Rethinking Climate-Driven Investing

The SG Pensions Enterprise Masterclass on "Rethinking Climate Driven Investing," held on Tuesday, 19 March, was the last of the "Rethinking Responsible Investment for a Better World" series. This event brought together senior colleagues from across the pensions industry for a deep dive into climate change's impact on pensions and their members. The discussions centred around the urgent need for pension funds to reimagine their governance, fiduciary duty, risk management, and approach to stewardship in order to effectively tackle climate change and achieve net-zero targets.

We started with a poll that highlighted a widespread belief among participants that current commitments are insufficient, putting the planet on track for a temperature increase exceeding 2.5 degrees Celsius. This highlights the urgency for intensified climate adaptation and mitigation efforts. For example investing in renewable energy, energy efficiency initiatives, and nature-based solutions, as part of a portfolio of climate-driven investments.

Keynote: Implications of Rethinking Climate Governance for SAA and Investment Decision-Making.

Julius Pursaill, Strategic Adviser at Cushon, delved into the urgent need to overhaul the conventional approach to scenario analysis when investing, particularly regarding climate change. He critiqued the current integrated assessment models for significantly underestimating the impacts of climate change, thus misleading fiduciaries into believing that climate risks do not demand immediate action. Highlighting 'No Time to Lose – New Scenario Narratives for Action on Climate Change', he shared how the University Superannuation Scheme (USS), in collaboration with Exeter University, has developed narrative-based scenarios that are both decision-useful and successfully engaged with their trustees. This innovative approach aims to offer a more accurate assessment of climate risks and their financial implications, encouraging better-informed investment strategies.

He then navigated the complex terrain of balancing engagement with high-carbon-emitting companies against the necessity of divestment. He illuminated the challenge that engagement can foster positive change within these companies. However, a point may be reached where it no longer yields results, prompting divestment. However, divesting entails losing influence over the company's actions. The discussion highlighted diverse viewpoints, including scepticism about the effectiveness of engaging with oil and gas companies, underscoring the nuanced debate surrounding the optimal balance between engagement and divestment in sustainable investing.

Julius then explored the alignment of fiduciary duty with climate change concerns, referencing a review by the Financial Markets Law Committee (FMLC). A consensus emerged that fiduciary duty should evolve to consider broader economic and financial system impacts, including climate change risks. This evolution suggests a move towards fiduciary duties that acknowledge climate risks and empower trustees to make investment decisions that could positively change the world for future retirees.

He then proposed a comprehensive roadmap for asset owners, emphasising the need for clear objectives for example understanding the difference between (i) portfolio decarbonisation, (ii) real-world decarbonisation, and building (iii) portfolio resilience. He ran through each approach, and highlighted the benefits of portfolio decarbonisation, the necessity of aligning investment with the organisational purpose, and the importance of resilience in fiduciary roles. This roadmap challenges asset owners to navigate the complexities of decarbonisation while ensuring robust returns and mitigating transition and physical climate risks.

The interaction between stewardship and policy advocacy by asset owners was also a key point, with Julius advocating for the critical role of policy advocacy in supporting successful transitions to greener economies. He emphasised the importance of members' voices in shaping trustee policies, suggesting that feedback from beneficiaries could bolster resistance against government pressures to invest in non-supportive ways.

After Julius' presentation we conducted a poll and he had successfully persuaded the attendees to prioritise portfolio risk mitigation (65% of respondents) when considering climate change, followed by 27% focusing on real-world decarbonisation and 8% on portfolio decarbonisation.

Panel Discussion: What Asset Owners Really Want From Their Managers and Advisers.

The panel moderated by Charlotte O'Leary, CEO of Pensions For Purpose, brought together panellists including Mike Clark of Ario Advisory, Jason Fletcher, former CIO at London CIV, Nigel Keogh, an Independent Consultant, and Nick Spencer, Sustainable Investment Strategist at Gordian Advice. They delved into how to integrate climate change considerations into pensions and the broader financial sector.

