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Investment Institute

Why now is the perfect time for schemes to act on climate change

  • 30 September 2021 (5 min read)

“Human influence has warmed the climate at a rate that is unprecedented in at least the last 2000 years.”1

The latest Intergovernmental Panel on Climate Change (IPCC) report doesn’t mince its words.

And rightly so: the science is stark, the required policy decisions are clear. The risks are existential.

Against this backdrop, top of the agenda for many pension schemes is considering how to integrate climate specific objectives into their portfolios. The question of ‘if’ is almost redundant.

With the de-risking trend in many pension schemes likely to continue, we expect a greater portion of their overall portfolio would be in credit assets. As a result, integrating climate risk in their credit portfolios will be essential.

From a credit perspective, we believe there are four compelling reasons that make now the perfect time to act on climate.

The first is regulation. Under guidance from the DWP, from 1 October 2021, the largest UK pension schemes will be subject to far more stringent climate change governance and disclosure requirements, with medium and smaller schemes set to follow over the next couple of years.

For many schemes, preparing for these requirements may require significant changes to be put in place.  We would encourage all schemes – no matter their size – to get ahead of the regulation and start putting steps in place now, to ensure they are properly equipped when their time comes.

For smaller schemes, this is an opportunity to look at what their larger counterparts are doing and publishing, and see how they can use this information to inform their own decisions and integration.

The second is the increase in quality data at our fingertips. Better data enables better decision making.

There was a time when asset managers, asset owners and the issuers of securities could argue that poor data impeded meaningful action on climate.

Not so today as the data is exponentially better. To use an example of a portfolio we manage, our buy-and-maintain credit strategy manager will have sight on about 90% of emissions data from the underlying securities – albeit at the moment this is largely for Scope 1 and 2 emissions data but we are also starting to see more transparency on Scope 3 as well.

And it is not just carbon data that is improving. We consider a dashboard of climate-related metrics for our clients and have seen better coverage and availability of data from initiatives such as the Science Based Targets Initiative, Transition Pathway Initiative as well as in areas such as the measurement of climate value at risk.

This better (and still improving) data empowers us as managers to take more precise action and for asset owners to hold their managers to account on decisions made.

Third, supply of green securities is starting to balance out with demand, meaning a greater proportion of new market issuance is coming from the green, social and sustainability bond market.

The benefits of this for asset owners coming to market are numerous.

Firstly, it is working to offset some of the ‘green premium’ around these assets caused by such high investor demand.

An increase in issuance from a broader range of sectors – outside of just utilities and financials which have previously dominated – is also creating better diversification opportunities.

Additionally, there is often a premium on offer when engaging in the new issuer market. As a manager this also provides an opportunity to engage with the new issuer to agree terms of the deal at the time of issuance. Increased diversity and scale can also reduce the need to trade, thereby offering more buy-and-hold opportunities.

Of course, not all bonds are “green enough”. Our analysts tend to decline as many as one in four. This is either because we don’t agree with the issuing company’s overall management strategy or because we don’t think the use of proceeds is adequately separated from the proceeds of their ‘normal’ bonds.

But the direction of travel in debt markets is clear and, from a climate perspective, very helpful.

The fourth reason to act now on climate is because it makes sense to do so when you are already running an exercise to rebalance or de-risk your portfolio.

If you’re reading this as the trustee of a defined benefit pension scheme, the chances are your most recent, or forthcoming, investment committee meeting will feature a discussion on derisking.

If this sounds familiar, is there a strong reason not to make that derisking decision in favour of action on climate? Is there a strong fiduciary reason to derisk in a way that does not align with climate goals?

We’d argue it’s a perfect opportunity to implement climate-related guidelines and achieve both goals. It’s something we’re seeing more and more in our own client base.

If you’re in the defined contribution market, your investment committee meetings may well focus instead on boosting the efficiency of fixed income allocations. Again, allocating scheme assets to strategies and securities that have science-based and / or green targets can also achieve financial and climate goals.

To paraphrase the IPCC: human influence through capital markets can have an unprecedented effect on our planet’s climate. If the time to act isn’t now, when is it?


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