and decision-making processes of pension trustee boards, including defining investment beliefs, setting investment strategy, manager selection, and monitoring.

It also contains technical details on recommended scenario analysis and metrics that trustees could use to record and report their findings.

The document recommends that trustees work with advisers and asset managers to ensure a joined-up approach to the TCFD recommendations, which ensures companies they are investing in are considering their approach to climate risk in terms of governance, strategy and risk management.

The guidance is currently voluntary, but many of the TCFD recommendations are aligned with existing statutory requirements such as the disclosure of any environment, social and governance (ESG) and climate change policies.

“By applying the TCFD recommendations and making the recommended disclosures, trustees will be better placed to properly assess and understand what climate change actually means for their particular scheme,” Pinsent Masons’ Jones said.

Jones said trustees should adopt a proportionate approach and focus on key points as a priority, especially when it came to small and medium-sized schemes.

“The guidance recommends that trustees identify the relevant climate-related investment beliefs and disclose the processes which the trustee board are informed about, and assess and monitor climate-related risks and opportunities. We think this is a good starting point for trustees,” Jones said.

“It is also important for trustees to consider climate-related risks in setting investment strategy, which should be consistent with trustees’ investment objectives and those set for their investment advisers,” Jones said.

The consultation period closes on 7 May 2020.