Oscar Warwick Thompson is senior policy and communications manager at UK Sustainable Investment and Finance Association (UKSIF)
In recent months ahead of the COP26 Summit in Glasgow, we have seen the UK’s pension sector increasingly playing its part in the UK’s transition and commit to moving towards net zero.
This has seen many pension schemes, including members of the UK Sustainable Investment and Finance Association (UKSIF), which represents the UK’s sustainable finance sector, commit to ambitious net-zero targets by 2050, or sooner, and back initiatives supporting the alignment of investment and lending portfolios with net zero by 2050, such as the Net-Zero Asset Owner Alliance and Make My Money Matter’s ‘green pensions charter.’
Given the considerable risks we know that climate change presents to pension schemes, and in particular for young people auto-enrolled in a pension scheme (who will retire into a world radically transformed by society’s response to climate change), UKSIF will continue to actively encourage the sector to commit to net zero ahead of and beyond COP26, believing this will increasingly be the expectation of pension scheme members.
With net-zero pledges growing steadily among UK pension schemes and other investors in advance of COP26, there is the temptation for policymakers to heed the call from some groups for a mandatory approach to be adopted on target-setting.
We saw this emerge during last year’s debate in Parliament over the Pensions Scheme Bill, with MPs considering an amendment on whether to require schemes to set out a Paris-aligned strategy.
Although the amendment was voted down by MPs, we expect this debate to re-emerge in future as collective scrutiny inevitably turns following COP26 towards how financial services firms have gone about implementing net-zero commitments announced in the run up to the summit.
In anticipation of this developing narrative post-COP26, UKSIF see several pitfalls with mandating the UK’s pensions industry to set net-zero targets. We are keen instead to continue to encourage schemes to voluntarily agree targets and support them to quickly evaluate the barriers they may face in implementing them (one key barrier is different investment strategies and asset classes will all have different pathways to net zero).
First, a mandatory approach could lead schemes to quickly exit certain companies and simply ‘park the problem’ elsewhere, including to investors operating in opaque private markets that are not engaging in active stewardship or good reporting.
Second, is the real danger of ‘green asset bubbles’ forming in the event transitional activities and sectors are not funded. This is a possibility of immediate divestment being pursued by pension schemes as a result of mandatory targets, leading to a rise in the costs of capital for companies needing to transition from ‘brown’ to ‘green’ over time.
Third, there is the question of how a mandatory approach could interfere with trustees’ fiduciary duties to act in the best interests of members. Trustees would have to consider whether or not an investment meets a government-imposed net-zero target, not what was necessarily in scheme members’ best interests, and could be pushed into a position to choose between making the right investment decision for their members, or breaching the law.
The case proposed for mandatory targets also does not recognise the crucial role that investor stewardship can play. Investor stewardship has been a real ‘game changer’ through collaborative investor initiatives, such as Climate Action 100+, which UKSIF and our members continue to support.
We know stewardship can lead to meaningful results, such as companies outlining the steps they will take to move to net-zero emissions over time. One recent example of successful stewardship includes the replacement of two incumbent board directors at ExxonMobil by shareholders given its lack of progress on climate change.
Trustees would arguably be more likely to stop positive engagement with companies with a mandatory decarbonisation target, if accompanying penalties for divergence is hanging over them.
Investors should however do more to highlight that those companies playing a larger role in contributing to global warming should act with much greater urgency and shift their scrutiny of companies’ climate commitments to assess whether they are: credible, explicitly linked to factors such as executive pay and capital expenditure, can be effectively implemented during the tenure of executives, and accompanied by clear implementation plans.
Finally, mandatory targets are ill advised with the whole global economy not yet aligned to the Paris Goals, and there are challenges for schemes in creating a 1.5°C aligned portfolio in a 4°C aligned economy.
In many respects, pension schemes meeting mandatory net-zero targets could be achieved relatively easily should divestment be adopted immediately, but there is the question of whether this leads to meaningful decarbonisation of the real economy in the long term and a more sustainable future for us all.