Article

Heat is on pension schemes in climate risk disclosures

Sonia Shah Sonia Shah

Occupational pension schemes must report in line with TCFD climate risk recommendations in a phased rollout from October. Sonia Shah outlines the key expectations. 

Environmental, social and governance (ESG) is a key concern for regulators and governments around the world, with a focus on transparency and disclosures.

The Task Force on Climate-related Financial Disclosures (TCFD) recommendations have informed the government’s introduction of TCFD-aligned disclosures by 2025 and the Department of Work and Pensions (DWP) is consulting on disclosure requirements for occupational pension schemes.

The guidance applies to trustees of money purchase and non-money purchases schemes (with £1 billion in assets), trustees of authorised master trusts and authorised schemes providing collective money purchase benefits. 

I've outlined below the key points from the consultation, covering governance and disclosure expectations:

Identifying the risks

Occupational pension schemes form the largest body of institutional investors in the UK, with around £2 trillion in assets. Despite this, the DWP highlights that only 42% of large pension schemes make TCFD-aligned disclosures, or plan to in the next 12 months.

All pension schemes are exposed to climate risk, which can crystallise through physical and transitional factors, with financial and legal implications. Occupational pension scheme trustees have a fiduciary duty to protect their beneficiaries investment and deliver a return, so it’s vital that they understand the risks and put measures in place to mitigate them.

As such, the DWP has opted for a comply-only approach to mandatory disclosures to prevent occupational pension schemes from assuming the risks are not material for them. This is in contrast to the Financial Conduct Authority (FCA) and Prudential Regulatory Authority (PRA), which have so far given an initial ‘comply or explain’ option to help more firms disclose what they can sooner.

Some feedback suggested a ‘rehearsal year’, but the DWP has pressed the urgency of the situation and opted for a no-delay approach. Others suggested adopting ‘comply or explain’ for smaller pension schemes, but the DWP highlights that they are in the later stages of the rollout, giving them more time to prepare and the onus to comply sets a higher bar from the word go.

Climate risk disclosure expectations

TCFD disclosure guidelines cover risk management, governance, strategy and metrics – which schemes must report against annually. The DWP expects firms to embed these requirements, and also provides statutory guidance on how to achieve that from an operational standpoint. Firms can innovate and diverge from the guidance, as long as they explain their reasoning.

Governance

The report must include details of any individuals who govern climate risk on behalf of trustees, with assurance that they are assessing and managing the risks appropriately. Similarly, schemes must provide details of anyone other than a legal adviser who is advising on climate risk governance, with assurance that they are appropriately identifying the risks and opportunities.

Find out more about creating a governance framework for climate risk

Strategy

The report should also include information on the occupational pension scheme’s climate risk strategy – both risks and opportunities – and the impact on investment and funding strategies (where relevant).

This includes short, medium and long-term planning and the impact on liabilities or other payment obligations.

Scenario planning

Scenario planning is an essential tool in climate risk management and schemes must report on recent scenarios. At least two scenarios must be carried out, considering the impact on investment and funding strategies, resilience, liabilities and assets.

In the first year of application, one scenario analysis is expected, with one every three years after.

Risk management

Pension schemes must embed climate risk processes across the scheme, as part of the wider risk management framework. To achieve this, trustees must have a good understanding of the financial risk due to climate change to identify, assess and manage the risks effectively. As an emerging area of research and a new expectation for trustees, the DWP recognises that it will take time to develop the skillset and may require additional training.

Metrics and targets

The ability to calculate meaningful metrics and convert them into targets is one of the biggest challenges in climate risk management. In terms of metrics, schemes must produce an emissions intensity metric, an absolute emissions metric and one further metric depending on the type of assets held, to be reviewed regularly. The report will outline these metrics and any issues with the underlying data. It will also include at least one target set against a metric and progress assessed annually. Schemes will need to review if the target is still appropriate or needs updating.

Availability of the climate risk report

The report itself must be free and available on the scheme’s website, and referenced in the annual statement. The annual benefit statement for members will include details of the report and details of where to read it in full, in addition to the scheme funding statement.

The Pensions Regulator (TPR) must receive a link to the document, and schemes are obliged to inform them if the reporting period has ended before a report is produced.

Scope and key dates of reporting requirements

The climate risk disclosure requirements will be rolled out gradually, based on the size of the occupational pension scheme and reporting dates.

This hasn’t been the most popular approach and feedback from the initial consultation highlighted that it was potentially confusing, and created greater challenges for some firms depending on their year-end date. The DWP has maintained its rollout plan structure on the basis that a simpler timeline would give some schemes very little time to prepare. However, it has updated it’s year-end cut-off for the first and second wave to give schemes more time to meet the reporting requirements. 

A high-level summary of the timeline is below, as stated in the guidance:

Assets worth £5 billion+

Trustees of schemes whose relevant assets are £5 billion or more at the end of their first scheme year to end on or after 1 March 2020 will be subject to the climate change governance requirements from 1 October 2021, or, if later, the date they obtain audited accounts in relation to that scheme year.

Authorised master trusts and schemes

Trustees of authorised master trusts and authorised schemes (once established) providing collective money purchase benefits will be subject to the governance requirements from 1 October 2021, or, if later, the date the scheme becomes authorised.

Assets worth £1-5 billion in their first year

Trustees of schemes whose relevant assets are £1 billion or more at the end of their first scheme year to end on or after 1 March 2021 will be subject to the governance requirements from 1 October 2022, or, if later, the date they obtain audited accounts in relation to that scheme year.

Assets worth £1-5 billion after 1 March

Trustees of schemes whose relevant assets are £1 billion or more at the end of a scheme year that falls on or after 1 March 2022, will be subject to the governance requirements from the beginning of the scheme year, which is one scheme year and one day after the scheme year end date when the relevant assets were £1 billion or more.

Source: Governance and reporting of climate change risk: guidance for trustees of occupational schemes, DWP, 2021

Work ahead for schemes

The requirements currently include defined benefit (DB) superfunds with assets of or above £1 billion, but this is subject to a further consultation. Schemes with assets under £1 billion are not in scope.

In addition to the complexity of the rollout timeline, the timescales are challenging in their own right. Schemes have a lot of work ahead to embed the necessary processes, governance and risk management practices to support the reporting requirements.  

Generating the right data and metrics will be a key hurdle, which can hold back the other requirements, but establishing some basic metrics and data now will be a starting point to build on in the long term.

For more information on climate risk and disclosures, contact Sonia Shah.

 

Article ESG: a defining factor in investor confidence Discover why the social factors of ESG are important to investors
Article Sustainable finance: a guide to the EU taxonomy How can you grow environmentally-friendly investment?