How does the £30bn master trust invest responsibly? How does it see performance and report on value chain emissions, and what are its plans for investing in nature? Find out in this exclusive interview with senior responsible investment manager Katharina Lindmeier.
   

 
mallowstreet: Nest, even for a large investor, has a pretty strong focus on responsible investment, which is generally a growing and developing space. 

Can you tell us what's top of your agenda at the moment? 

 

Katharina Lindmeier: So responsible investment is really a core part of our investment philosophy. And we've just come to the tail end of the voting season. We've seen most of the AGMs taking place in the UK and the US, so that's been a busy time for us - it is every year, but particularly this year.  

 

We've had quite a lot of media focus as well, particularly on the oil and gas companies. As a result of the Russia Ukraine war last year and the high energy prices, there's been a particular focus on energy companies and the record profits that they've made, at the same time as increasing scrutiny from investors as to whether they are going to be sticking to their net zero commitments and not just to the long term commitments but actually taking the steps necessary to align with net zero by 2050 in terms of short to medium term targets. So that's been a big focus for us.  

 

One of our other priority areas is the banking sector – the banking sector is sometimes a bit hidden – because of scope 3 emissions. So it's what they do through their financing activities rather than their direct emissions from their operations. But they've got such a huge role to play in ensuring that we do transition to net zero. Phasing out fossil fuel financing is one of the key demands that investors have been asking banks for a number of years, and also investing more in low carbon solutions.  

 

And then there's a lot happening in the policy space as well. So one thing that Nest is involved in quite heavily is the Transition Plan Taskforce, which has been set up by Treasury. This is a cross-sector industry/government group that's trying to develop a gold standard for what transition plans should look like. So that's a really interesting initiative as well to be part of. 

 

mallowstreet: You mentioned the price spikes in fossil fuels and profits by fossil fuel companies. And obviously, that's been a boost for performance for people who invested in that. One of the questions around responsible investment has historically been, does it perform as well as standard investment? What would you say to people who feel that their argument has been strengthened? 

 

Lindmeier: I would say we are a long-term investor, we are going to be holding these assets, or we want to be holding these assets, almost in perpetuity, but certainly for the next few decades. And that's the reason why we are still invested in most energy companies, we have excluded some who we feel are just not transitioning at all.  

 

But what we are seeing here is that while we appreciate these sort of short-term headwinds. We don’t believe that the targets that the companies set out to 2030, bearing in mind already energy prices have come down again this year we don't see expansion of oil and gas up to 2030 as being compatible with net zero alignment. And that's not just our view, that's the research that's coming out from the International Energy Agency, the Intergovernmental Panel on Climate Change. And we are concerned that by developing new infrastructure, those assets could become stranded, because we do expect that there will be more regulation coming in the future as we get the more severe impacts of the physical risks of climate change. 

 

And frankly, we just believe that this is not in the best interest of our members because they will be saving with us and investing in these companies for a long time to come.  

 

mallowstreet: As you said, Nest did divest from some fossil fuel companies about a couple of years ago. Nest also voted against the chairs of BP and Shell in this AGM season and has been supportive of a claim that campaign group ClientEarth has been trying to bring to court against Shell over its transition plan. Shell disputes these allegations and the court has dismissed the claim. But generally on litigation, what role can it play? And do you think there will be more of it? 

 

Lindmeier: I definitely think there will be more of it, from shareholders, but we're also seeing a lot more around campaign groups bringing litigation as well. Particularly what we've seen recently that has been very interesting is that France introduced a ‘corporate duty of vigilance’ law. And we've seen a number of lawsuits at French companies, including Total Energies [Ed: dismissed by a Parisian interim judge in February 2023 for procedural issues], but also one of the banks, BNP Paribas, around that.  

 

The EU is now going through the motions of introducing similar regulation at a broader level. So we're expecting to see more of that. From a shareholder perspective, we think that litigation can be a useful tool for escalation. We wouldn't go straight in with litigation, but it's part of that engagement process, the engagement cycle. We'd usually go in, have the engagement with companies, then we might take action through our voting. But there are times when that doesn't give us the outcome that we want. And litigation is another route that we could take as well to further try and push companies in the right direction. 

 

mallowstreet: Do you think Nest will ever front a litigation or take class action? 

 

Lindmeier: That's a good question. I think at this point, we haven't got any plans to do so. And there are a lot of litigation cases ongoing already at a lot of companies. So like in [the Shell] case, we provided evidence to the case, which means we're not a claimant in the case, but we provided a letter to set out what our concerns were. And that for us seems like a good approach to take at this point in time. How this space develops, as we said, litigation is increasing. Who knows? 