Starting with a strong emphasis on the need for pension systems to rethink their investment strategies and the governance structures supporting them. Charlotte underscored the crisis where current pension contributions are insufficient for retirement, pointing to the significant role pension systems can play in addressing climate change goals. The panel advocated for a 'just transition' to a sustainable economy, stressing fairness, inclusivity, and the consideration of intergenerational impacts.

Another poll revealed a divide in opinions on who is responsible for managing climate change risks in the UK finance sector, with no clear consensus emerging among pensions executives, trustees, policymakers, and regulators. This led to discussions on the legal and practical aspects of responsibility, highlighting the importance of personal agency across all stakeholders in the investment process, including individual consumers, members and voters.

A concern raised was the confidence gap pension committee members face in challenging their advisors. This gap underscores the need to empower trustees and enhance advisors' competency through education and developing decision-useful climate metrics. The panellists expressed a desire for more forward-thinking approaches in advisory services, especially for smaller pension schemes that rely heavily on external advice.

Collaboration emerged as a key theme, with panellists arguing for bridging divides between asset owners, consultants, and other stakeholders to address climate change effectively. The discussion pointed out that collective action, facilitated by events and initiatives aimed at asset owners, could lead to impactful collaborations and systemic change.

Moreover, the panel discussed aligning organisational incentives with sustainability goals. They debated the authenticity of asset managers' commitment to sustainability, suggesting that a genuine commitment should be reflected in internal practices, including employee pension offerings. This part of the discussion also highlighted the potential burnout of sustainability professionals within asset management firms due to misaligned incentives and a disproportionate focus on costs over value.

Lastly, the complexity of integrating Environmental, Social, and Governance (ESG) and impact considerations into investment strategies was acknowledged, with a call for levelling up among advisors to ensure high-quality, consistent advice across the industry. The panel concluded that asset owners should assume more responsibility for the costs associated with sustainability efforts and emphasised the need for initiatives that empower asset owners to make better-informed decisions about sustainability integration.

Presentation: Mitigating Risk and Enhancing Performance Via the Carbon Credit Markets.

David Ryan, Head of Distribution at Carbon Growth Partners, underscored the critical role of carbon credit markets in addressing climate change and enhancing financial investment opportunities. He highlighted the alarming global emissions rates and insufficient progress towards climate targets, spotlighting the distinction between compliance markets, regulated by governments, and voluntary carbon markets, driven by project-based initiatives. He discussed the European Union's cap-and-trade market, the world's largest, aiming for EU Member States to become climate neutral by 2050, and reduce net emissions by at least 55% by 2030 compared to 1990. He raised concerns about the EU's Carbon Border Adjustment Mechanism potentially creating trade barriers. The integrity and effectiveness of voluntary carbon markets were discussed, noting efforts to improve standards and address the imbalance between emissions and the volume of carbon credits issued. In Q&A David concluded with the importance of diverse decarbonisation strategies, including direct air capture and reforestation, and the crucial role of fossil fuel companies in funding these efforts.

Presentation: Insurance Linked Strategies and ESG -  How ILS Prices Catastrophe Risks to Enhance Return, Diversification and Social Resilience.

Alistair Jones, Managing Director at Insurance Linked Solutions, Leadenhall Capital Partners, gave a presentation on the role of insurance-linked securities (ILS) in pricing climate risks and enhancing financial returns. He emphasised insurers' daily use of short- and medium-term tail-risk models to accurately price property damage from natural disasters. This differs significantly from the long-term models used by pension funds. He noted the increasing interest in ILS by institutional pension funds, citing their benefits in return diversification and social resilience. Alistair underscored the importance of transparency in location data for effective risk pricing and how ILS transfers insurance risks to capital markets, providing high yields even in economic downturns. He concluded that the significant role of ILS is in contributing to sustainability goals by offering protection to underserved regions, stressing the adaptability of the market to transition and physical risks.

