DC pension providers are at the vanguard of economy-wide changes to help drive down greenhouse emissions to address the challenges of climate change.
Understanding what changes individual providers have made to date — and how they are progressing towards net zero ambitions has been difficult, given the scarcity of robust data on this issue. But this is changing, thanks to regulatory initiatives which now compel trust-based pension schemes to publish a raft of data on carbon emissions and the carbon intensity of their portfolios — data which is now being collated as part of Corporate Adviser’s annual ESG in DC Pensions report.
At a roundtable event to discuss the main findings of this report, consultants, and providers debated the structure of the metrics now available — and their usefulness the it comes to comparing propositions and their progress towards net zero goals.
Most consultants agreed data collection was still very much in its infancy, with a variety of metrics being used — and there remained significant gaps within this data.
LCP partner Nigel Dunn said: “The metrics that are being reported right now have big holes in them from a data coverage point of view.”
He pointed out that TPR-regulated schemes now have to publish mandatory TCFD reports — contract-based FCA-regulated DC pensions will start making similar declarations from this year.
These TCFD reports include data on total carbon emissions and carbon intensity, scaled for the size of company. However, at present this only includes Scope 1 and Scope 2 greenhouse gas emissions. Scope 3 emissions — which cover the carbon footprint from suppliers and the customers’ use of product or services — are largely outside these
metrics at present.
Consultants also pointed out that this data largely relates to equity and corporate bond holdings — although a small handful of providers are now reporting this data for private assets, infrastructure and sovereign debt holdings.
Redington’s managing director and head of DC Jonathan Parker said in many cases there is just one year’s worth of data, limiting its use at present for clients,
when it comes to comparing providers, or making investment decisions. “I’m not sure the data is good enough yet. The lack of Scope 3 means that clients are a bit nervous about making strategic decisions on this level of data.”
A number of the consultants said that as this carbon data collection improves, this is likely to lead to current figures being rebased and changed — which could obscure progress some firms are making on this issue.
Barnett Waddingham partner Hugo Gravell said schemes need to handle the “reputational risks” of these metrics appearing to show financed emissions are increasing, as it starts to include other scopes and more asset classes.
As these metrics change this could lead to a change in investment strategy, potentially increasing costs for trustees, while not necessarily reducing ‘real world’ emissions if changes are being driven primarily by changes to the modelling methodology. “This could be at detriment to returns that could alienate and frustrate trustees in terms of what they are trying to do on climate,” Gravell said.
There was also considerable debate about which metrics are the most effective when it comes to comparing providers and their progress towards to net zero.
Most of the consultants in the room favoured a measure of carbon intensity, effectively showing the tonnes of carbon emitted per £m (or $) invested. This should give a snapshot of where a scheme is now in terms of greenhouse gas emissions — although as was discussed there are some limitations to this approach.
Most consultants preferred economic emissions intensity – the intensity per £/$ invested of financed emissions – based on the Enterprise Value, Including Cash (EVIC) measure, which effectively takes into account equity, debt and cash, when calculating the financed emissions, rather than the Weighted Average Carbon Efficiency (WACI) figure — which reflects the revenue of the business invested in.
These aren’t the only metrics in play. Julius Pursaill, an adviser to Cushon said the company is also interested in forward-looking metrics — for example on scenario analysis, which predicts how a portfolio will perform for members under different global warming scenarios. However he said this analysis needs to be matched with “actionable output”.
“The challenge is how you change your investment strategy to hedge some of these risks and how do you understand these risks better.”
Dunn also mentioned alignment data, again another forward-looking metric, which aims to show what proportion of schemes assets have credible targets to meet net zero goals. “Most of our clients are using Science Based Targets (SBTi) around portfolio alignment. to see what proportion of these underlying investments are on track to meet net zero targets.”
XPS Pensions Group senior investment consultant Alex Quant said he also is in favour of some forward looking data. “I think we are all getting towards the narrative that blindly focusing solely on the reductions of emissions within a portfolio is not necessarily the answer.
