How new rules have sharpened the ESG focus of pension schemes

New climate-related disclosure rules should spur increased ESG investment from pension schemes, future-proofing portfolios against climate change


From record rainfall and flooding in New York to devastating wildfires in Turkey, the consequences of inaction on climate change are now impossible to ignore. For pension schemes, a new regulatory environment is on the horizon. 

From October, a host of occupational pension schemes will have to start complying with the Task Force on Climate-Related Disclosures (TCFD) reporting framework. This will see them communicate with scheme members on how their pensions are exposed to climate risk and how investee companies are being held to account for reducing their carbon emissions.

While the TCFD framework initially mostly applies to larger schemes — defined benefit schemes with more than £5bn of assets under management — it also applies to pension funds that are under a master trust arrangement. This affects a number of defined contribution (DC) schemes that are significantly smaller than £5bn, says Jennifer O’Neill, a responsible investment consultant at Aon.

“There is a lot that needs to happen to make those disclosures in terms of building the reporting structure and the governance that sits around it, determining the strategy and looking at the risk management effectiveness, that all has to happen before the pension fund is in a position to disclose,” O’Neill says. “That means for trustees and pension scheme decision-makers, there is an awful lot of work involved which they need support with.”

Pension schemes’ adaptation to climate change is not an option — all pension providers and schemes have a crucial role to play in getting Britain to net zero

For smaller schemes that have fewer resources, meeting the new rules is likely to be a challenge.

“The costs are quite onerous,” says Francois Barker, a partner and head of pensions at law firm Eversheds Sutherland. “The bigger schemes have got bigger in-house resources and more budget for external advisors, so there is no doubt that the bigger schemes and the bigger providers are much better placed to do this.”

ESG pressure

While the TCFD requirements are focused on reporting rather than prescribing how pension schemes should invest their members’ savings, Barker believes that as schemes are forced to disclose more, it will likely influence their investment decisions as member scrutiny grows.

“You’re already finding with some of the bigger schemes that there are groups of members getting together and challenging the pension scheme for not doing enough about climate change, so when they have to start publishing this information that will give much more ammunition to those groups of members as well as third-party industry groups that want to challenge pension funds to do more,” says Barker.

The increased focus on climate risk and wider environmental, social and governance (ESG) considerations could also create additional challenges for pension scheme trustees as they try to balance growing ESG commitments with their other fiduciary duties.

“There is a slight risk that as you hone in on ESG and you devote all of this effort to ESG that you could potentially drop the ball somewhere else,” says Barker. “If your ESG policy causes you to sell an asset that then happens to outperform, you need to be able to justify what you’ve done in the round, rather than just because it was a good ESG decision.”

Rita Butler-Jones, co-head of defined contribution sales at Legal & General Investment Management, says TCFD is ultimately about galvanising change across the entire investment chain — from asset owners and asset managers to the investee companies — by allocating capital to those who are doing most to reduce their carbon footprints, as well as future-proofing pension portfolios and helping to build more resilient societies. 

ESG seems to be the magic key that is helping people engage with their pension and look at their pension more broadly

“There’s definite evidence that disclosure requirements can speed up the deployment of more green and fewer brown investments,” she says. “Pension schemes’ adaptation to climate change is not an option — all pension providers and schemes have a crucial role to play in getting Britain to net zero. Pension providers and schemes that are shunning ESG risk incurring fines, legal challenges, irreparable reputation damage and potential investment losses.”

Butler-Jones says her firm has encouraged companies to strengthen the transparency of their climate impacts and their strategies to cut emissions, while sanctioning those companies that fail to meet their targets.

Social and governance focus

While the main focus so far has been on climate-related investing — the “E” in ESG —O’Neill says the social aspect is growing in importance. Indeed, socioeconomic inequality is the second-highest issue on pension fund investors’ minds, according to a recent Aon investor survey. Butler-Jones says there is also increasing focus on issues such as the gender pay gap and diversity at boardroom level.

“Climate has been at the forefront of peoples’ minds, but ‘S’ and ‘G’ is really coming to life now in terms of how people view it and how important they are rating it,” she says.

While the focus on reducing carbon emissions and ESG investment in general can benefit society at large, it also has the potential to deliver better outcomes for UK pension holders.

“Members are why we’re here and that should be at the forefront of our minds — better investment decision-making has a positive effect on pension outcomes for members, and that better decision-making has to include responsible investment,” says O’Neill.

The wider public discourse and increased attention on climate change is also encouraging scheme members to take more of an interest in ESG matters and by extension, their overall pension plans.

“It has always been challenging to engage members in their savings, especially in the DC space, but what we’re finding is that ESG seems to be the magic key that is helping people engage with their pension and look at their pension more broadly,” says Butler-Jones. “It’s not just about ‘is my fund ESG’, it’s also about ‘am I saving enough and will I have enough for retirement’, so it’s had a knock-on impact on engagement in the DC pensions world.”