Panel Discussion:  How to Accelerate the Low Carbon Transition – The Investment Strategies That Will Drive Net Zero.

In the final panel discussion, moderated by Kerry King, Director of the Asset Owners Network at Accounting For Sustainability, experts from the financial and sustainability sectors explored strategies to accelerate the low-carbon transition. The panellists included Marian D'Auria from GFG Alliance, Julia Dreblow of SRI Services, Mark Thompson of the M&G Pension Scheme, and Jane Wadia from AXA Investment Managers, who collectively underscored the critical role of pension schemes in the net-zero transition.

The dialogue began with an emphasis on pension funds' dual responsibility to ensure financial security for their members while addressing climate change. This involves carefully decarbonising investment portfolios and engaging in stewardship activities to influence broader climate initiatives. The panellists highlighted the importance of investment strategies that focus on reducing carbon footprint and ensuring resilience against climate-related risks by investing in both 'green' companies and those transitioning towards sustainability.

The discussion also highlighted the significance of supporting emerging markets through targeted investments, recognising their pivotal role in the global shift to net zero. It acknowledged the complexities and barriers to achieving climate goals, such as integrating climate objectives with pension scheme strategies, the need for asset manager upskilling, and the challenges of communicating transition strategies without causing confusion or inadvertently greenwashing.

Lobbying for supportive climate policies was identified as a potent tool for pension funds to influence decarbonisation efforts on a broader scale, given their substantial assets under management. This approach requires a nuanced understanding of investment impacts and clear communication strategies to build public trust and ensure policy alignment with net-zero objectives.

Furthermore, the panel shed light on incorporating adaptation and resilience measures into investment portfolios. Recognising the potential risks of an overemphasis on transition without adequate policy support, the discussion highlighted the need for investments that maintain their value and contribute to societal resilience amidst the advancing effects of climate change.

The session concluded with a consensus on the urgent need for pension schemes and their managers to adopt comprehensive strategies aligned with a sustainable future. By focusing on decarbonisation, resilience, and proactive policy engagement, the financial sector can play a pivotal role in driving the transition towards a low-carbon economy, ensuring not only the safeguarding of investments but also contributing to the broader goal of mitigating climate change.

Devil’s Advocates summary.

Karen Lockridge from CAAT Pension Plan and Bobby Riddaway of Capital Cranfield, summarised by delving into the nuances of climate-driven investment within pension schemes. The discussion underscored the imperative of setting clear investment goals that align with environmental sustainability, highlighting the pivotal role of consultants in enhancing the industry's proficiency in sustainable investments. It also touched upon the challenges U.S.-owned firms face in embracing ESG principles, illustrating the global disparity in sustainability approaches. They highlighted the rising emissions despite a shift towards cleaner energy, underscoring the complexity of achieving real environmental impact. The conversation also addressed the financial industry's credibility crisis and the need to demonstrate genuine impact in climate and ESG efforts. Concluding with a call to action, Karen and Bobby concluded with the urgent need for widespread industry collaboration and implementation of the discussed strategies, concerted climate action and policy change.

My Five Key Insights on Rethinking Climate Driven Investing.

As chair I concluded with my five key reflections.

1. Agency: Each of us, as voters, consumers, employees, and stakeholders within the pensions landscape, holds significant influence. Recognising and harnessing this agency is crucial for impactful decision-making in climate-driven investing.
2. Collaboration: Asset owners and suppliers need to collaborate more to accelerate our journey towards a world worth living in.
3. Context Matters: Effective climate-driven investing strategies are not universal. They must be customised to suit the unique needs and frameworks of Defined Contributions (DC), Local Government Pension Schemes (LGPS), wealth management portfolios etc, and their respective governance structures.
4. Advocacy: Please spread the word, engage in meaningful conversations, and inspire others to Rethink Climate Investing.
5. Action: Be Bold, be Brave and take Action. We cannot afford to wait.