Wake up and smell the risk

Behind the walls of the Palace of Westminster in London, it can feel like things are stuck in the past with some of its archaic customs, not to mention the physical decay of the building and the multi-billion-pound refurbishment required.

Yet, in an act of forward-thinking last Friday, the House of Commons’ Environmental Audit Committee released a report examining the approach to climate change risk of the country’s 25 largest pension funds, made up of both corporate and local authority schemes. The responses were varied but Mary Creagh MP, chair of the committee, had some words of warning for several of them.

“A minority of funds appear worryingly complacent,” she stated. “Pension funds should at least assess the exposure of their assets to the physical, transition and liability risks from climate change that will materialise during savers’ lifetimes.”

In total, four of the pension funds were listed by the committee as “less engaged”, meaning they have not formally considered climate change as a strategic risk. A further nine were described as “engaged”, regarded by the EAC as having identified climate change as a risk but with less evidence of this being implemented in specific investment decisions. Only seven of the schemes have committed to CO2 reporting guidelines drawn up by the Financial Stability Board for investors and managers in the wake of the COP21 Paris Agreement.

Simply put, for pension funds representing more than £520 billion ($689.3 billion; €594 billion) assets under management, this is no longer good enough and the risks, by now, are obvious. There have been warnings about stranded assets for some time, while reputational risks have been a strong driver in climate change adaption by many funds.

There is mitigation for some, as explained by Stuart O’Brien, partner at pension funds-focused law firm Sackers, in that these long-term investors are likely still holding relatively insignificant stakes in such investments. Yet, that doesn’t explain the somewhat indifferent mindset displayed by the schemes’ responses to the EAC, which shows active investment strategies are not accounting for this risk significantly enough.

We’ve heard plenty in recent times regarding the pressure on fund managers to incorporate effective ESG strategies – with climate change at the top of this – or risk losing investment. Indeed, at our European fund managers’ roundtable last year, ESG was described by Nina Dohr-Pawlowitz, chief executive at DC Placement Advisors, as “one of the most relevant issues” for investors choosing a manager. But can it be turned the other way? In an environment in which co-investment is becoming increasingly common, can a manager see the results from the EAC’s report and view an investor with scepticism?

One leading infrastructure fund manager tells us that it’s now imperative an investor is responding to the issue, with it being “part and parcel” of being a long-term investor. “How can you not be thinking about climate change?” the manager asks.

Dohr-Pawlowitz’s comments at last year’s roundtable suggest those UK-based schemes thought to be “complacent” by the EAC are falling behind what is a growing trend.

“[ESG is] at the top of the due diligence questions of most European investors. It’s a must-have, especially for the French and Nordic investors,” she said.

Ralph McClelland, a fellow partner to O’Brien at Sackers, responded to the EAC report in agreement, acknowledging such risks have “been climbing up the trustee agenda for some time” and that “it’s going to be hard for pension trustees to ignore these issues for much longer”.

Perhaps a good place for UK pensions to start would be the MPs’ pension fund, which was revealed by the Huffington Post last week to have increased its investments with fossil fuel companies in the past 12 months. In a statement, the scheme said it “was in common with most large, diversified investors”. Therein lies the problem.

Write to the author at zak.b@peimedia.com