DC pension providers now disclose a raft of data and metrics relating to the carbon emissions of the assets they manage, and the steps they are taking to mitigate the financial risks of climate change.
Corporate Adviser’s ESG in DC Pensions Report is the only industry publication to log these metrics and collate key data points from providers and asset manager’s TCFD reports — helping consultants understand the progress being made across the industry on decarbonisation, and revealing which companies are leading the field on wider sustainability goals.
At a recent roundtable event consultants, providers, asset managers — alongside key policymakers and campaign groups — met to discuss the findings in this report, and the best ways to interpret and use the range of ESG data now being disclosed.
Those attending the event were impressed with the quantity of ESG data now being published, partly due to mandatory TCFD reporting.
XPS senior investment consultant and head of ESG research Alex Quant said that the progress can be seen when looking across Corporate Adviser’s previous ESG reports. “It is clear that the availability of this data and the coverage has definitely improved.”
He pointed out that all the major DC pension providers now publish carbon footprint metrics, typically relating to the listed equities and bonds in their portfolios. In most cases these figures relate to Scope 1 and Scope 2 emissions, with a handful of providers starting to look at Scope 3 reporting.
Barnett Waddingham associate and senior sustainability consultant Clare Keeffe said these tables, along with those setting out providers’ and fund managers’ net zero targets are very interesting, and show the “level of ambition between different organisations” when it comes to climate goals.
But the report highlights an often confusing array of metrics being used across the industry to measure carbon emissions from a portfolio. Both consultants and providers agreed there should be greater standardisation, with clearer regulatory guidance on this issue.
Keeffe highlighted the problem of different metrics being used across different parts of the DC landscape. “We are now in a situation where master trusts and DC providers are a using the carbon footprint figure as a way to show the carbon intensity of their portfolios. But asset managers favour the Weighted Average Carbon Intensity (Waci) figure as their main measure.” As she points out this does not make comparisons easy.
Keeffe added that both these metrics — which use different calculations to show the total carbon emissions (CO2) per £1m of the portfolio — have their own limitations. “Both are relative measures, which means there is a denominator that can move up and down. I think it is important that DC providers are explaining the movements year on year, and possibly disaggregating the numerator and the denominator so you can see why these figures may be moving.” For example, if a company’s share price rises significantly, this can impact the WACI calculation, even if there has not been any significant change to the underlying carbon emissions from that particular holding.
These weren’t the only issues raised when it comes to using these metrics to compare providers, potentially building league table of the best and worst performers.
Andrew Doyle, director of investments at WTW, which runs the LifeSight master trust, said while most providers use this carbon footprint metric, some calculate this across a DC scheme and others for specific defaults.
In Corporate Adviser’s report LifeSight has a carbon footprint figure of 82 tCO2e/£m, which relates to its diversified growth fund. However Doyle pointed out that the figure calculated for the equity portfolio it runs, used by many younger savers, is just 57 tCO2e/£m.
“This is a really complex area. When oil and gas stocks shot up in value in the wake of the Ukraine war this can impact these figures, with these energy companies forming a much larger part of a stock market benchmark. Should we be adjusting figures to account of that? Given all these complexities I think some kind of standardisation would be really helpful.”
David Farrar, senior policy and international programme manager for Peers for the Planet provided valuable insight into the regulatory background to these TCFD requirements, from his previously role as a senior civil servant within the Department of Work & Pensions.
He pointed out that the DWP wanted to offer a degree of flexibility, particularly as feedback from consultations was divided as to which metric was preferred.
Although he acknowledged there remains some issues, he said these TCFD regulations are delivering on their main objectives. “At the risk of quoting Nadine Dorries talking about Boris Johnson, I think with the regulation around this we got the big calls right.
“Deciding on the carbon footprint versus Waci was one of the hardest aspects. There were a lot of strongly held views from respondents supporting both sides. The DWP was the only one that was agnostic on this point.
“We did try to create some flexibility. Ideally everyone would be using the same measure, but it is starting to feel like that is happening, with guidance from TPR leading the DC pensions providers towards the carbon footprint metric.”
He pointed out that part of the problem is that the pensions landscape is essentially covered by two separate regulators, and there remains at times a lack of joined up action between the FCA and TPR. He added that hopefully these points will get addressed in the DWP review of the TCFD regulations — which was due last year but has yet to materialise.
