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Governance and reporting of climate-related risks and opportunities

  1. Background
  2. Governance
  3. Strategy and scenario analysis
  4. Risk management
  5. Metrics
  6. Targets
  7. Publishing your report
  8. Appendix: a step-by-step example of following the climate change guidance

Appendix: a step-by-step example of following the climate change guidance

Issued: February 2022
Last updated: September 2022

About this example

This example illustrates the types of steps that you and your advisers could consider taking as you work through the requirements of the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021 and the Occupational Pension Schemes (Climate Change Governance and Reporting) (Miscellaneous Provisions) Regulations 2021 (the climate change regulations).

It could be helpful to you if:

  • you are currently required to comply with the climate change regulations
  • you are not currently required to comply but want to do more to manage your scheme’s climate-related risks and opportunities

The example is intended to help develop your understanding of how you might approach implementing the climate change regulations at a practical level. However, it is not intended to be used as a checklist. The governance structures of schemes, the skillsets of their trustees and their investment implementation arrangements vary significantly. The processes you put in place and the actions you take to understand and address the risks and opportunities that climate change poses to your scheme should reflect your individual scheme arrangements.

We expect you to take appropriate advice and ensure that the approach you adopt to meeting the requirements of the climate change regulations is suitable for your scheme.

About the XYZ pension scheme

The trustees of the XYZ scheme are starting to review how they might approach meeting the requirements of the climate change regulations which apply to their scheme.

The XYZ scheme has three separate sections.

  • A very mature defined benefit (DB) section, closed to accrual.
  • An immature DB section, open to accrual but closed to new entrants.
  • An open defined contribution (DC) section, growing rapidly.

DB scheme sections

  • The trustees have a well-diversified, well-hedged, complex investment strategy in place for both DB sections.
  • The investment strategy is invested across a wide range of investment mandates and fund structures.
  • The DB sections hold a mixture of segregated mandates, pooled funds and other collective investment vehicles. The scheme also has significant exposure to private market investments.
  • The trustees have completed one buy-in transaction with an insurer in relation to the very mature DB section. They plan to carry out further transactions in the medium term.

Table 1: the high-level asset allocation of the DB scheme sections

Asset class Immature section asset allocation Very mature section asset allocation
Equities: UK 3% 1%
Equities: overseas 31% 6%
Equities: unquoted private equities 2% 0%
Equities: derivatives 1% 0%
Sovereign bonds: fixed interest 12% 18%
Sovereign bonds: inflation-linked 21% 38%
Corporate bonds: fixed interest 7% 12%
Corporate bonds: inflation-linked 1% 1%
Property 5% 2%
Alternative assets 7% 15%
Pooled Funds/CIVs 9% 0%
Insured annuities 0% 6%
Cash/cash equivalents 1% 1%
Total 100% 100%

The scheme’s employer covenant is rated ‘tending to weak’, and the employer operates across several industry sectors. The employer’s business activities are well-diversified, but their supply chain is significantly dependent on carbon. However, the employer is now developing plans to lower the carbon dependency of the business in the future.

The DB sections are currently underfunded, and a 10-year recovery plan is in place, which is back-end loaded. The trustees currently have a long-term objective of being funded on a low dependency basis after 20 years.

The durations of the two DB sections’ liabilities are around 10 years (very mature section) and 24 years (immature section).

DC section

The asset allocation of the default arrangement of the DC section varies depending on how far away a particular member is from the state pension age (SPA).

Table 2: the main default fund’s asset allocation at 30 and five years before a member reaches SPA

Asset class 30 years to SPA 5 years to SPA
Equities: UK 10% 7%
Equities: overseas 65% 38%
Sovereign bonds: fixed interest 6% 12%
Sovereign bonds: inflation-linked 2% 9%
Corporate bonds 5% 20%
Property 5% 4%
Other 6% 6%
Cash 1% 4%
Total 100% 100%

The trustees also offer a range of self-select funds, but few DC members invest through them. As a result, the value of the scheme’s investments in each self-select fund is relatively small.

