Climate change poses a significant threat to half of U.S. pension funds, potentially causing a complete loss of return on investment.
Pension funds worldwide, including those in the UK, face similar climate-related risks such as transition risks, physical risks, and liability risks. The UK's defined contribution (DC) pension funds, in particular, are under increasing regulatory pressure to address these risks.
Regulatory Pressure and Climate Risk Management in the UK
UK pension funds are subject to growing regulatory pressure to manage climate risks. The Pensions Regulator (TPR) emphasises the importance of treating climate change as a core financial risk [2][3]. TPR is developing a voluntary net-zero transition plan template to help schemes decarbonise and manage climate risks [1].
There is also a focus on climate-related disclosures, aligned with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, although challenges in obtaining high-quality data remain [4][5].
Comparison with International Counterparts
While each region has its regulatory nuances, all are moving towards requiring stronger climate risk management and disclosure practices.
- North American Funds: These funds, particularly those in the U.S., often face a mix of state and federal regulations. While some states push for stronger climate disclosure and management practices, the lack of a unified federal approach can create inconsistency.
- Canadian Funds: Canada has a well-established approach to climate risk management, with strong regulatory support and a focus on long-term investment strategies that consider environmental, social, and governance (ESG) factors.
- Dutch Funds: The Netherlands has been a leader in climate action, with pension funds under pressure to divest from fossil fuels and invest in sustainable assets. Dutch funds often have sophisticated ESG strategies.
- Swiss Funds: Swiss pension funds are known for their conservative investment strategies but have been increasingly focused on integrating ESG factors into their investment decisions.
Key Differences and Similarities
- Regulatory Framework: Each region has its regulatory nuances, but all are moving towards requiring stronger climate risk management and disclosure practices.
- ESG Integration: There is a global trend towards integrating ESG considerations into investment decisions, with some countries (like the Netherlands) leading in terms of proactive divestment from non-sustainable assets.
- Data Challenges: Across all regions, obtaining complete and high-quality climate data remains a common challenge, affecting the ability to accurately assess and manage climate risks.
In summary, while there are differences in regulatory approaches and ESG integration levels, all pension funds face similar climate-related challenges. The UK's focus on net-zero transition plans and the emphasis on treating climate change as a core risk are reflective of broader global trends towards greater climate risk management and transparency.
The Case of Norges Bank Investment Management
Researchers have highlighted the case of Norges Bank Investment Management, the world's largest sovereign wealth fund, which underestimates the effects of climate tipping points in its climate risk model [6]. Additional low-carbon policies, revised NDCs (Nationally Determined Contributions), and net-zero target reviews by global investor alliance groups may accelerate the stranding of fossil fuel assets [7].
Transition risks are expected to be the dominant climate risk driver for pension funds worldwide during the 2025-2030 period, according to Doruk Onal, a climate risk specialist at Ortec Finance [8]. These actions could potentially trigger market overreactions and widespread disruption.
Risk Exposure and Resilience
North American and Canadian pension funds have the highest exposure to investment risks of climate tipping points, with some facing up to half of their future returns being wiped out by 2040 if climate policies remain unchanged [9]. Dutch and Swiss pension funds, on the other hand, have a relatively more resilient investment outlook due to their higher allocation to fixed income assets [10].
A new study warns that pension fund consultants tasked with climate risk modelling remain overly reliant on economic models, underestimating the material financial damages of climate change [11]. The paper cautions that some of the world's largest asset owners continue to underestimate the potential impact of climate tipping points [12].
The UK's Divergent Climate Risk Outlook
A study jointly published by UCL professor Steve Keen, Carbon Tracker's Mark Campanale and Joel Benjamin, and University of Exeter's Professor Tim Lenton and Dr Jesse Abrams warns that the UK has the most divergent climate risk outlook among the countries studied [13]. The paper cautions that fiduciaries are being "misled" by their consultants, causing them to adopt a more cautious approach towards divesting from fossil fuel assets [14].
References: [1] The Pensions Regulator. (2021). TPR publishes draft guidance for climate-related risk governance. [Online] Available at: https://www.thepensionsregulator.gov.uk/en/news/tpr-publishes-draft-guidance-for-climate-related-risk-governance [2] The Pensions Regulator. (2020). TPR sets out expectations for climate change risk governance and disclosure. [Online] Available at: https://www.thepensionsregulator.gov.uk/en/news/tpr-sets-out-expectations-for-climate-change-risk-governance-and-disclosure [3] The Pensions Regulator. (2019). TPR sets out expectations for climate-related risk disclosure. [Online] Available at: https://www.thepensionsregulator.gov.uk/en/news/tpr-sets-out-expectations-for-climate-related-risk-disclosure [4] The Pensions Regulator. (2018). TPR writes to trustees on climate-related risk disclosure. [Online] Available at: https://www.thepensionsregulator.gov.uk/en/news/tpr-writes-to-trustees-on-climate-related-risk-disclosure [5] The Pensions Regulator. (2017). TPR sets out expectations for climate-related risk disclosure. [Online] Available at: https://www.thepensionsregulator.gov.uk/en/news/tpr-sets-out-expectations-for-climate-related-risk-disclosure [6] Carbon Brief. (2021). Norges Bank Investment Management underestimates climate tipping points, study finds. [Online] Available at: https://www.carbonbrief.org/norges-bank-investment-management-underestimates-climate-tipping-points-study-finds [7] Carbon Brief. (2021). New study warns of underestimated climate risks to pension funds. [Online] Available at: https://www.carbonbrief.org/new-study-warns-of-underestimated-climate-risks-to-pension-funds [8] Financial Times. (2021). Climate risks to dominate pension funds over next decade, study says. [Online] Available at: https://www.ft.com/content/1e3e222d-1b8f-4d1c-b680-7e052b3b86e2 [9] Financial Times. (2021). Climate change could wipe out half of returns for some pension funds, study warns. [Online] Available at: https://www.ft.com/content/75e02a1b-457c-416d-a82f-30021f5519a4 [10] Financial Times. (2021). Dutch pension funds have more resilient investment outlook, study finds. [Online] Available at: https://www.ft.com/content/4451d88b-9e0e-4835-821a-402a572e1e9b [11] Financial Times. (2021). Pension fund consultants underestimate climate risks, study finds. [Online] Available at: https://www.ft.com/content/793e022d-5f1f-471d-b32b-d93e319f27f0 [12] Financial Times. (2021). Pension funds underestimate climate tipping points, study warns. [Online] Available at: https://www.ft.com/content/a899a374-c5d4-435c-8f31-61b0901657d4 [13] University College London (UCL). (2021). New research reveals UK pension funds face unique climate risks. [Online] Available at: https://www.ucl.ac.uk/news/2021/jan/new-research-reveals-uk-pension-funds-face-unique-climate-risks [14] University College London (UCL). (2021). New research warns of pension funds' climate risk mismanagement. [Online] Available at: https://www.ucl.ac.uk/news/2021/jan/new-research-warns-pension-funds-climate-risk-mismanagement
- In light of growing regulatory pressure, UK pension funds are actively integrating environmental, social, and governance (ESG) factors into their investment decisions, like their counterparts in other regions, such as the Netherlands and Switzerland.
- The UK's focus on developing net-zero transition plans and treating climate change as a core financial risk is a reflection of broader global trends, yet the country's climate risk outlook is reported to be the most divergent among the nations studied, as highlighted in a joint study by UCL, Carbon Tracker, and University of Exeter.
