A report entitled ‘The hot debate on climate risk and pension investments: Does practice stack up against the law?’ published earlier this month by environmental lawyers Client Earth and responsible investment charity Share Action seeks to clarify the legal obligations that United Kingdom (UK) pension fund trustees and asset managers have regarding assessment and management of climate change and carbon-related financial risks. In order to clarify these obligations, Share Action (a registered charity that promotes responsible investment) and Client Earth (a non-profit environmental law organisation) engaged with legal and investment communities to ascertain the extent to which climate change risk features in pension fund investment decisions. The resulting feedback is that less than one third of UK pension trustees and their advisers view climate change as a material financial risk.

trustees often claim legal advice as a reason for not considering climate change as a material risk

A material risk is one considered relevant based on its nature or significance. UK pension fund trustees are legally required to address any material risk to funds and need to demonstrate they have obtained the appropriate advice; have equipped themselves with relevant knowledge; and considered all relevant issues in the investment decision-making process. While trustees can delegate investment decisions to asset managers, trustees retain the legal responsibility for decisions made by asset managers. According to the Share Action and Client Earth report, trustees often claim legal advice as a reason for not considering climate change as a material risk due to climate change risk not being compatible with their legal and fiduciary duties.

The report considers three sources of climate change risk:

1) Financial risk from physical climate change impacts – Physical impacts such as those caused by extreme weather events could adversely impact the economic value of a range of asset classes (e.g. property, agriculture, infrastructure).

2) Financial risk from the transition to a low carbon economy – Policy and market changes resulting from the transition to a low carbon economy may influence the extent of stranded assets (e.g. assets that lose their economic value prior to the end of their economic life cycle.

3) Systemic financial risk – Risks from physical impacts and the transition to a low carbon economy could develop into systemic risks to the global economy.

In their report, Share Action and Client Earth also discuss three questions with legal and investment communities:

• Do pension trustees and their advisers view climate change risk as material to their portfolios?
• What barriers prevent climate change risk being taken into account in investment decisions?
• What changes are required in order for climate change risk to be more comprehensively considered in investment decisions?

In terms of advisers viewing climate change risk as material to their portfolios, responses include:

• 53% of respondents saying they did not see climate change as a material financial risk to either their own or their clients’ portfolios
• 31% seeing climate change as a material financial risk
• 16% saying they didn’t know whether climate change was a material financial risk to portfolios

Respondents also reported the following barriers to climate change being taken into account in investment decisions:

• Trustee boards do not view climate change risk as a sufficiently high risk factor (32% of trustees)
• Advisers don’t talk to trustee boards about climate change risk (24%)
• There is a lack of legal clarity as to whether climate change risk can actually be taken into account (16%)
• Climate change risk presents an additional expense that is difficult to justify (12%)
• The current incentive structure for trustees and asset managers rewards short term thinking, whereas climate change risk assessment and management requires long term thinking (7%)

‘The hot debate on climate risk and pension investments: Does practice stack up against the law?’ notes the following trustee recommendations to facilitate climate change risk being more comprehensively considered in investment decisions:

1. 24% reported that advisers need to highlight climate change risk more
2. 20% stated a higher profile for the financial impact of climate change risk would increase the likelihood of it being taken into account
3. 18% suggested better trustee education with regards to climate change risk
4. 16% suggested the law on pension investments should be clarified
5. 14% suggested a toolkit be made available that provides guidance on climate change risk is, why it should be considered a material risk and what can be done to assess and manage the risk

Read ‘The hot debate on climate risk and pension investments: Does practice stack up against the law?’ here

Reflecting on the Share Action and Client Earth report, I have mixed feelings regarding the findings. On one hand, it is clear that a lot of work needs to be done to highlight climate change risks,the potential economic impact on pension fund investments and how the risk can be managed. On the other hand, there is clearly a unique opportunity to better enshrine climate change impacts into the law regarding Fiduciary duties of trustees and their advisers with regards to the investment of pension and other funds. There is also an opportunity to educate trustees and their advisers on climate change risk, why it should be considered a material risk, and how it can be assessed and managed.

I believe that while the report is focused on the UK, the results are likely to be similar in many countries around the world and therefore the same opportunities to better enshrine climate change risk and to educate trustees and advisers exist globally. Such an approach should be considered a central tenet to fighting global climate change – a fight that involves individuals, trustees, advisers and Governments each playing their role in environmentally, socially and economically responsible investment.

less than one third of UK pension trustees and their advisers view climate change as a material financial risk

Trustees and their advisers have a responsibility to ensure that they are aware of, understand and manage climate change risk in order to invest individuals’ funds in a way that de-risks them as far as is practicable. Governments have a responsibility to ensure that the law is clear with respect to trustees and their advisers being required to demonstrate awareness and understanding to effectively manage the climate change risk for the funds they invest. If we are serious about fighting climate change as a global community, we should be sparked into action by this report’s finding that less than one third of UK pension trustees and their advisers view climate change as a material financial risk. Numerous recent articles have pointed to the billions of dollars that will need to be invested globally in coming years to fight climate change and in this light it is clear that Governments, trustees and their advisers have a responsibility to ensure funds are responsibly invested, taking climate change risk into account.