Climate change is one of the greatest risks facing our planet and is firmly in the spotlight for governments and regulators around the world. A cornerstone of tackling climate change is our ability to successfully assess the impact of our economic activity and price this into financial markets.
To do so requires a coherent policy approach among different government departments and regulators with oversight for different parts of the investment chain – companies both private and public, investment managers and asset owners like pension funds. It will also require international collaboration.
Last year, a joint government announcement set out a roadmap for making Task Force on Climate-related Financial Disclosures (TCFD) reporting mandatory across the economy by 2025. The Department for Work and Pensions (DWP) followed up with suggested regulations for pension schemes, this follows the Financial Conduct Authority’s announcement of new rules for premium listed companies to report in line with TCFD.
These are much needed steps to ensure financial markets effectively price in climate change-related risks and opportunities, supporting financial stability and the efficient allocation of capital that is needed to achieve the UK’s commitments to net-zero carbon emissions by 2050.
Four pillars of TCFD
As long-term investors, pension funds are in an excellent position to benefit from investment opportunities that accelerate a sustainable and low-carbon transition, and from assets that support efforts to adapt to and mitigate against the inevitable impacts of global warming.
Regulatory alignment is key to support pension fund trustees to meet their regulatory obligations. Information needs to flow from the companies and real assets, which produce a significant proportion of the green-house gas emissions, through investment managers who can aggregate this information from disparate investments up to the portfolio level, and finally onto the pension funds and other asset owners such as charities, insurers and governments.
Investment managers are working at pace to enhance climate-related disclosures at the portfolio level for their clients. However, these disclosures are dependent on the information available from the assets they are invested in.
We want companies to report against the four pillars of TCFD and communicate to investors whether their business models are ‘Paris-aligned’ and how they intend to make the necessary emissions reductions.
Gone is the day when pension funds primarily invest in listed equity. To produce a comprehensive TCFD report, pension funds must glean information about the impact of climate change on the wider range of assets they are invested in such as real estate, private markets, and sovereign debt.
In many of these asset classes, disclosures are currently too sparse, or incomparable to be meaningful or to drive effective investment decisions. Even within listed equity, it is challenging to make accurate comparisons between companies within the same sector on the basis of the information they disclose, which is why we are asking companies to use SASB’s sector specific guidance to determine what information is ‘decision-useful for investors.
The UK government can play an important role in driving up disclosures through the leadership role it is playing in hosting the G7 and COP26, by encouraging other jurisdictions to legislate for TCFD reporting and supporting efforts to harmonise sustainability reporting standards. This will help to give investors comparable, sector specific climate information to build up a portfolio level of climate risk for their clients.
The UK can also show leadership in supporting the development of climate information in the full investable universe. A key step will be the expected amendment of company law so that TCFD disclosures are required from both private and public UK incorporate companies.
The government should also look to improve the availability of climate-related information in its debt issuance programme, in parallel with its green bond programme and ensure its planning laws incentivise accurate climate disclosures from real estate and infrastructure investments.
There is an argument for pressing ahead with imperfect information, recognising the urgency with which climate change must be addressed. However, acting on imperfect information may result in the misallocation of capital, counterproductive to driving the net-zero agenda and putting pension scheme members’ savings at risk.
While the DWP’s emphasis on metrics, emission reduction targets and scenario analysis is an essential barometer of progress, given the availability and completeness of data at this stage, there is a risk that short-term, volatile and incomplete metrics drive ineffective investment decisions. This needs to be complemented by a strong regulatory focus on the governance of climate risk and how pension funds are addressing climate change through their investment beliefs and objectives.
It is essential that in the race to act with urgency, policymakers think carefully about the incentives they are introducing across the investment chain. Decarbonising our economy will only be achieved by companies making some big, long-term decisions about their capital management. Many companies will need to expend significant capital on acquisitions and disposals; investment in research and development to develop new products and services and changes in infrastructure and operations.
This is unlikely to be achieved by minor adjustments to business as usual that will lead to linear emissions reductions. Pension funds, as providers of long-term capital are well-placed to support investee companies as they undertake this transition.