“There needs to be a forward looking consideration alongside a recognition that emissions will be required in the short to medium-term.”
Willis Towers Watson senior director, investments Marc Bautista said ultimately a range of metrics should be used. “There’s no one single metric that tells the whole story.
“Reporting total emissions is important, but we know if you’re a growing scheme your emissions are going to go up, even if you’re doing the right thing, so you need an intensity metric too, whether WACI or EVIC to reflect your carbon footprint.”
Bautista said it is likely that a range of metrics will be used to reflect where schemes are now but also to model future progressions.
Hymans Robertson senior investment consultant Alison Leslie said: “It could be that you are the bottom of the pack now, but are actively engaging with a number of companies that is likely to have a huge impact in five years’ time.
“This might be more impactful from a real world perspective because it is reducing emissions, not just taking them out of a portfolio. If these assets are simply sold to another asset owner, this is essentially just kicking the problem on to someone else, not solving it.”
Leslie added that while there was a need for both forward- and backward-looking metrics, there was the danger that too many datasets become confusing and contradictory. “What you don’t want is to be telling conflicting stories, with one set of data saying one thing, and the other painting a diametrically opposed picture.”
Both Bautista and Leslie disagreed with some on the panel about the utility of the data available at present.
Bautista said: “There are data challenges, and there is no doubt the metrics we have will improve. But the data we have is good enough to take action
and make tangible decisions today. I fear that we could collectively hide behind the fact that there are some problems with this data and not make progress on what we are trying to achieve — that is a system-level transition towards net zero as quickly as possible.”
Leslie agreed that the metrics are not perfect but said they remain a good starting point to build a framework. There was the danger of the “perfect being the energy of the good” by waiting until data sets improved”.
However, many of those attending the event were wary about these metrics being used in ‘league tables’ – particularly at this early stage. Bautista said: “Given it is quite hard to interpret what this data shows at present it could be dangerous.” He favoured an approach where metrics are used to chart a particular scheme’s progress over time, rather than compare one provider with another.
Many consultants pointed out that league tables can create perverse outcomes, by driving corporate behaviour in certain ways, that in some cases might not be compatible with ensuring a decline in real world emissions.
Isio head of ESG research Cadi Thomas said: “There is a risk it becomes a fight just to get the lowest emission number possible, without thinking about the longer term impact of relevant investment decisions.”
Katherine Patel, senior investment consultant at Aon said this is reflected in the current vogue for low-cost index tracking funds that utilise ESG tilts: “We know many clients are jumping into these tracking funds as they can potential reduce stated carbon emissions by 50 per cent.”
This helps schemes present a more positive picture of the progress they are making towards net zero goals in their TCFD reports, but Patel warned that as Scope 3 emissions come through this could affect the attractiveness of some of these options. “Some of these funds actually have higher scope 3 emissions than the funds the clients may have been in originally.
“Clients have already made that decision to change? Do they do that again? Or do they take a different approach, and start using more active funds where managers are engaging with companies to help drive down emissions across the economy?”
The latter approach she said may not result in the same “overnight” improvement in a scheme’s emissions but could drive more substantial impact over the longer term when it comes to tackling climate change.
For many this was at the crux of the matter of the debate around metrics — whether this data would be instrumental in driving change around emissions and net zero goals — or became more of a distraction.
Mercer head of sustainable investment, UK Europe and IMETA, Brian Henderson said: “I find the debate about metrics a bit difficult, and am agnostic to which we use. The exam question that needs answering is how we get these emissions out of the atmosphere
“I think you should pick your metric, and go for it: get that number down. We’ve got to get off the technical debate around different metrics rather than focusing on solving the problem.”
He said there’s a danger that rather than challenging ‘greenwashing’ in the industry, these metrics could add to it — particularly as some figures may not cover all asset classes or all GHG emissions.
