The Department for Work and Pensions (DWP) has published its response to its consultation on climate and investment reporting: setting expectations and empowering savers. The Occupational Pension Schemes (Climate Change Governance and Reporting) (Amendment, Modification and Transitional Provision) Regulations 2022 (the 'Regulations') are due to come into force on 1 October 2022.
The Regulations implement the necessity for trustees to report their scheme’s Paris-alignment by virtue of the requirement for them to select and calculate a portfolio alignment metric and to report on that in their TCFD report.
Who should read this update?
This update is of relevance to trustees and advisers of all occupational pension schemes, authorised master trusts and authorised collective money purchase schemes, not just those larger occupational schemes with assets in excess of £1bn on 1 March 2021 who will become subject to TCFD reporting requirements from 1 October 2022.
What was the background to the consultation?
The consultation, which ran from 21 October 2021 to 6 January 2022, sought views on the government’s proposals in relation to the following:
- policy proposals, draft regulations and draft statutory guidance to require trustees of occupational pension schemes with £1bn or more in relevant assets and authorised schemes who are subject to the Climate Change Governance and Reporting Requirements (colloquially known as TCFD requirements), to calculate and report an additional metric setting out the extent to which their investments are aligned with the Paris Agreement goal of pursuing efforts to limit the global average temperature increase to 1.5 °C above pre-industrial levels, and
- draft non-statutory guidance explaining best practice in relation to the Statement of Investment Principles (SIP) (which describes trustee’s climate change and stewardship policies) and draft statutory guidance explaining the government’s expectations across the Implementation Statement (IS) (which describes how they have implemented these policies).
Although these may seem two separate issues, they are linked. The consultation states that the government commends the emphasis that some respondents placed in linking Paris alignment and stewardship more closely. It states that it is not enough for schemes to ‘simply tick-box their way to net zero’ and that effective stewardship, informed at least in part by portfolio alignment assessments, will help trustees drive real-world decarbonisation outcomes while delivering long-term value to savers.
What was the outcome? What issues were raised and have any changes been made?
Chapter 1: Measuring and reporting Paris alignment
Alongside the consultation response the DWP has published the Regulations, which amend the Climate Change Reporting and Governance Requirements, requiring schemes in scope to report their portfolio alignment with the Paris Agreement from 1 October this year.
In the consultation, both the respondents and the government acknowledge that the accessibility, coverage, and quality of the data needed to measure and report on the Paris alignment is a key challenge. To address the data challenge, the Regulations contain the ‘as far as they are able’ principle (which is also applied to the other metrics required as part of the reporting requirements) which gives trustees the flexibility to obtain data within the boundaries of what they regard to be reasonable and proportionate for their holdings.
The consultation also noted that methodological discrepancies in calculating and reporting portfolio alignment metrics could result in subjective and incomparable portfolio alignment metric outcomes across pension schemes. The government response is that: ‘the FCA are working closely with HM Treasury on the development of a sustainable investment labelling regime and the UK Green Taxonomy. The labelling regime will help consumers select investment products based on their sustainability preferences...’. In addition, there was an acknowledgement that some stakeholders have concerns that some metrics are not suitable for pension schemes and therefore certain metrics are being removed from the list of additional climate change metrics.
The ‘net zero’ goal has also been removed. The Carbon Risk Real Estate Monitor tool (CRREM) has also been included which trustees can use to assess the net zero alignment of their real estate holdings.
Complying with the requirements may involve the use of external consultants or third-party analytics, which will represent an increase in the cost of administering schemes.
Multiple respondents stated that the proposed requirements would result in additional burdens to trustees not accounted for in the impact assessment.
Chapter 2: Stewardship and the implementation statement
As a result of the consultation, some drafting changes were made to the guidance including the following:
- the government clarified that the Pensions Regulator should be the main audience of SIPs and ISs. The government pulled back from suggesting these documents should be written for members. However, the guidance has been amended ‘to encourage schemes to consider producing member-facing summary versions of the SIP and IS (with signposting to the full document) if scheme-specific research has found that members are more likely to engage with a different style of communication’
- the IS must describe the voting behaviour by, or on behalf of, the trustees, including the most significant votes cast by trustees or on their behalf. The guidance is being updated to clarify that a significant vote is likely to be one that is linked to one or more of the scheme’s stewardship priorities/themes and the guidance encourages schemes to think about the connection between the scheme’s wider stewardship priorities and the votes cast on the scheme’s behalf
- some respondents raised points about member views in relation to investment decisions, pointing out that the guidance could be read as an expectation that trustees must take member views into account. The guidance has therefore been updated to clarify that trustees are not expected to take non-financial factors (i.e. members’ views) into account but may wish to do so. It is acknowledged that member views will inevitably be diverse and, where they are taken into account, they will need to be balanced against other factors in trustee decision making
- it was noted that the divide between financial factors and non-financial factors may be unhelpful and therefore the guidance clarifies that trustees are encouraged to keep under review non-financial factors that may not immediately present as financially material but have the potential to become so, particularly for schemes with a long-term horizon
- some respondents were concerned that the proposed guidance went too far by saying that where voting and engagement rights are exercisable by a third party rather than by trustees, trustees must ‘acknowledge responsibility for the voting policies that asset managers implement on their behalf’. The guidance clarifies that they do not mean ownership of the manager’s policies, but ownership of the scheme’s stewardship and trustees are encouraged to be proactive stewards
The consultation asked whether the DWP should include a vote reporting template in its implementation statement guidance for trustees to use, but the response was that there was no appetite for such a template or a template to report engagement activities. Where trustees would like to use templates, the response states that trustees may like to consider the Pensions and Lifetime Savings Association (PLSA) voting template and the guidance on reporting engagement drawn up by the Investment Consultants Sustainability Working Group (ICSWG) although the consultation response suggests that both of these may benefit from further development.
As a general point, there were concerns by respondents about the mix of statutory and non-statutory guidance; the text has, therefore, been amended to provide further clarification.
What are the implications for pension schemes?
Trustees who are subject to the Climate Change Governance and Reporting Requirements will now have to report their scheme’s Paris-alignment by virtue of the requirement for them to select and calculate a portfolio alignment metric and to report on that in their TCFD report. The ‘as far as they are able’ principle helps address data availability concerns in relation to certain assets when calculating a portfolio alignment metric. The principle gives trustees the flexibility to obtain data within the boundaries of what they regard to be reasonable and proportionate for their holdings.
Trustees will have the flexibility to select a portfolio alignment metric of their choice, which is most suitable to the circumstances of the scheme. This is supposed to ease the issues associated with incomplete information and lack of industry standards. The government is not seeking to impose any particular metric or standard.
Trustees of all occupational pension schemes should familiarise themselves with the draft non-statutory guidance in relation to the Statement of Investment Principles and draft statutory guidance in relation to the Implementation Statement.
What happens next?
The Regulations were made on 30 June 2022 and are due to come into effect on 1 October 2022. From that date trustees must select and calculate a portfolio alignment metric for the assets of their scheme. Trustees will have to report against the new metric within 7 months of the end of the scheme year which is underway on 1 October 2022.
We expect the guidance in relation to the Statement of Investment Principles and Implementation Statement to also come into force in October 2022.
How can we help?
We are well placed to advise on climate change, stewardship and reporting requirements in relation to pension schemes of all sizes. If you would like to explore this topic further, please contact Kate Granville Smith or your usual member of our pensions team.
This article was first published in substantially the same format on Lexis® PSL on 7 July 2022 and can be found here. This article was written by Kate Granville Smith.