UK pension providers have set stretching net zero targets — with many already making significant progress towards 2050 goals by reducing carbon emissions. But how much influence can decarbonising portfolios have, when it comes to making a ‘real world impact’ that can shift the dial on climate change?
This was the key question debated at a recent Corporate Adviser round table event, looking at sustainability and ESG strategies in the pensions sector.
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Those attending agreed stewardship was likely to be far more effective than simply reducing the carbon footprint on a pension portfolio. However, the sustainability experts attending the event said this activity needs to be supported by action from government and policymakers — and warned that without this, the global economy could face a more disorderly transition with higher temperature rises.
Carbon metrics
When it comes to sustainability in pensions the focus in recent years has been on decarbonising portfolios, with climate change being the dominant ESG issue.
This has been supported by legislative change, with pension schemes now required to publish TCFD reports which include a carbon footprint metric — showing the tonnes of carbon emitted per £1m investment in their default funds.
However those attending the debate were not convinced about the effectiveness of this metric, particularly as a way of comparing schemes and their sustainability credentials.
LCP’s head of responsible investment (systemic stewardship) Claire Jones says one of the basic problems is that if schemes divest shares in high-emitting companies — going underweight in oil, gas, airlines and mining for example — they are invariably selling these listed holdings to someone else. “The risk is these stocks just get bought by investors who are not as focused on aligning with transition plans, and less likely to pressure companies to change business models.”
TCFD reports can encourage schemes to divest from these areas, to lower their own carbon footprint, but this doesn’t necessarily lead to any real-world reduction in these emissions she said.
Julius Pursaill an independent consultant who has NatWest Cushon as a client said, that the relatively small size of the UK DC market, meant divestment was a less effective lever for change, particularly when there remain larger sovereign states and wealth funds happy to pump money into oil and gas, he said.
Now: Pensions director of investment Martyn James said this basic carbon footprint metric can also lack context — and doesn’t reflect the totality of action necessarily being taken to reduce future emissions.
Hymans Robertson head of DC investment and master trust Alison Leslie agreed. “A scheme could have high carbon emissions because it is investing in assets [like offshore wind farms or green infrastructure] which have the potential to have a huge real-world impact on emissions five or 10 years down the line.”
A successful transition is likely to need significant investment into such carbon-emitting assets now she added — not just in the UK, but across the globe.
Laura Hillis, head of stewardship at the Church of England pointed out that the converse can also be true: portfolios with a low carbon footprint typically have lower exposure to oil, gas and mining firms but are often overweight in banking stocks for example. “But banks are some of the biggest fossil fuel funders in the world,” she pointed out.
Despite recognising these potential limitations, most at the event agreed carbon footprint remains a useful metric. Jones said that collating this data on individual holdings, to give an overall portfolio view, can help trustees and providers to identify ‘hot-spots’ within their portfolio — which can inform stewardship activity.
She said these carbon footprint figures need to be viewed in conjunction with more forward-looking metrics. “My personal favourite metric is the alignment maturity scale: what proportion of a portfolio’s holdings are already aligned with a net-zero pathway, which are committed to align [but have yet to publish detailed plans] and what proportion have yet to make these commitments.” These alignment plans can include firms signed up to the Science-Based Targets initiative (SBTi).
There was general support for such forward-looking metrics, particularly as these tend to reflect transition progress made by underlying holdings, and the economy in general — not just how an individual portfolio is positioned.
However, there was some disappointment with the effectiveness of the scenario-analysis figures that are included in many TCFD reports.
Hillis said: “I was a fan of the idea of scenario analysis at the outset. But I’ve found the majority of the analysis done to date to be fairly useless.” Hillis said problems lie with the underlying modelling, and the fact this doesn’t adequately integrate transition, physical, societal and political risks.
Pursaill agreed saying it this metric was largely “a complete waste of time”. He added disclosures within the TCFD report should support portfolio resilience, helping schemes identify future risks.
Now: Pensions head of sustainability Keith Guthrie said that from a provider point of view it was important to look at practical and qualitative approaches alongside these quant models.
“I think there needs to be a common sense approach. If we are looking at scenario of three degree warming then this is going to be a worse financial outcome for members than a world with one and a half degree warming. If we want to affect this, and deliver better outcomes then stewardship becomes the most important thing to focus on.”
Stewardship versus divestment
While those attending the event agreed divestment did not necessarily lead to real-world reductions in emissions, most said it was still a useful tool for providers and asset managers in the DC space.
