Climate change: no box ticking for pooled funds

Last week's climate strike is a timely reminder to pension scheme trustees that they must take account of climate change risk in their investment decisions.  By 1 October, they must have updated their Statement of Investment Principles (SIP) to reflect a new requirement to set out their policies in relation to financially materially considerations, including climate change.

The Pension Regulator's investment guidance for defined benefit schemes published last week expressly states that trustees should understand the implications of the systemic risk of climate change on investment decisions.

Where scheme assets are invested in pooled funds, trustees may feel that there is little they can do to influence the approach of either the fund manager or investee companies to climate change or wider environmental, social and governance (ESG) issues.  This is unduly pessimistic, and leaves trustees exposed to a disproportionate drag on investment returns as other schemes align their strategies with best ESG practice.

Trustees are in the strongest position to engage with fund managers over climate change at the selection stage and during mandate reviews.  But trustees should be prepared to engage at any time.

The object of engagement is to understand the manager's policy, to change behaviours where they do not reflect best practice and to identify risks to the mandate's returns where engagement with climate change is weak.  Trustees should therefore ask current and prospective asset managers about their approach to engagement on the risks and opportunities resulting from climate change and their track record of successful engagement.

Trustees should not be satisfied with an anodyne policy statement from a manager (and nor should they include such statements in their SIP).  They should request details of the nature of the research conducted by the managers, how the manager influences decision-making and concrete examples of how climate change opportunities and risks are taken into account in the investment process.

The type of question trustees can ask of their manager include:

• What collective initiatives in the investment community have they joined – eg the Climate Action 100+ Sign-on Statement
• Have they analysed potential implications for their portfolios of different global temperature increase scenarios?
• Do they engage with investee companies over their carbon-reduction strategies and promote the adoption of clear criteria for measuring progress over an agreed timeframe?
• Do they monitor investee companies' performance against their carbon-reduction strategies?
• Do they promote the alignment of executive pay with meeting carbon-reduction targets?
• Do they engage with other investors to promote changes of behaviour by investee companies?
• Do they propose or support shareholder resolutions at AGMs promoting carbon-reduction?
• What is their approach to voting in pooled funds and can trustee investors direct how their votes are used?
• Have they voted against remuneration policies which fail to prioritise sustainability and a business model compatible with climate change mitigation?

Where trustees take advantage of ESG fund ratings produced by their investment consultants, they should demand information to understand how the ratings are produced and the weighting given to the specific ESG priorities of the trustees.  And questions can still be raised directly with the fund managers during the pitch process.

From 1 October 2020 trustees of schemes with 100 or more members will have to include in their SIP details of how the arrangements with their asset managers incentivise the managers to align their investment policies with the trustees' policies and how the trustees monitor and evaluate the managers' performance in line with these policies.  Trustees will also have to make the SIP publicly available free of charge on a website (this will apply from 1 October 2019 for defined contribution schemes). This will expose trustees to greater scrutiny from both their members and activist organisations, like Client Earth which has highlighted the risk of litigation if trustees fail to develop their approach to climate risk and has already engaged directly with a number of schemes.

In short, even where trustees are invested in pooled funds, the changes to the way they take account of, record and report on climate change and other ESG issues demands careful consideration.  It is far from a box ticking exercise.