 

mallowstreet: Do you see any problems or challenges in the concept of shareholder engagement and even shareholder primacy? And what does that mean for stewardship? 

 

Lindmeier: The first thing I would say is that dissent is not negligible at these AGMs. So I think at the Shell AGMs, 20% of shareholders voted for the resolution filed by ClientEarth. So that's not a negligible amount. And that is definitely something that companies should be listening to and engaging with those shareholders. I don't think that there is a challenge to shareholder stewardship here. Obviously, different investors might have different objectives. As we said, we're really long-term investors. 

 

The concerns that we have with both companies’ strategies as well, they keep telling us, ‘We’re committed to our net zero target by 2050’, but they’re changing their short and medium term targets. So effectively they are delaying the difficult decisions to a future board, because they won’t be with the company anymore, but we will still be invested. 

 

mallowstreet: Let's talk about reporting for a moment. As a DC master trust, you have to produce a report in line with the Task Force on Climate-Related Financial Disclosures. What have you learnt from that process? What challenges have you encountered? And how is climate reporting evolving generally? 

 

Lindmeier: We actually started doing TCFD reporting in 2017. So when the recommendations first came out, obviously that's evolved a lot over the last few years, particularly when we got the statutory guidance. And it's now our third year reporting in the TCFD framework that was set out in the Pension Schemes Act. We did almost a dry run when we had most of the statutory guidance available. And then we did a gap analysis, and our first report under the new regulatory regime last year. 

 

It is quite a time-consuming effort. There are still challenges, particularly around the data. But certainly what we found is it's a really helpful process to help you develop your risk management processes, the governance around it as well. One of the most interesting things we found was, we did a workshop last year with our investment committee on scenario analysis. And while we had already made all of our net zero commitments, the feedback that we got from our investment committee was actually, obviously bearing in mind a lot of the complexities and assumptions that go into scenario analysis, putting some numbers around how members will be affected by different climate change scenarios, a 4 degree world versus a 1.5 degree world, really brought to life what we're doing and gave a lot of credibility as well to what we're doing around our net zero strategy. So that was really helpful. 

 

It's just a good opportunity, as well, to report to stakeholders what we're doing. We were one of the first schemes to set a net zero target in the UK. But now, I think it's at least two-thirds of the economy that set a net zero target. But what we're hearing is that emissions aren't going down. So we're kind of in a situation where you're seeing a bit of a gap between commitments and action. And that's why I think TCFD reporting has been really helpful to demonstrate progress.  

 

In terms of where it's going, there are two elements. So one, I think I already mentioned the Transition Plan Taskforce. This is something that the UK government has set out that it will mandate for companies going forward to publish a transition plan. So TCFD is mostly backward looking and a transition plan is much more about, what are your commitments and what steps are you taking to get there. While there's a section on targets in TCFD, this kind of builds that out further.  

 

The other element is TNFD. So the Taskforce on Nature-related Financial Disclosures, which is expected to publish its final framework in September. At the moment, obviously, there's no regulatory requirement like for TCFD. But it's certainly an area we're looking at as well. And I think over time, we'll see whether these are standalone reports or TCFD and TNFD become combined, because there are similar elements around the way they are structured. So it remains to be seen, but we are expecting to start reporting on nature-related risks as well in a similar format, at least. Although we expect it will take a few years to get to the stage of where we're now with TCFD. 

 

mallowstreet: With reporting, obviously, there are many aspects that might be a bit difficult. You might not have the data and also, things like scope 3 carbon emissions, how do you quantify that, so the emissions from assets in the value chain that you don't own directly? What's your approach to that? 

 

Lindmeier: For Nest, we report on scheme assets, which are our scope 3. So Nest Corporation obviously also reports its carbon footprint, but operationally, that's very small. This is the same for pension schemes. 

 

And then when we report on the carbon emissions in the portfolio, we get the data from managers. And we ask them also to disclose the data quality metric, which basically looks at whether the underlying data is reported by the company, estimated by a third party or the manager or unavailable. And certainly what we've been seeing in recent years, and we're just going through that process again for our most recent scheme year, is that while in scope 1 and 2, so the direct emissions and emissions from energy use, the proportion of reported data is quite high, for scope 3 it really drops and we're very reliant still on a lot of estimations from data providers. 

