Greater clarity on mandatory climate change governance and reporting standards for pension schemes

• United Kingdom

• Pensions

04-02-2021

Speedy summary

On 27 January, the Department for Work and Pensions (“DWP”) published more detail around how the new climate change requirements in the Pension Schemes Bill will operate, including draft regulations and statutory guidance. Under the new requirements, starting from October 2021 (depending on the nature or size of the scheme), trustees of larger occupational pension schemes, authorised master trusts and collective money purchase schemes will need to:

• adopt governance and risk management systems
• consider climate-related risks and opportunities as part of the scheme’s investment strategy and (if applicable) its funding strategy
• prepare and publish a report on a publicly available website in line with the recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”)

This speedbrief provides a summary of the latest proposals and what has changed since the Government’s initial consultation last year. It also outlines the steps that trustees and sponsors should consider taking now to ensure they keep pace with these reforms.

Brief actions

As these requirements will start to apply from 1 October 2021, trustees need to be considering now:

• is their scheme in scope and if so, when will they need to comply with the new requirements?
• are there any gaps in their governance and decision making in the context of the TCFD framework?
• what new processes and reporting frameworks need to be put in place?
• what further data will they need in order to comply – especially when calculating metrics and carrying out scenario analysis?
• do they need additional training to meet the new knowledge and understanding requirements?
• do they want to respond to the latest consultation? It closes on 10 March 2021 so the deadline for responding is quite tight. It appears the Government’s policy intention is set and the Government is likely to only want to make minor changes

Some more detail

Which schemes are in scope?

The requirements are aimed only at larger occupational and commercial schemes and will be phased in over a 12 month period. It is therefore key to understand which schemes are in scope and when.

These timings have been changed slightly since the initial consultation in August 2020 (summarised in our autumn 2020 Pensions Investment Newsletter). In addition, proposals for a longstop deadline of 31 December 2022 or 2023 (as appropriate) for the first report have also been dropped.

Another welcome change to the proposals made in August is the exclusion of bulk and individual annuities from the scope of the thresholds for assessing scheme assets. This reflects a comment we made during the consultation that the costs of compliance are likely to be disproportionate to the benefits for scheme beneficiaries – particularly given that insurers are subject to separate TCFD requirements.

Although the first requirements will only apply from 1 October 2021, in-scope trustees should already be identifying any gaps which do not reflect the TCFD framework and making decisions now about how to develop their governance systems to reflect these new rules before the scheme year which includes 1 October 2021 (or 1 October 2022, as applicable) starts.

How will trustees need to implement the TCFD recommendations?

The draft regulations tailor the 11 recommendations published by the TCFD for pension schemes and incorporate them into law. The recommendations fall into four categories: governance, strategy (including scenario analysis on the scheme’s investment and funding strategies), risk management and metrics and targets (see our spring 2020 Pensions Investment Newsletter for more detail). In-scope trustees will need to report on how they satisfy them.

It is proposed that in-scope trustees will have to run a climate scenario analysis every three years, with an annual review in-between. They will also need to assess portfolio emissions data and calculate climate metrics annually (not quarterly, as proposed last August). They will need to calculate three metrics: an absolute emissions metric (giving the total greenhouse gas emissions of the scheme’s assets); an emissions intensity metric (the total carbon dioxide emissions per unit of currency invested by the scheme); and an additional climate change metric.

Trustees may be relieved to note that DWP has limited some of their new obligations to what is reasonable and proportionate, taking into account the costs and time compliance would involve.

These requirements form part of a wider framework for making climate reporting mandatory across the UK economy. This means that asset managers and insurers will also be required to report in line with the TCFD framework, which will give trustees more rights to access the data and information they need to meet their own duties (see A new chapter: UK’s roadmap for ESG funds clarified).

What about the relationship with the scheme sponsor?

The strategic requirements under the new regime focus not only on the impact of climate-related risks and opportunities on investment strategy, but also (in the case of DB schemes) on funding. The draft statutory guidance confirms that this will require additional scrutiny of the employer's covenant – including undertaking scenario analysis “as far as [the trustees] are able”.

Even if funding risk is limited and trustees do not need to carry out a detailed covenant assessment, they should consider engaging with the employer early on climate-related issues. The employer may themselves be subject to mandatory TCFD requirements and be able to offer central resources and experiences to help the trustees comply with their own obligations.

Trustees should also consider how greater transparency on climate change could affect how they communicate with members and the scrutiny they (and/or the employer) face from industry groups and trade unions.

How will the new rules change trustee training?

The new proposals will require trustees to have a knowledge and understanding of the principles relating to the identification, assessment and management of risks and opportunities arising from climate change – including steps taken in response to climate change (e.g. from governments). These obligations are intended to ensure that in-scope trustees can understand the results from their scenario analysis, calculation of metrics and other steps taken under the new rules.

Trustees who fall outside the scope of the new rules may also want to revisit how they satisfy their TKU requirements, to anticipate greater scrutiny from the Regulator on climate change issues.

How will trustees need to disclose their climate change compliance?

Schemes with assets of £1bn or more will need to publish a TCFD report disclosing how the scheme complies with the TCFD recommendations annually and make it freely available on their own (or the employer’s) website.

Schemes will also be required to confirm that this report has been published, and provide details of where it can be found online, in:

• the scheme’s annual report and accounts
• the scheme’s annual funding statement (for DB schemes)
• members’ annual benefit statements (in the case of members with cash balance and/or DC benefits)

In the case the annual funding statement and annual benefit statements, trustees will also need to confirm when the report will be provided on request in hard copy.

What happens if trustees don’t comply?

The penalty regime set out in August 2020 consultation is largely unchanged:

• discretionary penalties and compliance notices: the Regulator can impose penalties and issue compliance notices if trustees have failed to comply with the new governance and disclosure rules. The existing disclosure penalty regime will apply if trustees fail to inform members where they can find the TCFD report. Penalties will be up to £5,000 for an individual and up to £50,000 for a corporate trustee.
• mandatory penalties: the Regulator must impose penalties of at least £2,500 if a trustee fails to publish a TCFD report on a publicly available website.
• third parties: compliance notices can be issued against third parties where the Regulator considers that party is wholly or partly responsible for a failure.

What are the key next steps for trustees?

Regardless of the size of the scheme, trustees should consider whether they are identifying, assessing and managing the risks and opportunities that climate change poses to their scheme. They should identify gaps and make decisions to remedy those gaps. They should also document their approach in preparation for increased scrutiny of these issues from the Regulator.

For instance, trustees should be:

• updating governance processes to incorporate TCFD recommendations and allocating responsibilities for ensuring the new obligations are met
• reviewing the investment strategy to incorporate climate scenario analysis
• reviewing and monitoring existing investment managers and advisers and processes for making new appointments to ensure adequate rights to data and that responsibilities for assessing climate-related risks and opportunities are clear
• setting metrics and targets, taking into account recommendations from advisers and the availability of data
• incorporating climate scenario analysis into the covenant review process – including engaging with the employer to ensure adequate access to information and appropriate processes for identifying and handling confidential information
• evaluating whether trustee training equips trustees to identify, assess and manage climate-related risks and opportunities effectively
• allocating responsibility and confirming the time-frame for TCFD reporting and checking compliance with requirements for the annual report and accounts, funding statements, and members’ benefit statements (as appropriate)
• considering how greater transparency on climate change could affect wider communications with members and the scrutiny from industry groups and trade unions