Climate risk governance and reporting duties: new obligations for occupational pension schemes

Among the wide-ranging reforms that the Act introduces (which will be the subject of future Insights in this series), the new legislation makes significant changes as part of the government's decarbonisation agenda. The Act brings in new scheme governance duties relating to climate risk for all pension scheme trustees (whether defined benefit or defined contribution), together with a requirement to make climate-related disclosures.

Climate change represents a major systemic financial risk to the UK (and global) economy, and in particular to the long-term sustainability of UK private pensions (which have almost £2 trillion of assets under management). All UK pension schemes are therefore exposed to climate-related risks. These reforms represent UK government's attempt to help pension trustees fight climate change and limit the related risks to members' retirement incomes.

What has happened?

The Department for Work and Pensions (DWP) has outlined how the new rules will work, in a response to its 2020 consultation in this area of climate change duties, published at the end of January 2021. At the same time, it opened a consultation on draft regulations and statutory guidance confirming the action trustees should take. The consultation is open until 10 March 2021.

When will the new climate duties start to apply?

Broadly, the position is that:

• Schemes with assets of £5 billion or more will be required to meet the new governance requirements from 1 October 2021, and the new disclosure requirements within seven months of the end of scheme year that is under way on 1 October 2021.
• Existing authorised master trusts and collective money purchase schemes of any size will be required to meet the new governance requirements from 1 October 2021, and the new disclosure requirements within seven months of the end of scheme year that is under way on 1 October 2021.
• Schemes with assets of £1 billion or more will be required to meet the new governance requirements from 1 October 2022 and the new disclosure requirements within seven months of the end of scheme year that is under way on 1 October 2022.
• Schemes with assets of less than £1 billion are not currently within the scope of the new rules, but the government intends to hold an interim review in the second half of 2023, and consult again in 2024 on extending the duties to them from late 2024 or early 2025. It is also urging these schemes to start to take action now.

What are the new governance requirements?

The governance requirements on trustees are divided into seven areas:

• Governance: trustees must oversee climate-related risks and opportunities that are relevant to the scheme, and satisfy themselves that anyone advising the trustees in relation to governance activities, or undertaking governance activities on their behalf, is also taking adequate steps to identify, assess (and where relevant, manage) relevant climate-related risks and opportunities.
• Strategy: trustees must identify, and assess the impact of, climate-related risks and opportunities that will have an effect on the scheme's investment strategy (and, for DB schemes, funding strategy) over the short, medium and long term. For DB schemes, this will mean that trustees need to consider impact of climate-related risks on the employer covenant.
• Scenario Analysis: in the first year, and at least every three years after that, trustees must (as far as they are able) assess the impact of at least two global average temperature increase scenarios on the scheme's assets and liabilities, and assess the resilience of the scheme's investment and (for DB schemes) funding strategies to those increase scenarios.
• Risk Management: trustees must adopt and maintain processes for identifying, assessing and managing climate-related risks and integrate these into their overall risk management framework.
• Metrics: trustees must each year select and (as far as they are able) calculate at least two emissions-based metrics and one additional climate-related metric – and use these to identify and assess the climate-related risks and opportunities that are relevant to the scheme.
• Targets: trustees must set a target for the scheme in relation to at least one of the metrics they have chosen and (as far as they are able) measure performance against the target on an annual basis.
• Trustee knowledge and understanding: trustees must ensure they have the appropriate degree of knowledge and understanding of the principles relating to the identification, assessment and management of climate change risks and opportunities.

The draft statutory guidance provides more detail on what is needed.

What are the new reporting and disclosure requirements?

Each year, trustees will need to prepare a "TCFD report" (Taskforce on Climate-related Financial Disclosures report) setting out, in detail, how they have met the governance requirements and what they have found.

They will need to publish the TCFD report on a website which is publicly accessible, free of charge, and give the website address (and other information) in their scheme return, annual report, annual benefit statements and (DB schemes only) summary funding statements. This will add to other scheme documents that trustees need to publish online (for example, their statement of investment principles which had to be published by October 2019 or 2020, depending on scheme type).

What are the penalties for non-compliance?

The Pensions Regulator will be able to issue a compliance notice and / or a civil penalty of up to £5,000 for individuals, or £50,000 for companies, that do not comply. A mandatory penalty of at least £2,500 will apply where schemes fail to publish a TCFD report.

How does this fit with trustees' existing duties?

Trustees already have a duty when making decisions about the scheme's investments to consider financially material risks, including the impact of climate change. This will not change. Nor is this a call for trustees to divest immediately from all high carbon assets. It is recognised that exercising stewardship rights could well be an appropriate response to risk.

The new requirements also build on and complement:

• Recent changes to the required content of statements of investment principles and the introduction of implementation statements (with all schemes required to publish their first implementation statement by 1 October 2021).
• The Pensions Regulator's work on a new code of practice which will, amongst other things, trigger a requirement for trustees to complete a regular governance risk assessment, including a review of how they assess new and emerging ESG risks.

Although the principles are not entirely new, the foreword to the consultation response acknowledges that for many trustees the requirements will be a "new process" and "a learning curve". The government also recognises that schemes will be dependent on others for the information they need. Things should become easier as more and more parties make TCFD disclosures in line with the November 2020 UK Taskforce indicative roadmap but it is helpful that trustees will, to begin with at least, only be required to perform some of the new duties "so far as they are able".

Action points for trustees and employers

Trustees of pension schemes with assets of £1 billion or more, and of master trusts, need to discuss the new proposals now with their advisers and start to prepare for them coming into force. This will be either later this year (where they have assets of £5 billion or more, or for master trusts) or in October 2022 (where they have assets of between £1 billion and £5 billion).

The trustees of schemes with assets of less than £1 billion need to understand what is changing and consider, with their advisers, what action they can take now in relation to TKU and climate change governance and reporting in the period up to 2023-24. The government encourages "smaller schemes not in scope to begin to report on a voluntary basis … wherever it is proportionate to do so. Trustees of these schemes can use both the statutory guidance which will accompany our regulations and The Pensions Climate Risk Industry Group (PCRIG) non-statutory guidance". The key word here is "proportionate".

Employers might also like to discuss the changes with their trustees, with a view to working together on these important climate change issues where possible. The trustees are likely to need to understand what steps the employer is taking on climate change, and what climate-related financial disclosures it is required, or otherwise plans, to make. Good communication could also avoid the reputational risk that might result from the employer and trustees taking very different approaches. The disclosure requirements mean that members, and anyone else who is interested, will be able to look at the scheme's TCFD report.

Although the impact on smaller schemes is not so immediate, employers might also wish to take the introduction of these new duties into account when considering whether there would be value in consolidating smaller DC pension schemes as a good governance solution.

The overarching message emanating from government is that, for all pensions schemes of all sizes, climate change risk and governance is something they need to start grappling with now, even if the actual governance and disclosure requirements in the Act will not affect those schemes for another two or three years.

Osborne Clarke's pensions and cross-disciplinary decarbonisation teams are helping our clients to understand what they need to do to prepare for the new governance and disclosure requirements, along with the wider regulatory, legal and business challenges that decarbonisation brings. Please contact one of the experts below, or your usual Osborne Clarke contact, to discuss how we can help your business.