Small DB schemes more at risk from climate change
Image: Tima Miroshnichenko/Pexels
Pardon the Interruption
This article is just an example of the content available to mallowstreet members.
On average over 150 pieces of new content are published from across the industry per month on mallowstreet. Members get access to the latest developments, industry views and a range of in-depth research.
All the content on mallowstreet is accredited for CPD by the PMI and is available to trustees for free.
Defined benefit schemes with assets of less than £5m are more like to see returns diminish over time due to climate change, through their higher allocations to return-seeking assets, compared with large funds, one consulting firm says. Elsewhere, calls to rethink climate change reporting are growing louder.
Broadstone argues that return-seeking assets are more likely to see diminishing returns through climate change than matching assets. Smaller and less mature schemes tend to hold a larger proportion in return-seeking assets, the consultancy says, attributing this to “simplified investment strategies”, while schemes of over £1bn in size and those that are more mature tend to hold more matching assets.
Based on its modelling, small schemes have a risk of negative performance of –16.9% over 20 years, compared with –13.8% for their larger peers.
Immature schemes, defined as those with less than a quarter of pensioners, have almost double the risk of negative performance than more mature schemes with more than three-quarters of pensioners – with a -15.7% versus -6.7% negative performance over 20 years, it projects.
The consultancy’s modelling is based on the average asset allocations for different types of DB schemes by the Pension Protection Fund’s Purple Book 2024, and on proprietary climate scenarios from Dutch investment advisory Ortec Finance.
Broadstone defines climate change risk as the difference between its standard asset return assumptions, using its capital market assumptions, and those under a 3⁰C climate change pathway by 2100 – the world’s current trajectory if no further action is taken, according to the Intergovernmental Panel on Climate Change.
“For most DB schemes, climate change risk manifests as a slow erosion over time of expected returns, which accelerates as physical risks impact returns and investment markets start fully pricing in future climate change risks,” the firm says. “The severity of this is largely a function of the scheme’s exposure to traditional return-seeking assets such as equities and diversified growth funds and the length of time that the scheme is exposed to these assets.”
Deon Dreyer, investment and climate risk director at Broadstone, adds: “As the severity and frequency of risks increases over the coming years, there are likely to be material impacts on traditional growth assets such as equity, real estate and infrastructure. Scenario modelling can help schemes and trustees measure this previously neglected risk and incorporate that into their investment strategies.”
The risk of returns being impacted reduces as schemes mature and shift into matching assets, the consultancy adds.
TCFD now seen as hindrance
Schemes with £1bn or more in assets are required to produce a report in line with the Task Force on Climate-related Financial Disclosures, while all schemes must produce an implementation statement that details schemes’ stewardship policies and any significant voting activity.
However, TCFD and other forms of environmental reporting have come under scrutiny. Many now believe that a narrative-based transition plan would be less burdensome and more effective than quantitative emissions reporting.
Professional trustee Bobby Riddaway, who chairs the Trustee Sustainability Working Group, is among those making the case for replacing TCFD with transition plans. He says sustainability professionals are “consumed by reporting obligations” which leave them little time for strategic engagement or education and has called for a moratorium on climate reporting. Doing so would lead to a “short-term surge” in UK investment and lay the foundations for private market growth, he claims.
The Department for Work and Pensions is due to review the Climate Change Reporting Regulations, which govern TCFD reporting, this year, building on evidence by the Pensions Regulator. TPR is convening a transition plan working group of sector stakeholders and large pension schemes which is due to present its findings to the DWP this year.
In June, the government published three consultation papers on transition plans and sustainability reporting, asking pension funds how they think any new transition plan requirements should integrate with those around TCFD reporting.