Forward-looking metrics
Many of those attending the event were also interested in the range of forward-looking metrics that are included as part of these TCFD requirements. But concerns were expressed that there appeared even less standardisation on this data at present, with questions raised about the accuracy of some of these figures.
While Waci and carbon footprint essentially measure last year’s carbon emissions, other data points are more forward looking. For example the report asked schemes what proportion of the companies they invest in have signed up to the Science-based targets initiative (SBTi) — which commits firms to an externally-validated net zero pathway. In theory this should indicate which schemes are better placed to manage the transition to a lower carbon economy.
Other measures include the implied temperature rise (ITR), showing the temperature alignment of an investment portfolio and scenario analysis, that models the potential financial impact on the portfolio in different climate change scenarios.
Fidelity International director, sustainable investing (climate) Phil Cliff said there is a lot of potential with these forward-looking metrics. But he adds: “These metrics are only as good as the assumptions being fed into the models they’re based on, and there needs to be more work done on that. But I do think these forward-looking angles are really important as they help give a clearer understanding about the potential impact on the portfolio if a certain pathway works out.”
He adds it can also help identify potential ‘heat maps’ in a portfolio — assets that could be at risk in future.
Farrar said he remained comfortable with the flexibility built into these TCFD rules around these various metrics. But he said he regrets not laying down stricter guidelines around the scenario analysis.
“I can’t speak for current officials but we probably ought to have been stronger in saying don’t bother with using the scenarios for four degrees warmer because they are massively understating the climate risk.”
He pointed out that he had read some “ludicrous TCFD reports” that seemed to indicate the best outcome for savers was a four degree temperature rise.
There have been criticisms of this scenario analysis from other parts of the industry, with the The Pensions Regulator highlighting the limitation of current models, while saying this remains a rapidly-developing area.
Farrar also gave an interesting insight into how some of these metrics emerged, with the ITR being announced as an additional metric just before the Glasgow Cop 26 “partly because ministers wanted to have something new to announce”. He adds that although it appears more firms are using the SBTi than the ITR it was “probably right to give this flexibility at the outset.”
Cliff added that regardless of which metrics were used it was important not to get too bogged down in the minutiae of these numbers.
LCP senior investment consultant, DC and responsible investment Drew Henley-Lock agreed, stressing that it was important to contextualise this data and information when talking to employers and clients. “It’s important to talk about what these numbers mean, and where necessarily look at more than one metric.”
As Henley-Lock pointed out investing in infrastructure such as offshore wind farms should help the transition to a lower carbon economy, but is likely to be more carbon intensive in the short-term — potentially raising carbon emissions on a pension scheme. “So there’s a plausible view where you go heavily with decarbonisation now. But there’s another view to invest loads now to put in place the infrastructure in order to change the world. Are we comparing these different approaches against each other when looking at these figures?”
He said alongside these figures he’d like to see firms publish a clear statement of what they are trying to do, and how these figures relate to that goal. “It’s about the engagement, telling a clear story, setting out a statement of what you plan to do, and then holding yourself to account for this at the end of the year, saying this is what we achieved against this plan.”
Legal and General Investment Management head of DC investments Jesal Mistry said it is important to look at both backward and forward-looking measures. He said that while much of the focus for TCFD reports is climate and decarbonisation, there was also a need to look at social factors to ensure a just transition. “If an oil company is moving to build wind turbines are they re-training staff to avoid communities being blighted by unemployment? It’s important there is a focus on the social factors as well as the environmental ones,” he said.
However he said there aren’t the same metrics at present covering these wider social issues, but he said this should improve over time.
Mistry made an important point — picked up by many in the room — that it was key to distinguish between action taken by schemes to help reduce global carbon emissions and changes made to a portfolio’s holdings that would lower its carbon metrics on a TCFD report, but may not have any ‘real world’ impact.
“Excluding companies is all well and good and may lower the carbon footprint of a portfolio. But if these are simply owned by someone else it is not having a significant impact on global emissions. A scheme might feel good about itself for reducing its carbon number but is this having a wider real world impact?
“What we need to be doing is setting real world targets, and having some pathway as to how you are going to get there over a period of time. This is where forward-looking measures like SBTi can help.” These he said can give a clearer picture of the likely trajectory in terms of reaching net zero goals.
Carbon league tables
The panel discussed whether there was a danger schemes or investment companies may be too focused on reducing their own carbon metrics, at the expense of wider real world emissions. Most did not think this to be a major issue at present, and said that the range of forward-looking metrics should counter this potential problem.
