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Every month, employees over the age of 22 and their employers pay into pensions. Pension funds are then managed and invested by fund managers. Traditionally, funds were invested in high-value necessities like oil, petroleum and other similar commodities.
However, as climate change has exponentially worsened, the government has introduced legislation and guidance to ensure that billions of pounds in pension funds are responsibly managed in line with overall carbon Net Zero targets and the Paris Agreement, a legally binding climate change agreement signed by nearly 200 global parties.
But how will this affect businesses, their employees and their respective pension funds?
What is the current issue with pension investments?
As it stands, the current higher-value pension investments are in so-called dirty or brown investments, due to the nature of the impact they have on the planet. These include the likes of oil, coal and gas mining, which are all finite resources, as well as harmful companies, such as arms manufacturers and gambling facilitators. While valuable now, these investments are likely to plummet in the long term as the world moves to more renewable sources of investment such as wind farms, or recycling companies for example.
As of 2018, there is over £6 trillion of private pension wealth in pension funds meaning there is sizeable buying power and investment backing available within the UK’s pension fund schemes. It’s therefore important to ensure that pension funds are being managed responsibly, and in line with global climate targets.
What measures has the UK government introduced around pensions and climate change?
The UK government has introduced a range of measures to inform investment managers, strategists and trustees of pension funds on how they should make decisions on where the money held in pension funds is invested. These are namely the TCFD, Taskforce on Climate-related Financial Disclosure and the Pension Schemes Act 2021.
TCFD and pensions
As climate change is, in equal parts, a financial risk and an investment opportunity for pension schemes, TCFD guidance recommends the use of the TCFD framework to report on climate change risks. The TCFD is spearheaded by the Pensions Climate Risk Industry Group, which is a cross-industry body to oversee green decisions on pensions.
The TCFD framework is a flexible set of 11 disclosures that show the risks and opportunities presented by climate change. These disclosures help to make better informed and more transparent decisions around climate change and financial investments.
A large part of TCFD guidance that pension scheme operators will use is scenario analysis. This analysis presents a set of scenarios that shows how investment changes will affect pension schemes. These use a combination of transition risks, which are economic system risks that are due to the alignment with low, no or carbon-positive solutions, and physical risks, which relate to the impact that climate change will have on the planet, and therefore businesses by default. The three scenarios, as created in 2017, are:
- An orderly transition, where pension funds move to carbon neutral or lower investments in a 2⁰C or lower scenario. This has significant transition risks but lower physical risks, as emission reductions start now and wean off high-emission investments.
- An abrupt transition, where everything is moved in swift action to carbon-friendly investments. This has a high transition risk, as it is done abruptly, so to speak, but lower physical risks as immediate action is taken.
- Finally, there is no transition at all, where investment companies choose to stay investing in dangerous and harmful to the planet opportunities. This has high physical risks and defies the Paris Climate Agreement.
Pension Schemes Act 2021 and climate change
In the Pension Schemes Act 2021, there is a crossheading dedicated to climate change risk. This section includes measures such as:
- Potential requirements on scheme governance of climate change risks
- Targets and performance against risk reduction of climate change
- Making steps to achieve the Paris Agreement (2015)
- Publishing in a freely accessible way, the description as to which a pension scheme is adhering to climate change risk
This places an onus on trustees of pension schemes to secure “effective governance of the scheme with respect to the effects of climate change.” For trustees of pension schemes, there is now more expectation that the direction of a fund will be towards green investments and that all strategies support this.
There are also new requirements to freely share such information with the public to help give those choosing a pension provider knowledge of where their money, and their employees’ money, will be invested.
What do employers and payroll managers need to do?
For employers, climate change risk management is slowly trickling down. While responsibility has largely remained with banks, investors, pension schemes and large corporations, employers of all sizes will inevitably have to begin to report on climate impact.
This will include things like ensuring pension schemes chosen are meeting climate targets, as well as other responsibilities that are still being speculated on, such as emissions reporting. So, how can you ensure that your chosen pension scheme meets climate requirements?
- Ask your account manager at your pension scheme about their TCFD disclosures, and whether you can view their climate sustainability report or similar. West Midlands Pension Fund, for example, has theirs here.
- See if your pension scheme has a green pension on offer. This is a pension that solely contributes to green investments. Consider switching to this.
- Have a variety of pension choices and allow your employees to choose where their pension goes. Many employees may want to know that their money is being invested in green investments.
- Share where your employee’s pension contributions go. New investment publication regulations introduced in June 2022 require pension schemes to “measure and publish how their investments support the Paris Agreement climate goal of limiting global warming to 1.5 degrees Celsius above pre-industrial levels.”
- Manage pensions digitally. A system like Staffology Payroll allows for simple pension management, including multiple pension schemes and payment types. This way, you can easily move someone onto a green pension scheme with little fuss.
Staffology Payroll can help your pension management
Our cloud-based payroll software reduces the reliance on paper and ensures that you can move to greener pension schemes with ease.
Why not give it a try today? Get a demo.
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