TCFD reporting is not yet driving the climate strategy of pension funds. But the industry is learning, and there are plenty of reasons to be optimistic.
The world is currently facing a climate crisis, posing a serious threat to the planet's future. The United Nations’ Intergovernmental Panel on Climate Change (IPCC) has warned that developed countries must push forward their net zero target by ten years, to 2040, to avoid catastrophic climate change. The pensions industry has the chance to make its mark on the race to net zero, but it needs to work faster to achieve this.
The UK government has already implemented plans to ensure pension funds double down on their push towards achieving net zero. One such measure was the obligatory requirement to produce annual Task Force on Climate-related Financial Disclosures (TCFD) reports, which came into effect in October 2021 for pension schemes with assets over £5bn and and master trusts, and for those with over £1bn in October the following year.
Despite this measure, which allows savers to see the impact of their investments on the climate, TCFD reporting has been subject to some criticism from the pensions industry. Issues with unreliable data collection, inconsistent data between asset classes, and conflicting views on whether to calculate Scope 3 emissions and carbon offsets, have all placed obstacles in the way for funds looking to make effective net-zero-focused investment decisions.
When it comes to different asset classes, both the format and time frames for emissions calculations differ, especially between publicly traded assets and more illiquid ones. Due to the absence of an industry wide accepted standard, it is also more challenging to measure the emissions of government debt, such as bonds or gilts. Private debt and real estate also suffer from inadequate data, and it has proven equally hard to quantify corporate climate transition plans.
Very few pension funds mention carbon offsets in their TCFD reports due to the question around whether they are a truly effective tool on the path to net zero. The issue lies in the fact that with offsets a company can pollute the world in one place, but plant some trees elsewhere and, technically, still be carbon neutral. We should be trying to reduce our emissions full stop and opt for genuine decarbonisation strategies.
When Pensions for Purpose looked into TCFD reporting, it found that funds had different methods of setting targets: 42% of funds had emissions intensity goals, while 21% had absolute emissions and data quality targets and only 16% had forward-looking targets.
Some pension funds that are ahead of the game, having incorporated climate risk and decarbonisation into their investment strategy in the past, have viewed TCFD reporting as a compliance requirement rather than an effective driver in their climate investment strategies.
This means that, for some pension funds, the government’s intention of having TCFD reporting drive climate strategies towards a net-zero target has been limited. Even for those funds that have produced TCFD reports, 25% do not have a public net-zero target. Indeed, some larger DB schemes have mentioned that they are less vulnerable to climate risk owing to their shorter timelines, given that their schemes are closed to new members.
However, despite some negative views towards TCFD reporting, pension funds shouldn’t be overly dismissive. While many funds agree the data isn’t quite there yet and needs improving, it is a step in the right direction for the industry. Besides, investors do want to see climate-related financial disclosures, with 90% of those surveyed by Pensions for Purpose using them in financial decision-making, and 66% factoring them into the way they price financial assets. As more and more companies disclose their data, the young TCFD reporting framework will mature and develop, improving methodologies.
The TCFD reporting as it stands does have its positives too – gathering the required data provides some beneficial exercises for pension funds from a race-to-net-zero perspective. For example, TCFD’s “scenario analysis”, which to some funds may be an entirely new exercise, is used to test the resilience of schemes in different future climate scenarios. The methodologies may still be in their infancy for scenario analysis, but this will help investment managers understand their portfolios better in terms of climate impacts, shining a light on potential areas of adjustment.
For some funds, increased climate reporting requirements such as TCFD have undoubtedly supported their overall net-zero strategy and targets. The selection of metrics not used before, such as emissions intensity, has refined comparisons between investments. Many have gained a better understanding of the greenhouse gas emissions associated with investments, current data limitations, and areas for improvement. These considerations feed into the setting of overall investment strategies, and any future changes to be made to them.
Disclosing climate-related information also provides an opportunity for funds to get members and investors bought into what pensions can do for the planet, and this visibility of disclosure data allows companies and investors to make informed decisions and contribute to a more sustainable future.
The key aim, after all, is to ensure that pension funds are doing their part in the race to net zero by 2040, and if TCFD reporting can help do this by allowing pension funds to further develop their policies, processes, and beliefs for managing climate-related risks and opportunities, then it can only be a good thing.
Launched in 2015, Smart Pension exceeds £4bn in assets under management (AUM) and now serves over one million members and more than 70,000 employers. It is powered by Keystone, Smart’s global savings and investments technology platform.
Aquiline Capital Partners, Barclays, Chrysalis Investments, DWS Group, Fidelity International Strategic Ventures, J.P. Morgan, Legal & General Investment Management, Link Group and Natixis Investment Managers are all investors in Smart Pension.