What should you know about net-zero commitments?

Key considerations

One of the key considerations when it comes to pension scheme net-zero commitments is setting a timeline. This is a complex matter and operates on several levels. At the member level, trustees strive to meet the wants and needs of their membership. At a scheme level, they need to ensure the overall portfolio and investment strategy is meeting objectives for the scheme.

Finally – and on a much larger scale – trustees are considering how their choices reflect on the employer, many of whom have their own goals when it comes to reducing their impact on the environment. Trustees are continually seeking ways to meet all of these different needs while also ensuring that members’ benefits are delivered in line with their expectations.

Contributing to a just transition or a global transition

The simplest thing that trustees can do is employ positive green filtering to find investment opportunities which actively address climate change problems, such as investing in green energy. However, this is only half of the battle. What about the large number of companies that are not actively trying to combat ESG issues? Trustees face a difficult question when it comes to choosing how they wield their considerable influence and assets. For example, should they engage with assets and funds that have not yet met their ESG goals and/or operate in sectors that create high levels of pollution, or exclude them? When considering a just and/or global transition, it does not seem to be acceptable to leave an area to fall behind.

Engagement at an initial glace may look like a compromise, or an attempt to circumnavigate the mantle of ESG responsibility. Under this model trustees continue to invest in lower-rated ESG assets, but use their voting rights to influence change and better practices, thereby reducing environmental damage.

The argument could be made that these companies will likely be able to find investment from alternative sources, and if trustees step back, other investors will fill the void. There is no guarantee that they will use their influence to try and improve the situation. In this instance, trustees are applying the influence awarded by their relative size to keep as many companies moving in the right direction as possible.

Exclusion is, as the name suggests, the policy of not investing in any asset or fund which does not comply with the trustees’ ESG objectives. The hope is, if these companies struggle to find investment, they will have to improve the way they operate in order to attract investors back.

In reality, trustees are likely to use a blend of these strategies, defining their tolerances of what investments they are willing to engage with to try and drive change, and those that they do not feel they can co-operate with because they are too at odds with their own goals.

The impact on outsourcing

It is becoming increasingly common during tendering exercises for third party service providers to highlight their own environmental targets and roadmaps for carbon neutrality. Fund managers in particular often lay out how their strategies and asset allocations are making a difference and are increasingly a deciding factor in trustees’ selection criteria. Administration and communication can have a huge impact on member behaviours, particularly for members invested in Defined Contribution arrangements.

If individuals are provided with the tools and knowledge to assess the ESG impact of their investments they can begin to self-govern and actively make a difference through their choices. We are starting to see many providers develop the tools and educational materials needed to empower members to make these choices.

The new reporting framework and requirements laid out by the Task Force on Climate-Related Financial Disclosures will soon come into effect for many schemes. This will require schemes to publicly report on the climate change related risks associated with decisions made by trustees and their asset managers. The requirements will introduce new monitoring standards that will be embedded in virtually all key areas of scheme governance and will be at the forefront of trustees’ minds when it comes to activities such as choosing an insurer responsible for providing members’ pensions after a scheme has wound up. The ESG credentials and governance framework of the prospective providers will be of great interest to trustees who will be looking to secure members’ benefits in the long term.

Carbon assets

There has been a great deal of discussion and thought in the industry regarding the specific risks impacted by carbon assets. Just like any other asset class, carbon assets are susceptible to certain types of risk. A key focus for any trustee considering the purchase of a bulk annuity will be understanding the risks they are exposed to when taking on these assets and trying to align them with the risks experienced by the annuity market.

Misaligned assets that experience unwanted volatility at the wrong point in time can be very problematic when purchasing annuities and will need to be carefully considered. Balancing these risks is an area that is going to develop over time as more as more schemes look to provide long term security for members while also fulfilling their ESG commitments. The increased reporting and focus that will be implemented in the coming years will help trustees and their advisers to better understand these challenges and implement successful strategies to manage them.

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