However despite his reservations Henderson said he would like to see some measure of sustainability, or durability added to the FCA’s new VFM assessments — though given the lack of agreement of the relative value of these different metrics, this might be a challenge for regulators.
Many consultants agreed that greenwashing remains an issue for the industry and they wanted to see firmer definitions when it comes to labelling funds and investment strategies. There was concern, for example about the somewhat loose definitions of the new Article 8 and Article 9 definition that are part of the new European SDFR regulations. Leslie pointed out that managers and providers are effectively “marking their own homework” when determining whether funds meet these new labels, potentially creating confusion for members.
Net zero goals
There was considerable debate about whether net zero targets could potentially hamper investment returns for members, and whether providers needed a date to meet these goals.
Henderson said care was needed here as to how such targets were articulated. “Everybody should have ambitions towards being net zero. But an ambition, is very different to a pledge or commitment to meet a target by a set date.”
There were fears this could result in potential legal action from activists, if pledges are not met, and could also
entail reputational risk for companies and providers.
Patel pointed out net zero targets aren’t legally binding. “It’s very clear n the regulation that it should not interfere with fiduciary duty. This is about the ambition, it’s not about getting whipped if you don’t make it.” But while the regulators may not come down on firms that miss target dates, consultants said this does not rule out class actions from independent legal firms, particularly those funded by activist groups. The UK after all has its own legally binding target to be net zero by 2050.
The investment challenge
There was also debate as to whether a fixed target to halve emissions by 2030 say, or the race to be net zero by 2050, 2045 or 2040 could hamper investment returns.
Henderson explained: “I always like to try and get it back to the investment piece. There may be funds that meet the Article 8 or 9 definitions but are they good investment funds? Sticking to strict net zero goals could alter the investment risk. There may come a point where other risks overtake climate risks and we need to be ready when we’re asked why we have pursued these strategies.”
Pursaill said that Cushon does not have a specific net zero target. “We don’t know how we are going to get there yet, and we don’t know how diversification is going to impact our ability to get there. But what we do have is a very aggressive 2030 reduction target across all our assets, and we really understand at a granular level how we are going to do it.”
Parker agreed that trustees should not lose sight of the wider investment duties amid the blizzard of new climate change regulations and considerations.
“Clearly you need to build a sensible risk-adjusted portfolio for members at different stages of their life and try to optimise that with carbon reduction and other ESG factors and, likely biodiversity soon and it is very, very hard.
“But hopefully the debate around all this will change and we can start talking about potential investment opportunities, and what a fantastic opportunity the DC pensions industry has to drive change on this, rather than fiddling around at the edges and focusing on the lowest cost.”
While investment consultants must look at and manage a range of risk factors with DC funds, Bautista said climate risk remained fundamental, when compared to these other considerations.
“We are used to making decisions based on imperfect information, imperfect data and imperfect tools. We make the assumptions as best we can and will alter strategies where appropriate. This will apply to how we manage climate risk.
“But it is important to remember that this is also very different to the other sorts of financial risks we deal with, in that we know its a systemic risk. If we collectively get it wrong it’s going to have a massive impact on all our returns and is therefore worthy of special attention.
“There may be some pushback from trustee boards but I think it’s our job and our responsibility as an industry to collectively tell them that science said this is a systemic risk that could have a massive impact on your members’ final outcomes.”
LGIM interim head of DC investment Jesal Mistry reflected on how the industry had made great strides. “We have come a long way in five years. I find it interesting that five years ago we were spending a lot of time trying to convince fiduciaries that they needed to take ESG seriously. Now it is largely a given, it’s a standard thing that we all need to do. But in order to do this we need to have better tools at our fingertips. This means data that is both forward and backward looking so we have a better understanding of what could happen to investments over a period of time.
“I think one of the key things from our perspective is how we do this at scale. It isn’t about buying some carbon credits when you have billions of AUM. It’s about understanding how we drive the market and the economy, and make changes that have real world impact and also result in good outcomes for members.”