Transitioning to a low carbon economic system is arguably the greatest challenge the modern economy has ever faced. The UK’s workplace pension funds are stepping up to the plate to play their full part in the process.
Key to the process is the Task Force on Climate-Related Financial Disclosures (TCFD), which made its final report and recommendations in 2017. The TCFD framework uses language familiar to pension professionals about governance, strategy, risk management and metrics and targets related to the global climate goals established at the Paris climate conference in 2015. These now sit at the heart of the TPR requirements, backed by UK legislation.
The TCFD requirements have been in scope since 1st October 2021 for £5bn plus schemes, master trusts and collective money purchase schemes and from 1st October this year extend to £1bn plus schemes. They must identify governance and risk management processes by their in-scope date. They must have undertaken scenario analysis, obtained emissions data (with an extra year to obtain the toughest scope 3 emission data), identified their metrics and targets, and measured progress towards their target by the end of the scheme year and must publish a TCFD report seven months after that.
Trustees must stay up to date in terms of “knowledge and understanding of the identification, assessment and management of the risks and opportunities relating to climate change” and to “understand any external advice or information”.
There is also a threat of fines. Not publishing a TCFD report carries a fine of £2,500 though TPR says other already-established fining powers could also be applied.
Corporate advisers and trustees do not underestimate the scale of the task.
Teething problems
Andrew Cheseldine, professional trustee at Capital Cranfield, says: “It is complicated and not helped by a plethora of similar, often overlapping, initiatives – TCFD, ESG, SRI, UN PRI, etc. But TCFD makes sense in that it combines taking investment decisions that are good for the planet with those that are good for members’ financial interests, at least for now and up to and including the medium/long term, that’s eight, 10 or 15 years. After that the crystal ball gets a bit hazy, but it’s likely still to be better than the alternative even after that.
“Like any new initiative, there will be teething problems – different interpretations, outright misunderstandings and attempts at greenwashing. But I think those that want to understand TCFD and who see the potential member benefits don’t see it as complex so much as requiring a reasonable amount of effort to acquire the relevant detail. The relevant detail is the challenge.”
He gets a sense that managers, even when fully engaged are feeling their way forwards partly because TCFD is being introduced gradually, with a phased disclosure regime.
“But most managers I have discussed it with are trying their level best, as are trustees. It’s just going to take a while to get consistent standards that allow us to compare properly and fairly.”
Stuart O’Brien, partner, at Sackers says: “Until last year most pension scheme regulation of ESG and investment matters were limited just to disclosures, with the Government at pains to point out that they weren’t telling trustees how to invest. However, the Pension Schemes Act 2021 and the regulations that followed, have ushered in a new era of climate-related “governance” as well as required disclosures.
“This means that for the first time, regulations prescribe not just what trustees must disclose but also certain actions they must take. There are some specific required actions, such as carrying out climate scenario analysis and identifying and monitoring certain climate-related metrics, but the wider requirement is that trustees of schemes in scope must establish and maintain clear governance frameworks and processes for identifying and managing scheme related climate risks.
“For the first wave of schemes to which the regulations have applied since 1 October 2021 and for the second wave to which the regulations will apply from 1 October 2022 it has been this requirement to get systems and processes in place that has been a primary focus over the last year.
“Data is a key issue too and the requirement to select appropriate metrics and ensure availability of data from managers has also been taking up a lot of trustee time.”
He suggests it is a little too early to say to what extent trustees have made changes to their overall investment strategies as a result.
Anne Sander, client director, at PTL says: “I’ve been working with some larger schemes on TCFD implementation. They are taking slightly different approaches, but the trustees are seeing this as an opportunity to better understand the risks their scheme faces. They’ve set long term and intermediate net-zero targets and either set up a separate working group to work on the details or have delegated this to the investment sub-committee. Investment consultants or specialist ESG consultants are engaged to provide training and guidance through the implementation process. A lot of focus has gone into understanding what metrics are going to be relevant for the scheme and that can actually be estimated and monitored and in building the links to asset managers to deliver the data needed.”
Amy Sutherland, climate change associate consultant at Hymans Robertson sees a significant variation in approach.
She says: “There is focus on the elements of the requirements where a particular scheme has its biggest gaps and prioritising based on what they think will have the most value, the biggest impact and how the trustees can use their resource efficiently to maximise the good they are doing by overlaying the TCFD framework with their current workstreams.
