U.K. funds lead way with first climate reports

The U.K.'s largest retirement funds have turned in their first mandated reports on climate risks, and while the grumbling may have subsided, questions remain about how much the reports can accomplish until there are consistent metrics and more widespread reporting in the financial sector, trustees and consultants say.

Larger pension funds with assets of at least £5 billion ($5.6 billion) have been following new standards for climate-related governance and reporting since October 2021, while funds with £1 billion to £5 billion started this October, and smaller ones will start in 2023.

The standards apply to both 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 to require pension trustees to consider, assess and report on the financial risks of climate change within their portfolios.

Launched by the Financial Stability Board to ensure standardized reporting of climate risks, the TCFD framework has four pillars: governance, strategy, risk management, and metrics and targets.

With nearly £2 trillion in assets between occupational defined benefit and defined contribution plans, according to the U.K. Department for Work and Pensions, pension funds are the first financial sector being relied upon to help the country fulfill its goal to be a climate leader and have mandatory TCFD-aligned disclosure across the economy by 2025. Similar rules for asset managers, insurers and corporations are next.

For officials with the largest pension funds, having to go first is one cause of the grumbling. Until asset managers and other providers are on the same mandated footing, the concern is that the available data are incomplete or inconsistent throughout the portfolios.

"A common challenge is around getting good data, particularly for assets in private markets where we're really relying on the fund manager to go to the companies and collect and reconcile the data," said Katharina Lindmeier, senior responsible investment manager for the £25 billion National Employment Savings Trust, London.

NEST is using the data it has to set decarbonization targets for all of its mandates, and working with investment managers on targets for assets and asset classes managed externally.

Even for sizable pension funds that got an early start on TCFD reporting, like the £35 billion Brunel Pension Partnership, Bristol, which has included TCFD-aligned summaries in annual reports and financial statements since 2018, the DWP process is not easy or inexpensive.

Just ask David Russell, head of responsible investment for USS Investment Management with the £90.8 billion Universities Superannuation Scheme, London, who calls the DWP regulations "onerous and burdensome."

It's not the TCFD framework, which "is a good framework to follow," Mr. Russell said. "It helps funds structure their governance and risk management processes, encourages scenario analysis, and clearly sets out the need to have targets and measure against them."

USS officials also understand the DWP's need to have more pension funds report on climate risk, "but between TCFD, PRI, Stewardship Code and implementation statements, I spend roughly half a year managing reporting," he said.

USS participants would probably prefer that he and his team spend more time "managing climate risk and doing stewardship than reporting about it," he said. Another worry for Mr. Russell is that smaller funds with far fewer resources will find the regulations "undeliverable" while it could be "a license to print money" for consultants and service providers helping to collect data and prepare reports, he said.

A lack of consensus on how many and which metrics to use is another concern for trustees.

The DWP calls for pension funds to use at least three metrics for their portfolios' 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 must also set targets for at least one metric and measure performance against that target annually.

One controversial metric is how closely the portfolio aligns with the Paris Agreement of limiting the global average temperature to 1.5 degrees Celsius above preindustrial levels.

Its addition as a mandated metric late in the rule-making process proved an unpleasant suprise for some, but it should serve as useful indicator of a pension fund's approach to climate change, sustainability experts said.

While pension fund consultants expect more standardized metrics to be developed at some point, the current rules are at least "forcing (trustees) to formalize their governance process," said Claire Jones, partner and head of responsible investment for consultant Lane Clark & Peacock LLP in London.

That was the experience for the defined contribution multiemployer plan NEST, Ms. Lindmeier said. It benefited from doing a practice TCFD report earlier in 2021 and once DWP guidance was finalized, it carried out a gap analysis to identify areas of improvement. "It helped reassure that we were in a strong position — our existing engagement with fund managers on achieving our net-zero commitment meant we weren't starting from scratch," Ms. Lindmeier said.

Still, the dry run showed many potential pitfalls, she said, including inconsistent methodologies used by fund managers to measure things like carbon intensity, and elusive figures for comparing companies in a portfolio across sectors.

For its final TCFD report, NEST did not try to aggregate one number on carbon intensity based on many assumptions, but instead provided a carbon breakdown by asset classes. "This approach feels more transparent and gives us the best idea of what's going on in each fund," even though it made the process and the report long, Ms. Lindmeier said.

Before the end of 2022, U.K. officials hope the new reports will capture the climate-risk profiles of more than 70% of retirement assets.

They have now turned their lens on local government pension schemes. A September proposal said that with a collective £332.7 billion in assets, they too have "an opportunity to drive change through the investment chain through asset managers to investee companies," by specifically calculating their carbon footprints.

The comment period for the Department for Levelling Up, Housing and Communities proposal ends Nov. 24, and the first reports will be due by December 2024.

So far, the 23 private-sector TCFD reports submitted as of Aug. 1 to The Pensions Regulator, the enforcer of DWP and other rules, have not been formally reviewed.

For this first round, there will be no penalties, except for failing to submit a report or not making "a genuine effort," a TPR spokesman said.

David Fairs, executive director of regulatory policy, analysis and advice for TPR, said that once the TCFD reports are assessed, TPR will provide "high-level observations" and feedback to plans and help DWP meet its own commitment to review pension funds' resilience to climate-related scenarios.

TPR's assessment will also inform a DWP review of the regulations — including their effectiveness — planned for late 2023.

For pension trustees, the TCFD reporting exercise will help them meet other sustainable reporting demands that are on the horizon, Mr. Fairs said in a recent blog.

In the meantime, it should improve data coverage and help pension funds get "high-quality, transparent, reliable and comparable reporting by companies and asset managers on climate and other sustainability matters," he said.

For all the caveats, this first round of mandated TCFD reports can help pension funds measure progress against their internal net-zero goals and across investment processes. They should also improve transparency and accountability, said Monique Mathys-Graaff, senior sustainable investing strategist at Willis Towers Watson PLC in London. This first batch "represents an important step in a multidecade task of combating climate change," she said.