Climate change presents a significant financial risk factor to pension funds, threatening the scheme’s ability to provide longterm, risk-adjusted returns to its scheme members. “From a traditional risk and return perspective, it unquestionably falls within a trustee’s fiduciary duty to consider and integrate climate impacts into investment decisions.” (Russell Picot, Chair of HSBC Bank (UK) Pension Scheme). As guardians of over £2.5 trillion in UK pension assets, trustees are essential to financing the transition to a net zero economy, and driving capital towards positive outcomes and climate resilience. This article focuses on practical steps that trustees can take.

The risk of doing nothing

Notwithstanding the regulation that came into play this October – section 124 of the Pension Schemes Act 2021 – setting out requirements on climate change governance and reporting, there is more than just compliance to motivate pension schemes to act.

Pension investments carry extensive and complex exposure to climate outcomes. Two key climate-related risks to underlying investments are:

• Physical risks of extreme weather (e.g. damage to buildings and infrastructure), which can halt supply chains and/or close operations in vulnerable locations.
• Transition risks that could result in GHG intensive businesses (or those slow to respond to the net zero transition) suffering from reduced demand, obsolescence and/or high regulatory overheads.

Both risks may result in significant business disruption, stranded assets and a resultant devaluation of the investment. For defined benefit (DB) schemes, they could also affect the prospects of the sponsor.

Litigation risk is also something that needs to be factored into
investment decisions, including: scheme compliance with
regulations; potential litigation faced by investee companies
failing to mitigate, adapt or disclose; and potential litigation against
pensions themselves.

Therefore, trustees should consider a range of responses towards
net zero alignment, protecting savers’ money from the potential
economic shocks of climate change, and leveraging investment
opportunities created by the global transition to a net zero economy.

Top tips for pension scheme trustees

1. Getting started

Whatever your scheme’s size and set up, there are tools, guidance and networks out there to help you take the steps to net zero alignment.

• Define the business case for action - Build your evidence base, e.g. research articles, speak to peer trustees, or contact insurance companies to gain insights around the pricing of climate risk. Translating this into your scheme’s risk register will help you frame the case for action.
• Get key decision makers on the same page - Provide a safe space for your board to explore options, ask questions and build a collaborative assessment of where the scheme currently sits on climate-related integration. The A4S ESG Maturity Map1 lays out a series of example behaviours for pension trustees across the broad spectrum of environmental, social and governance (ESG) issues. Hear from a professional trustee on using this resource to “put the trustees back in control of the ESG agenda” here.
• Leverage your peer support network - The best insights will be from your peers who have road-tested approaches to address similar challenges you are facing. There are many platforms to gain insights, whether through published case studies, third-party-led networks or peer-led networks such as the A4S Asset Owners Network.²
• Be bold and clear in setting out your intent - Your ‘why’ for net zero alignment could be multifaceted, so create a consistent narrative for trustees to use when communicating this intent, whether internally, with members or with media.

2. Taking action

Many schemes who have commenced their net zero journey perceive it as an evolution of their existing ESG practice, alongside emerging Task Force on Climate-related Financial Disclosure (TCFD)4 regulation.

• Don’t reinvent the wheel - There are plenty of established processes to support your action plans. Use the TCFD framework and scenario modelling to: help understand your exposure to climate risk and identify your net zero targets and metrics; test out different asset class approaches with the IIGCC ‘s Net Zero Investment Framework3; and embed identified objectives and milestones into your established internal processes, e.g. investment beliefs and mandates with service providers.
• Be detailed, not vague - Sort out the details and make key decisions early. This will include the approach and interim milestones for GHG reduction and your stewardship approach. Some decisions will be challenging to make, and are often impeded by a lack of substantial data or evidence, or considered controversial. Bring in external experts and peers who have gone through similar decision-making processes and set aside enough time to debate with fellow trustees.
• Establish methods to measure and report on your progress - Use existing reporting drivers and initiatives (e.g. mandatory TCFD requirements). Agree a clear definition of success with stakeholders, with some adopting ‘net zero scorecards’ to ensure they and their asset managers stay on target. Leverage peer experiences and best practice (e.g. through A4S’s suite of case studies).4
• Be confident of the ESG capabilities of your service providers - Ensuring your investment consultants and fund managers have the right capabilities to deliver your net zero objectives is critical. However, understanding what ‘good performance in action’ should look like is not always easy. Some steps can include: 

- Introducing set criteria to the procurement process, e.g. evidence of the candidate’s own TCFD implementation, net zero alignment and signatory status to, for example, UK Stewardship Code and net zero alliances.

- Use contract mandate templates to save time, ensuring net zero objectives are clearly set out.

- Test out your current service providers’ capabilities by asking them to respond to challenges such as assessing investments when different asset classes use different methodologies and GHG emission calculations; and sense-checking they can provide required reporting.

- The A4S ESG Maturity Map5 can also provide a useful tool for trustees to challenge and probe further into previous statements and responses from their investment consultants. The Investment Consultants Sustainability Working Group’s Guide for assessing climate competency of Investment Consultants6 also provides useful climate competency criteria on what trustees should expect of their investment consultants.

3. Maturing your approach

With the foundations in place, schemes can look to drive capital towards climate resilience in addition to mitigation, as well as applying these principles to the wider ESG agenda.

• Engage, engage, engage - Be an active shareholder, demonstrating strong engagement and stewardship either directly, through collaborative initiatives (e.g. Climate Action 100+)7 or through asset managers. Create an open dialogue with your sponsor and members about the scheme’s climate ambitions. Talking openly about experiences as an active shareholder can encourage and provide confidence for peers to take a similar approach.
• Be an ambassador for change - Support your peers to move towards net zero alignment by communicating your story through case studies, events and informal chats. If you are a Chair of Trustees, help to amplify the influential voice of the pension chair community by joining your peers in signing the A4S’s Pension Fund Chair Net Zero Statement of Support.8

Invest in opportunities that will accelerate the transition and build resilience - Review your investment strategy and identify opportunities appropriate to your pension scheme to: support the net zero transition of certain industries and economies; increase resilience, for example, through investment in natural capital, and be a catalyst for innovation.

The A4S Asset Owners Network is a grouping of pension fund chairs to share insights into integrating sustainability into investment decision making.