Pension stewardship and COP26 – Report Summary

This is a House of Commons Committee report, with recommendations to government. The Government has two months to respond.

Author: Work and Pensions Committee

Related inquiry: Pension stewardship and COP26

Date Published: 30 September 2021

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Every year a Conference of the Parties (COP) takes place, under the United Nations Framework Convention on Climate Change. Parties include all United Nations member states. The Paris Agreement at COP21 in 2015 committed to “keeping a global temperature rise this century well below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5°C”. The UK will host the 26th UN Climate Council Conference of Parties (COP26) in Glasgow between 1 and 12 November. It may well be the largest summit ever hosted in the UK.

Climate change and pensions investments are both international issues. UK pension schemes invest globally in green assets, and green initiatives and infrastructure in the UK are often funded by investment from pension funds outside of the UK. We recommend that the UK Government should seize the opportunity of COP26 to make every endeavour to build an international consensus on the role of pension schemes in achieving the goals of the Paris Agreement.

Reporting standards

The Task Force on Climate-related Financial Disclosures (TCFD) was created in 2015 to develop internationally consistent climate-related financial risk disclosures for use by companies, banks and investors. As the first economy to mandate TCFD reporting, the UK should play an active role in encouraging and facilitating other economies to do the same. Global harmonisation of climate-related reporting standards would considerably reduce the burden and the associated costs to pension schemes of meeting different reporting requirements. It would also improve the comparability of different assets across international borders. COP26 provides a significant opportunity for the Government to secure international commitments to work towards the global harmonisation of climate-related financial disclosures. However, this must not be a barrier to the UK implementing its own high standards at pace domestically.

The Government is planning to introduce a green taxonomy—that is, a common framework for determining which activities can be defined as environmentally sustainable—to improve the understanding of the impact of firms’ activities and investments on the environment. This green taxonomy will be vital to the success of measures introduced by the Government to tackle climate change. As far as possible the taxonomy should align with international standards, such as the EU’s green taxonomy published in 2020, whilst also fully reflecting the UK context.

Scheme governance

Most pension pots are held by a relatively small number of large schemes. For a number of years, the “long tail” of smaller occupational pension schemes has been identified as not meeting the standards expected by the UK’s Pensions Regulator. Making green investments, particularly in infrastructure, can be complex and costly. Larger schemes are usually better placed to meet those costs and to provide the high level of scheme governance required. We welcome the intent of the Department for Work and Pensions and the Pensions Regulator to encourage pension scheme consolidation.

Trustees of a pension scheme must act in the best interests of their scheme beneficiaries. This fiduciary duty is a core responsibility for trustees. It is clear that trustees have a fiduciary duty to manage the financial impact of climate change, but there is a debate about how they should consider the other impacts climate change may have on scheme members. Some trustees are concerned that acting on environmental, social and governance issues and climate change matters may be contrary to their fiduciary duty. While we do not believe the fiduciary duty should be changed, to address this uncertainty we recommend that the Pensions Regulator establish a working group to develop guidance for schemes looking to set net zero targets.

Defined contribution schemes used for automatic enrolment are required to have a default option into which the member is enrolled, unless they specify an alternative. We recommend that the Government consult on whether there is a case for mandating that these default options should align to UK Government climate goals.

As a large scheme Local Government Pension Scheme (LGPS) could be well placed to demonstrate and develop best practice in pension scheme governance, including on climate change. The LGPS is a statutory public service pension scheme. The Minister for Pensions and Financial Inclusion told us that he believes that the LGPS should be run by the Department for Work and Pensions. This is an interesting view. We are not convinced that DWP setting pension policy for the whole sector while running one of the largest pension schemes would be straightforward or desirable given the inherent conflicts of interest.

Investment and stewardship

There are a limited number of suitable green assets in which pension schemes can invest. That means that there is a risk of a “green asset bubble” in the short term, as the market for these products develops. It is important that the Government continues to support the development of products, such as green gilts, to mitigate this risk.

Pension schemes may already be exposed to brown asset bubbles. Investments, such as non-renewables, may be overvalued if investors have not yet adequately accounted for the cost of changes resulting from either climate change or policies to reduce the impact of climate change.

A clear UK—and where possible international—climate change strategy will provide greater certainty for pension schemes to make long-term investments for their members. We recommend that the Government sets out a UK climate roadmap—including sector specific pathways to meet the Paris Agreement goals—to provide greater certainty for pension schemes and other investors, particularly in long-term investments such as infrastructure.

The charge caps on default pension saving products used for auto-enrolment are an important part of ensuring good value for savers who have not made an active decision about where their pension should be invested. However, we support the Government’s decision to review whether there are other charging structures which could better enable long-term and resource intensive investments, such as in infrastructure, while continuing to protect savers’ interests.

Stewardship is the responsible allocation, management and oversight of the assets by an asset owner. The purpose of pension schemes setting net zero targets is not solely that the schemes themselves should be net zero aligned, but that they should make an impact in reducing the real economy’s contribution to climate change. Good stewardship is a method for achieving that change. Last year the Department for Work and Pensions set up the Taskforce on Pension Scheme Voting Implementation to make recommendations that drive better voting policies and vote reporting. We will be looking closely at its recommendations.

Divestment is the process of selling assets already held by a pension scheme. Divestment remains a fallback strategy for pension schemes with investments in assets which are unable to reduce their contribution to climate change or where a good stewardship approach has failed. Nevertheless, widespread divestment by pension schemes is unlikely to have the required impact on the real economy’s contribution to climate change. Encouraging behaviour change in companies through good stewardship is more likely to be an effective approach to help the real economy transition to net zero.