U.K. climate risk rules for trustees still evolving

Updated with correction

Trustees of U.K. retirement plans adjusting to new climate-related reporting rules are preparing for more changes as regulators consider further demands before the first reports are turned in.

Larger plans with assets of at least £5 billion ($6.8 billion) have been following new standards for climate-related governance and reporting since October, while funds with £1 billion or more will start this October. The standards apply to defined benefit and defined contribution plans.

The new rules, based on a framework developed by the Task Force on Climate-related Financial Disclosures, make the U.K. "the first G-7 country in which trustees of pension schemes are statutorily required to consider, assess and report on the financial risks of climate change within their portfolios," said Guy Opperman, U.K. minister for pensions and financial inclusion, in a foreword to the rules finalized in October.

With nearly £2 trillion in assets between occupational defined benefit and defined contribution plans, according to the U.K. Department for Work and Pensions, the sector plays a key part in helping the country fulfill its goal to be a climate leader and to have mandatory TCFD-aligned disclosure across the economy by 2025, said Mr. Opperman and DWP Secretary of State Therese Coffey in the foreword.

The first reports from larger plans are due by the summer, based on their plan year, and by the end of 2022, U.K. officials expect to capture the climate-risk profiles of more than 70% of retirement assets under management, Mr. Opperman said.

Before then, though, regulators are pursuing an additional metric.

Currently, trustees must use at least three metrics for greenhouse gas emissions, including two that are required: emissions attributable to plan assets, or "absolute emissions," and emissions per unit of currency, or "emissions intensity."

They also have to set targets for at least one metric and measure performance against that target annually.

On Jan. 7, the Department for Work and Pensions proposed another mandatory metric that is expected to be finalized within months: how investment portfolios align with the goals of the Paris Agreement to limit global warming to 1.5 degrees Celsius.

For larger plans that have been early movers on setting net-zero goals, that may not be too daunting.

National Employment Savings Trust, London, the £22.3 billion defined contribution multiemployer plan, has used TCFD reporting guidelines for several years, said Katharina Lindmeier, senior responsible investment manager in London. Beyond its goal of aligning its portfolio with the Paris Agreement by 2050, NEST is trying to halve its emissions profile by 2030, and it has already started the climate-risk analysis journey, she said.

Still, complying with the new rules "is a huge challenge because it (analysis) doesn't happen overnight," Ms. Lindmeier said.

NEST is analyzing each asset class for its climate risk, alignment with net-zero goals, and transition risks to the companies it holds.

NEST started with public equities "because it is easier to measure and set a baseline," but they are also working with asset managers in other areas like private debt. "Our asset managers have really been open to working with us and they really help us. They recognize that this is a huge area," Ms. Lindmeier said.

While NEST is already learning a lot about the climate risk to its portfolio, "this kind of work never stops. We are on an ongoing journey," she said.

On a related track, larger U.K.-registered companies and financial firms will have to report on climate-related risks and opportunities, in line with TCFD recommendations.

For retirement plan clients already thinking about Paris Agreement alignment, adding the fourth metric "isn't a dramatic shift," said Paul Lee, head of stewardship and sustainable investment strategy at investment consultant Redington Ltd. in London. It may not be easy for others, but "it will go a long way to helping trustees better understand the long-term impact of their investment decisions," he said.

"The TCFD conversation should not be seen as just a compliance process. It's much more about what does this mean, how does our investment approach need to change, if at all," Mr. Lee said.

The additional metric will also benefit investors because it should get the companies they invest in to disclose net-zero transition plans, and it will let trustees see how their asset managers are incorporating climate-change risk into strategies, said Vanessa Hodge, U.K. sustainability integration lead with Mercer in London. "Engagement with asset managers is an important part of the climate-risk management process," Ms. Hodge said.

Officials with the Association of Member Nominated Trustees, a group representing private and public-sector pension fund trustees with a collective £1 trillion in assets, agree on that point, although they want regulators assessing compliance to consider a plan's stewardship activities such as corporate engagement along with the required metrics.

"The rules should result in fund managers having to greatly expand their stewardship departments in order to be properly accountable to the asset owners — a move that is long overdue," said Janice Turner, AMNT co-chairwoman.

The varied metrics available to trustees and plan investment officials raises another point of concern for trustees. "We have always encouraged (trustees) to look at more metrics. In an ideal world, it (more metrics) would encourage trustees to focus on science-based targets. The risk is that instead they use poor metrics," said Claire Jones , partner and head of responsible investment for consultant Lane Clark & Peacock LLP in London.

While standardization of metrics may come in the not-too-distant future, the new rules are at least "forcing (trustees) to formalize their governance process," Ms. Jones said. More than the threat of penalties up to £50,000, "it's reputational risk" for failing to comply with the new rules, she said.

Lack of uniform standards to meet the new assessment and reporting demands presents a bigger challenge for defined contribution plans' portfolios, said Mr. Lee of Redington. "We are finding that the metrics you need at various points are very different," as asset classes and strategies evolve to meet risk profiles. Defined benefit clients closer to winding down their plans and moving into the most conservative investments "have very little climate risk because they have very little investment risks," he said.

Will Martindale, group head of sustainability at Cardano Group in London, which advises pension funds with over £350 billion in assets, predicts there will be "methodology convergence." In the meantime, he sees support for the expected new metric on Paris Agreement alignment "because it is a useful indicator of a pension fund's approach to climate change," he said.

The additional metric "is part of a quite clear trajectory for the DWP, so they have a comprehensive understanding of climate risk," he said. And with regulators in other countries "closely following" the new rules, "there are implications here that go beyond the U.K.'s border," Mr. Martindale said.