“For some schemes, the governance requirements are most important; embedding climate-related issues within current scheme processes and policies to ensure that there is effective oversight of and an efficient approach to considering climate change.
“For others, this means setting a net zero target and feeding this through to managers – being clear about the trustees’ expectations on managers and how they plan to achieve their targets over time.”
She says another example is those schemes that want to focus on minimising the downside risk of climate change, and so use the metrics produced in order to take into account potential changes that they could make to their risk management framework and minimise potential climate risk within their assets.
Data questions
Do trustees and advisers have the necessary data? O’Brien says: “Data availability and data quality have probably been the biggest challenges for trustees arising from the new regulatory requirements. My expectation is that this first year of reporting will see many reports quite thin on the ground in terms of high quality, portfolio-wide and emissions data in particular. And in the second year of reporting the addition of scope 3 emissions data to the requirements is likely to be even more challenging.”
He suggests that even schemes coming into scope from 1 October 2022 really need to get onto this now, especially if they have a December year-end, as they won’t have much time to deal with data gaps otherwise.
Sander says: “Accessing complete and reliable data is challenging. For equity and bond investments getting scope 1 and 2 data is easier than some other asset classes. The template produced by the PLSA, Investment Association and ABI has been helpful.”
Yet, she says, there are continued obstacles including obtaining relevant data backing bulk annuities and even estimating the carbon footprint of government bonds can be problematic.
Sutherland adds: “Data limitations are widespread across climate change metrics. As well as this, the metrics themselves have various limitations; what this means is that there will be a necessary period of honing accuracy of the metrics produced.”
She says this is particularly the case for those schemes with more unusual assets, though that is recognised by regulators.
She adds that much depends on reporting by underlying companies though business department regulations (again related to the TCFD) for listed and private companies should support improvement over time.
Trustee greenwashing
With such uncertainty, is there a greenwashing risk and, if so, what is its nature?
O’Brien says: “Trustees have been taught to be alive to investment manager greenwashing but I think we might start to see an element of trustee green-washing as schemes seek to paint a favourable picture of
their climate governance activities in their TCFD reporting. Ultimately, however, the metrics and the data won’t lie and schemes with high emission portfolios will need a good story on their engagement strategies if they are to demonstrate credibly how they are managing climate-related risks.”
Sutherland says: “Trustees should regularly ask members for feedback, as well as trying to align with the sponsor’s approach to TCFD where appropriate. By maintaining good communication with both the employer and the members of the scheme, being transparent in the objectives for the scheme and beliefs held by the trustees on behalf of the scheme, ideally there should be no surprises as to what actions the trustees are undertaking in this space. This includes the targets set for the scheme, as well as the strategy to achieve them.”
Sander adds: “Pension schemes can only disclose based on what is disclosed to them. Until methodologies for assessing carbon emissions across the whole scope of asset classes is well established and all companies, regardless of size are required to make disclosures then there’ll be significant variance from year to year in disclosure reliability.”
She says the better-positioned companies and investment funds will have a bigger incentive to disclose than the worst performers. She suggests TCFD reports will quite likely show worsening positions from one year to the next over the first few years and that we may not see intentional greenwashing by pension schemes, but there may be “an appearance of it” because of incomplete and biased data availability.
Private questions
Erik Davey, director, UK & Europe at SECOR Asset Management says that data availability varies widely across asset classes making it difficult to accurately report at a total portfolio level.
“Despite not having portfolio level metrics, information that we do have provides valuable insight into public asset classes through benchmark and peer comparison. Because public markets are much more liquid, the information that we can gather is more decision-useful in terms of what portfolio changes can be made to reduce emissions if we were to receive the equivalent information for our private market investments.
“For private market managers, our data collection process relies more heavily on our interactions with managers and their own individual assessment of their assets from an ESG perspective, such as scorecards, company questionnaires and environmental reporting.”
Robin Jarvis, professor of accounting at Brunel University is currently working on a Financial Inclusion Centre, report ‘The Devil is in the policy detail – will financial regulation align financial market behaviours with climate goals?’
He says: “What trustees and pension schemes have to go on will be the data from the company annual report, which will be audited. To some extent they will be reliant on that.” He says this will involve narratives and targets. “Auditors are not very good at narratives nor are they very good at targets so that is going to take time to get the expertise required. Standards in auditing should improve over time and my feeling is that larger pension funds will probably employ specialist companies.”