This article was written by Leonardo Robinson and Jordan Russell and was first published on Lexis®PSL on 3 November 2021 and can be found here.
Following the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), the Department for Work and Pensions (DWP) published a consultation on 21 October 2021 seeking views on the amendments to the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021. The proposed amendments will require trustees to calculate and disclose a portfolio alignment metric, with the goal of limiting the increase in the global average temperature to 1.5 degrees Celsius above pre-industrial levels. In this article we analyse the background and implications of the proposals outlined in the consultation.
Who should read this update?
This update is of relevance to trustees and advisers of larger occupational pension schemes, authorised master trusts and authorised collective money purchase schemes. Larger occupational pension schemes are considered to be those with assets in excess of £5 bn on 1 March 2020 or £1 bn on 1 March 2021.
What is the background to the DWP consultation—‘Climate and Investment Reporting: Setting Expectations and Empowering Savers’ published on 21 October 2021?
A requirement to align investments with climate change targets will come as no surprise to the pensions industry as the government has been pushing further in this direction over the past few years. The 2015 Paris Climate Agreement concluded with a commitment to limit increases in global average temperature to well below 2 degrees Celsius above pre-industrial levels and pursuing efforts to limit temperature increases to 1.5 degrees Celsius above pre-industrial levels. It is recognised that net-zero emissions must be achieved by 2050 to be compliant with the commitment to limit temperature increases to 1.5 degrees Celsius.
This led to the recommendations of the TCFD being implemented into law last year in the Occupational Pensions Schemes (Climate Change Governance and Reporting) Regulations 2021, SI 2021/839 (the ‘2021 Regulations’). Among the requirements on larger occupational pension schemes and authorised schemes were identification, assessment and management of climate-related risks and opportunities. Originally, it was the intention of the DWP to introduce alignment reporting in these regulations, but it was delayed as there was a need to refine methodologies and ensure consistent, comparable and robust reporting. On the 14 October 2021 the TCFD updated their guidance to recommend financial institutions describe the Paris alignment of their activities. In reaction to this, the DWP published the consultation on 21 October 2021 which is due to come into force on 1 October 2022.
What is being proposed and why?
The DWP is proposing to amend the 2021 Regulations and statutory guidance to insert provisions mandating a fourth metric of portfolio alignment. This will require trustees to calculate and disclose a portfolio alignment metric setting out the extent to which their investments are aligned, with the goal of limiting the increase in the global average temperature to 1.5 degrees Celsius above pre-industrial levels (as opposed to 2 degrees Celsius, noting the scientific consensus set out in the IPCC’s report on Global Warming of 1.5 degrees Celsius). The proposed requirement is to comply from 1 October 2022, with a report against the metric within 7 months of the end of the scheme year which is underway on 1 October 2022.
The DWP believes that forward-looking metrics are essential to robustly assess and report portfolios’ alignment with climate goals. Another key emphasis coming from the government is the significant role that stewardship must play in aligning with the Paris Climate Agreement. In turn, the consultation also covers the draft non-statutory guidance on statements of investment principles and draft statutory guidance on implementation statements, which is of relevance to trustees of all occupational pension schemes.
What are the practical implications for occupational pension schemes and their advisers?
It is vital for trustees to determine if their scheme could be captured by these regulations. These new requirements will only be applicable to those who are subject to the 2021 Regulations including larger occupational pension schemes, authorised master trusts and authorised collective money purchase schemes. Larger occupational pension schemes are considered to be those with assets in excess of £5 bn on 1 March 2020 or £1 bn on 1 March 2021.
The ‘as far as they are able’ principle will also apply and will address trustees’ concerns about data gaps when calculating a portfolio alignment metric. This principle relieves trustees from an obligation to spend disproportionate sums for access to data as they are only required to make reasonable and proportionate efforts to obtain the data. The current statutory guidance addresses at pages 8-10 where it may not be possible to obtain all the required data, but also outlines that schemes must outline what data was considered unobtainable and why.
In the long term, the costs of compliance are likely to be minimal as the data is already usually required to be sold as part of wider data packages which are already obtained during compliance with the 2021 Regulations. However, there will be initial higher costs as the industry and data markets make the transition and experience costs in familiarising trustees of schemes with the requirements.
The Paris-alignment metric requires consideration of measurement methods. It is important for schemes to consider which portfolio alignment metric tool suits their institutional context and capabilities. The government has purposely restrained from enforcing specific measurement tools and blanket divestment from certain assets leading to more discretion in the hands of trustees.
The three main types to measure alignment are:
- binary target measurements: measures alignment based on a percentage of investments that have declared net-zero/Paris-aligned targets or are already net zero/Paris aligned
- benchmark divergence models: measures alignment based on forecasted emission performance of investment against benchmarks
- implied temperature rise models: translates an assessment of alignment with a benchmark into a measure of the consequence of that alignment/misalignment in the form of a temperature score
Takeaways for trustees and scheme managers of larger occupational schemes, authorised master trusts and collective money purchase schemes
- Affected schemes should review their current systems of governance to determine if they are compliant with their fiduciary duties to consider financially-material risks including climate change. This will need to be compared against the updated statutory and non-statutory guidance on Stewardship and Climate and Investment Reporting. Any necessary changes should be implemented as soon as possible.
- To comply with the new obligations, it will be necessary to first consider the tools trustees will use to measure Paris-alignment. In order to comply with the new legislative requirements, this data should then be used in the first report within 7 months of the end of the scheme year which is underway on 1 October 2022.
We are well placed to advise on climate change and reporting requirements in relation to pension schemes of all sizes. If you would like to explore this topic further, please contact Leonardo Robinson or your usual member of our pensions team.