 

So this is an area that we and our managers are also engaging with companies on, because ideally, we'd want that information directly from companies. But yes, for scope 3, still a lot of it is estimated or unavailable, unfortunately. 

 

mallowstreet: Do you think that will change, and how can it change? 

 

Lindmeier: I think so. It already has got better. We're seeing more companies reporting on it. 

Obviously, organisations like the Carbon Disclosure Project have been really helpful in that. It's also one of the objectives of Climate Action 100+. That was one of the first objectives that they set out, asking companies to report in line with TCFD, which includes full bio-chain emissions reporting as well. So we are seeing that number go up. But yes, it continues to be a challenge. 

 

mallowstreet: You mentioned TCFD reporting now, possibly in the future TNFD reporting. The field is expanding. Do you think responsible investment should still be a separate function or is it just investment as it is now? 

 

Lindmeier: We're certainly not in favour of a siloed approach. For us, it's about integrating ESG into the investment process. And we work very closely with the investment teams at Nest to ensure that when we are making asset allocation decisions, or we're doing a new manager search, that ESG considerations are kind of front and centre of that. 

 

What I would say is that I think there will remain a role for specialists on some of these topics. So the way that the responsible investment team at Nest is structured is that we've got thematic areas of expertise. And similarly to how we've got economists and strategists in the team, this is a similar type of role that should enable the investment teams to integrate it, but there will still be that need for specific research, I think from the ESG teams. 

 

mallowstreet: Nest is very active, it sort of takes a leadership role. But on the whole, when you look at UK pension funds, do you think they're doing enough on the responsible investment front? Is there a need for more action in certain areas in your view? 

 

Lindmeier: I think as an industry, there is a lot happening at the moment. The pensions sector was actually the first one to have the TCFD disclosure regulations. So actually, what we're seeing is that the rest of the sector is catching up, with asset managers coming into the regulatory regime, also real economy firms coming into that. So while we think there's a lot that asset owners can do for us to be able to meet our net zero commitments – but this doesn’t just apply to climate change – we need to be able to invest in assets that align with our objectives. And while we can do some of that through stewardship, we do need real economy firms to align as well.  

 

That's an area where, particularly in the UK, there has been a lot of focus on sustainability regulation for financial markets. And actually, I think we're in quite a good place with that. We've got the transition plans coming in. We've got the International Sustainability Standards Board standards being published soon as well. There's a lot happening. In some ways, it's more around what's the real economy doing, the underlying companies aligning here, because ultimately, our impact is through the companies we own. And while we have some say in how they’re run, and that's why stewardship is so important, we're not the only input into that. We need companies to do their bit.  

 

mallowstreet: Looking at responsible investment, when you talk to pension funds nowadays, it's almost always about the climate. What is Nest doing about other aspects of ESG? Elizabeth Fernando, Nest’s chief investment officer, has mentioned that something is afoot, can you tell us a little bit more about that? 

 

Lindmeier: We have a number of priority areas already, which we set out in our responsible investment report. Obviously, climate is one of them. But we have added natural capital recently, and we've started some work on that. It's quite a challenging area at the moment, because with climate change, what we've got is quite a straightforward international agreement, the Paris Agreement, which gives you some clear guidance, some clear targets. Obviously translating that into portfolio relevant metrics and so on is challenging. But with natural capital, we're not quite there yet.  

 

We have seen the COP process for biodiversity but just in terms of even identifying the metrics that you should be looking at, that's quite challenging. We started with deforestation, because that's a bit more straightforward, and we've got some things we can look at. We'll be disclosing some more info in our forthcoming responsible investment report, which should be out in Q3, around how we've been assessing deforestation risks across the portfolio. And we're also working on a wider environment policy on natural capital that builds on what we've already been doing on climate. 

 

And on social themes, we have worked on a number of social issues in the past as well and continue to do so. So human capital workforce issues are one of them. We've done a lot of engagement with companies. Last year, we co-filed a shareholder resolution at Sainsbury's asking the company to commit to paying the living wage across all the workforce and suppliers, contractors as well. [Ed: the resolution was not passed.] 

 

On the other themes, human rights is an area we've been doing a lot of engagements with, we've got one engagement ongoing at the moment, for example, on the rights of the Uyghur minorities in China and how companies are operating in China, are dealing with issues of, for example, forced labour in their supply chain.  

 

And another area that we've been focussing on is tech, big tech. There are governance issues but also social issues around privacy, cybersecurity and so on. So there are a number of areas ongoing. 

 

Sometimes the focus is overly on climate, but we do actually work across all areas of ESG at Nest.