Natalie Smith and Alice Garton discuss the need for pension scheme trustees to take heed of climate risk to ensure they are fulfilling their legal duties
Despite the growing global consensus, climate-related financial risks (known commonly as 'climate risk') are still not being adequately considered by those directly responsible for the pensions of millions of savers: trustees and investment managers of pension schemes. This could in turn be exposing trustees to the risk of legal challenge.
Climate risk is partially about extreme weather events and rising sea levels threatening the economic value of assets like property, infrastructure and agriculture, among other 'physical risks'. It is also presented by regulatory requirements to curb greenhouse gas emissions, resulting in the stranding of carbon-intensive and carbon-exposed assets, and increased competition from renewables and low-carbon technologies ('transition risk'). While climate risk is often regarded as an environmental, social and governance (ESG) factor, we are focusing specifically on the financial risks that stem from climate change.
Recent findings, and our wider work in this area, reveal that there is still an unacceptable level of scepticism on trustee boards that climate change poses financially material risks to pension scheme investments.
In a survey recently conducted in the UK by Professional Pensions, 53% of respondents said they did not think climate change poses financially material risks to their or their clients' portfolios. However, according to Howard Covington et al., initial estimates point to a "value at risk" of 10% of equity market value (that is, the measure of systemic climate risk to the world's equity markets). Covington is one of several experts addressing the systemic nature of climate risk.
The survey response is therefore surprising. These are individuals tasked with acting "in the best (financial) interests of members", and those who support and advise them. In our work, we have found that similar views are shared by those in the pensions industry of other jurisdictions.
A recent report by ClientEarth and ShareAction, The Hot Debate on Climate Risk and Pension Investments, seeks to provide some insight into the misconceptions around climate risk and why they remain so pervasive. Responses ranged from outright dismissal to more nuanced answers. For example, commentators noted the lack of understanding regarding the investment risks posed by climate change, the lack of diversity (especially demographic and gender) on trustee boards (leading to 'group-think'), and short-termism (among others) as factors precluding consideration of climate risk.
With respect to short-termism, the law requires trustees to balance imminent obligations to current pensioners with the long-term needs of future beneficiaries - one should not come at the cost of the other.
Some 16% of respondents to the survey said that "ambiguity" in the law also prevented climate risk from featuring in investment decisions. The lawyers among the respondents, however, maintained that the problem lies not with the law but with trustees' understanding of it - our opinion too. The legal position is simple. If trustees acknowledge that their pension schemes are exposed to climate risk, they are legally obliged to consider such risk during the investment decision-making process. In these circumstances, funds must measure/seek to quantify the risk, then adequately manage it on behalf of members. Trustees who fail to even turn their minds to climate risk could be exposing themselves to legal challenge for breach of their legal and fiduciary duties.
The position may be simple but, as noted above, the law continues to be misunderstood and/or misapplied in many cases. This is primarily owing to misapprehension on trustee boards about climate risk and what it means for investment portfolios. For trustees, this is a precarious position, since it is they who are ultimately accountable to their members. It is vital, therefore, that they fully understand their legal obligations - and the implications for them if they fail to do so. It is professional advisers like investment consultants and investment managers who will play a critical role in shifting and improving the status quo.
Actuaries have begun the extremely important work of highlighting climate-related financial risks to insurers, pension funds and other financial institutions. We would urge the profession to keep bringing these risks to the attention of trustees. By raising the requisite level of knowledge and understanding of climate risk across the industry, actuaries increase the legal and financial security of their trustee clients. This in turn helps to ensure that members' lifesavings are adequately protected in the long-term.
Natalie smith is a lawyer at ClientEarth
Alice Garton leads ClientEarth's company and financial work