While comparisons between providers were welcomed, most at the event did not think that league tables were useful to consumers at this stage. ShareAction UK policy manager Claire Brinn pointed out that disclosure alone is not going to tackle climate change. “But perhaps one of the benefits of greater transparency is that it encourages laggards in the industry to take account.” She pointed out that some larger asset managers, like Vanguard, did not publish this information.
Farrar said he remained “fully supportive” of schemes taking active steps to decarbonise portfolios, and being able to draw comparisons was important.
“If this is protecting savers from transition risk then this is what these regulations were designed to do.” He adds that if he was a member of one of the schemes with a higher carbon footprint, as highlighted by Corporate Adviser’s report, “I’d want to know more about the engagement they were doing. It puts the onus on these schemes to justify what they’re doing in terms of stewardship, and explain why they’re still investing in companies other schemes have lowered their exposure to.”
Fund labels
The panel also discussed the utility of the FCA’s new ‘green’ fund labels, due to be introduced later this year. These follow, but do not exactly match the ‘Article 8’ and ‘Article 9’ fund labels that have already been introduced by the EU as part of its sustainable fund regulations.
Under the FCA’s Sustainability Disclosure Regime (SDR) there will be four sustainability labels: improvers, focus, impact and mixed goals.
Henley-Lock said: “For more sophisticated investors this makes sense. But is the man on the street going to know the different between a sustainability focused fund and
a sustainability impact fund?”
He adds there is also the danger this drives a more cautious approach to fund management. “Could everything end up in the ‘mixed goals’ bucket because they don’t want to fall foul of compliance. And if we have everyone in the mixed bucket then we are really no further on.”
Quant also had reservations, saying he had head from a number of mangers finding it difficult to know which label to apply for. “I think [the labels] will provide a useful reference point. It’s another indicator of the approach a manager is taking. But I certainly won’t be forming views on the ratings we do based solely on whether a fund has this label or not.”
Mistry pointed out that the use of these may be far more limited across the DC landscape. “For pension funds with life company pension funds the SDR labels don’t apply.” However he added that LGIM was taking a “consistent approach” across is retail and institutional business.
Broadstone senior consultant Richard Sweetman asked whether this could be a catalyst for new fund launches. “In the occupational space we saw a lot of schemes swap out their conventional equity funds from ESG versions. I’m thinking something similar could happen here with these new fund designations.”
Industry collaboration
All attending the event agreed that engagement remains critical to encouraging firms to reduce their emissions and adopt more sustainable business practices: helping the shift toward a net zero economy, while also lowering schemes’ own carbon footprint.
To be effective, large asset managers and DC schemes need to work together. ShareAction’s Brinn said there remains “huge scope” for better collaboration on this issue. She said she remained optimistic that more collaborative action would be effective in the UK and Europe — despite a number of US-based fund manager pulling out of the Climate Action 100+ initiative, which was set up to get the largest institutional investors working together to tackle climate change.
She said: “I’m hopeful that despite the pushback in the US recently we will move towards collaborative engagement and better stewardship on a whole range of issues.”
Part of this optimism was based on new guidance from the Competition and Markets Authority. “The CMA’s Green agreement guidance is absolutely fantastic,” she said, “and should quell concerns in some quarters that companies getting together to discuss steward proposals might breach competition law.” She said this new guidance categorically shows that this is not the case.
She added: “My background is a lawyer working in competition law. I spent 10 years working in the City and I know what cartels look like. But cross industry initiatives to tackle climate change should not raise competition law concerns. I am really hoping this will encourage more collaborative engagement across the industry because that is the powerful way to address these challenges we face.”
BOX: Carbon Offsets
DC schemes and investment houses rarely use carbon offsets to meet their net zero targets – with the notable exception being Cushon. This DC manager offered a ‘net zero now’ approach, using offsets, but since acquiring other master trusts (and subsequently being acquired itself by NatWest) it has changed tack for new members.
Those attending the event were sceptical about offsets. Quant said he did not support schemes directly purchasing offsets to reduce their portfolio footprint, and was sceptical of claims made in relation to offsets.
Others agreed offsets have a place when it comes to decarbonising the economy but were more use for offsetting “unavoidable” emissions.Some pointed out that Cushon was able to offer this pledge, being a relatively small provider – but purchasing the credits needed to offset the emissions from providers the size of L&G or Fidelity would be prohibitively expensive within existing charging models.