Jones said: “I am a strong proponent of engagement over divestment, but to be credible engagement needs to be backed with a threat of divestment.”
Done correctly divestment can have impact Hillis said. “The Church of England is well known for a number of very loud and public divestments.” This can be effective she said, pointing out she agrees with the rule of thumb offered by an academic acquaintance at Cambridge University. “If you have more fame than money you should divest, and more money than fame you should engage.”
Pursaill agreed that divestment and ambitious carbon reduction programmes can send important signals to the market. “Cushon initially announced it was going to cut 80 per cent of its emissions by 2030. This helped force a lot of conversations within organisations about what they were doing about climate.
“This announcement I would argue made a real impact. It was a rallying call and it got a huge amount of coverage and helped drive this agenda forward.”
Effective stewardship
Those attending the event agreed stewardship remains the most effective way of driving down real world emissions. However they said effective engagement needs to encompass more than discussions with individual corporates about net zero targets.
Hillis said the focus needs to move to better engagement with policymakers, and the industry had not focused enough on this to date. “We need to get the right policy and regulation in place to make the transition happen. We’ve come to the conclusion we should be spending most of our time on policy engagement — and the engagement with companies should specifically focus on their policy engagement, because they have such an outsized voice in shaping policy.”
She pointed out there is often a disconnect between some company’s transition plans “often printed on shiny paper with beautiful photos” and the more negative lobbying that goes on behind the scenes, often via industry associations to protect narrower interests.
“This is rarely transparent. Firms might be giving millions to these associations who are lobbying to protect their own interests. Even if you can’t convince firms to change, then it would be good to encourage transparency around this.”
Many on the panel agreed a more robust legislative and regulatory framework would support stewardship action taken by pension providers — particularly with the government now looking at new disclosures related to nature and biodiversity.
Hillis added: “It’s been interesting to see the conversations we are now having with policymakers around nature. It feels like we are back on the merry-go-round that we went on with climate.
“The government starts by saying we need action on an issue, but then finds regulation isn’t easy, particularly as there are various interest lobbying against such change.”
Instead she says they often look to “mobilise finance” to try to solve the problem, by launching forums, and getting investors excited talking about disclosure and data. “I think we get a little distracted by this, and we forget to go back to government and say we also need the policies that will shift the economy on these issues.”
One example given was the recent Budget decision to continue to freeze fuel duty — further evidence that subsidies continue to underpin fossil fuel industries. Pursaill agreed that “subsidies are flowing in the wrong direction”.
He warned that without government action, investor behaviour could change: with some potentially looking to redirect funds away from a “successful transition portfolio” to invest in “adaption portfolios” instead. This may starve some parts of the economy from the finance it needs to effectively combat climate change.
Real world impact in action
Despite this rather bleak outlook, those at the event gave positive examples of how stewardship in the DC sector was already achieving real world impact even on a relatively small scale. Guthrie said: “I’ve been encouraged by how much we are able to have an impact. We’ve had success with issues like biodiversity, particularly through satellite intelligence initiatives.”
This he said enables the company to compile exact data on where deforestation is happening, particularly in relation to the palm oil industry. “This has opened the door to having meaningful conversation with companies like Unilever or Nestlé — where we might not ordinarily get much of an audience with.”
Continuing the theme of transparency, Guthrie said the company was being “loud and proud” about this unique data and engagement, helping to maximise potential impact.
There was also discussion about how portfolio construction can make a difference. Much of the debate focused on the need to boost funding towards emerging markets, where, according to Hillis, around 95 per cent of emission growth is coming from.
This highlights the mix between environmental and social challenges. As she pointed out, this rise in carbon emissions is coming in part from the need to build hospital, roads and schools in these emerging economies. “If the OECD investors in the room aren’t having these discussions and helping those countries move through these challenges then I think there a chance a transition by 2050 will fail.”
Pursaill said one the proudest moments of his career was delivering an investment strategy while at Cushon that reflected many of these issues. This included an actively managed debt portfolio, that included portfolios designed to support airlines and oil companies with transition plans alongside private markets.
“We also designed our own index. It was not perfect because it was in listed equities but it was a lot better than the MSCI world index.”
Tackling climate change remains a huge global challenge — one that has not got easier with the result of the recent US election. Stewardship and decarbonisation are now entrenched in investment strategies across the UK DC sector. But those in the industry say this needs to be supported with action from government to ensure strategies devised today remain appropriate for the future and deliver for their members.
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