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Pension funds face 2050 climate target challenge

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30 Jun 2022

With most pension schemes expecting to miss their net-zero deadline, a survey highlights the challenges they face. Mona Dohle reports.

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With most pension schemes expecting to miss their net-zero deadline, a survey highlights the challenges they face. Mona Dohle reports.

globe

The COP26 climate change conference in Glasgow has been the catalyst that has made the 2050 net-zero strategy mainstream.
From McDonalds to the Gulf States, organisations and governments are committing themselves to reducing their carbon emissions, and that includes pension funds. But in trying to achieve these targets, asset owners face stumbling blocks.

Pension funds have made enormous progress when it comes to being aware of climate change. Almost three quarters, some 74%, of UK pension schemes have net-zero plans or will commit to one in the next two years, according to a Pensions and Lifetime Savings Association (PLSA) survey.

And this trend is replicated on a global scale. A report published by Create Research, a strategic change boutique, which surveyed the opinions of 50 large pension plans across North America, Europe and Australasia, found that 42% are implementing a net-zero target.

But the poll also showed that only 16% had fully embedded these targets in their asset allocations.

More worryingly, 60% of respondents believe that they will fail to meet their 2050 targets. Only 16% believe it is “very likely” that they will meet their net zero targets and another 24% say it is “somewhat likely”, Create Research’s survey revealed.

The true cost

The cost of climate change is a key reason why pension funds want to tackle the problem head on.

Reducing the associated investment risk is the motivating factor for 66% of schemes, compared to domestic regulation, which the survey reported is a motivating factor by 52% of schemes, according to Create Research.

But accounting for the cost of climate change is also a pension fund’s biggest obstacle.

Until the full costs of the issue have been priced in, trustees will find it hard to justify investing in renewable energy, particularly at a time when fossil fuel and mining companies are offering record level dividends due to rising commodity prices.

“The ecosystem of capital markets remains centred on short-term financial goals, regardless of the uncompensated damage they inflict on wider society,” said Amin Rajan, chief executive of Create Research, who co-author of the report.

A study by University College London (UCL) published in Environmental Research Letters in 2021 backs up the argument that the cost of climate change remains grossly understated.

Using the latest climate modelling risk metrics, researchers predict that the economic damage of climate change could be six times higher by the end of the century than previously anticipated. This would mean that by 2100, global GDP would be 37% lower.

This raises serious problems for asset owners. Some 70% of respondents in the Create Research report fear that the inability of capital markets to price in climate risks will impair pension finances, another 66% believe government action is required to address these imbalances.

Passive on polar bears

But pension funds are also slow to adopt climate strategies for their passive investment strategies, the Create Research report revealed. While 74% of their active funds factor in climate change risks, those criteria are only applied to 42% of passive funds.

This could be addressed by customising passive funds to factor in climate risk trends, and demand among asset owners is growing.

While 40% of pension funds surveyed rely exclusively on off-the-shelf indices, 28% say they are now using custom-built indices to factor in climate risks, Create Research’s report shows.

The road to hell

It is clear that as the number of headlines on climate-related damages continues to increase, so will the heat on pension funds, particularly the 26% of UK schemes which have not set a net-zero target yet.

Campaigners such as Make My Money Matter have called for a legal obligation for pension funds to have net-zero targets in place.

But committing to eradicating fossil fuels by 2050 might not be enough.

Only 28% of pension funds surveyed by Create Research said that they had interim targets and clear milestones in place to show how they would achieve their net-zero target.

In the absence of those, a 2050 target could be a case of kicking the can down the road. And as the saying goes, the path to hell is paved with good intentions.

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