Pension Funds in a Changing Climate

The growing consensus that there is a negative correlation between global warming and returns has changed the landscape of pension regulation.

The Financial Times reported that as of November 2018, only 5% of the biggest corporate pension funds in the UK, which oversee a combined £479 billion, have policies that take climate change into account. This is despite warnings from the United Nation’s Intergovernmental Panel on Climate Change (IPCC) that we have 12 years to limit climate change impacts. If ignored, these impacts have the potential to increase the risks associated with investment and decrease returns.

On the 11th of September 2018, the Department for Work and Pensions announced an update to the Occupational Pension Scheme Investment Regulations of 2005. The changes require trust-based pension schemes to have a policy on financially material environmental, social and governance (ESG) factors, including climate change by October 2019. Furthermore, the new rules will require trustees to outline their policy on the extent to which non-financial matters are considered. By 2020, they will have to produce an implementation statement indicating how they acted on the principles they set out.

Altogether, a total of 8,421 schemes will need to update their Statement of Investment Principles (SIP), and 4,688 will additionally have to state their policy on stewardship. They will have to state how the schemes take ESG considerations into account in the selection, retention and realisation of investments.

This update therefore encompasses changes to what is defined as ‘financially material’ information, and the degree to which non-financial information is considered relevant. ESG factors measure companies on their sustainability and how their practices impact the wider world. It is accepted that these factors have a significant impact on financial returns, and this has led banks and investors alike to integrate ESG strategies into their work.

Furthermore, because pension schemes are long-term investors, they are therefore exposed to long-term financial risks, including risks associated with climate change, unsustainable business practices and unsound corporate governance. Despite the long-term nature of investments, these risks could be financially significant in both the long and the short term. As owners of capital with-long term horizons, both defined benefit (DB) and defined contribution pension (DC) funds are ideally placed to act as stewards of their assets and take account of climate change and other long-term risks. In doing so, they value of scheme members’ retirement savings can be protected and enhanced.

Already there has been global recognition of the benefits of adopting ESG strategies in investment funds. For example, the Government Pension Investment Fund (GPIF) of Japan, which manages USD$1.4 trillion, uses ESG data directed through Arabesque S-Ray® technology to assess the sustainability of companies in order to inform its investment process. Additionally, the Swedish National Pension Fund Forsta AP -Foden (AP1), which has approximately SEK 338 billion under management in a global portfolio consisting of equities, has also adopted the S-Ray® technology to assess the impact of its portfolio. Japan and Sweden have been leaders of the ESG integration, and in an area where there are guaranteed rewards for early uptake, UK pensions have a window of opportunity to cash in on these benefits.

Arabesque will be participating in the BYN Mellon Pension Summit on the 14th November 2018.