There are two groups of members in the DC section.

  • Members with only DC benefits.
  • Members with both DC benefits and legacy DB benefits (in the very mature DB section).

The trustees are considering setting up a decumulation option within the DC section. They expect the scale of assets relating to retiring DC members to start to increase materially within the next three to five years.

All DC investments are made through pooled funds, and around 85% of the assets are passively managed. The self-select funds are actively managed and include options for investing in property, corporate bonds, emerging markets and some multi-asset funds.

The funds do not currently have any specific environmental, social and governance (ESG) or climate credentials and the passive funds are benchmarked against market capitalisation indices. However, the passive fund manager has a strong ESG team and adopts a robust approach to engagement.

The trustees have access to some in-house investment advice and get additional investment advice from an external adviser as they need it.

The trustees’ first steps

Introductory training

The trustees know that there have been significant developments in relation to climate-related regulations, expectations and analysis. They understand that new requirements for knowledge and understanding in relation to climate change apply to trustees of schemes that are subject to the requirements under the climate change regulations. They also know that they need to develop their level of knowledge and understanding. They discuss the issue with their advisers and decide to develop a series of training workshops.

The workshops start with a high-level overview of their new responsibilities. The trustees outline some of the topics they feel are important to be aware of when addressing their climate responsibilities. Their initial list includes:

  • the new legal obligations: an overview of the climate change regulations and related requirements
  • fiduciary duty: how their new responsibilities in relation to climate change risks and opportunities interact with and support their fiduciary duties
  • greenwashing: how that might be identified and addressed in service providers and investment products
  • investment beliefs: how their current investment beliefs might inform their approach to climate-related matters and how and why those investment beliefs might need to be further developed
  • climate-related risks and opportunities: some examples over different time periods and in the context of other ESG and scheme risks
  • the role of engagement: how trustees or their service providers should engage with the companies and funds that they own in relation to climate-related issues
  • a Just Transition: whether and to what extent the trustees could seek to support this through their policies and scheme arrangements, taking account of member views
  • the practical implications of applying the climate change regulations to their scheme: the high-level implications of what that would mean in terms of changes, resources and other factors
  • adopting a net-zero target: whether that might be appropriate, how it might be achieved, and the high-level implications of what that would mean

Next steps

After completing the first overview workshop, the trustees understand the scale of the work involved and what additional training is needed.

The trustees complete an individual questionnaire, provided by their advisers, to help inform the development of a training programme. They ask their advisers to prepare the programme prioritised according to the likely timescales of the work they need to complete.

Developing the base case

The trustees understand that they will need to make some changes to:

  • their governance framework
  • their arrangements with scheme service providers
  • implementation aspects of their investment and funding arrangements
  • the detail of their risk monitoring arrangements

They also understand that they will need to obtain data to carry out scenario analysis and to calculate metrics. However, some asset holdings have material data gaps, and analysis techniques are still being refined.

The trustees want to start with a business-as-usual scenario to understand how, over future time periods, each section of the scheme might develop and continue to be supported by the employer covenant and be serviced by key service providers. They ask their advisers to set out how they expect the three sections of the scheme to develop over future time periods.

This helps them understand the following.

  • The very mature DB section might be managed down and run off through a series of future buy-in transactions and benefit payments. It also helps them understand the time period over which that might happen.
  • The immature DB section might continue to grow for some years before starting to mature. It will then start to run off and be managed down over an extended period.
  • The DC section might continue to expand. They also understand how the addition of a decumulation option might extend the time horizon of the scheme over which members’ benefits might be paid.

It also enables them to discuss with their advisers:

  • how they might expect their investment strategy and investment implementation arrangements to develop
  • what they might expect their level of reliance on the employer covenant to be at different points in the future
  • what the impact of a downgrade in the employer covenant might be on future funding and investment arrangements
  • what the outlook is for the sectors the employer operates in and how the employer covenant might develop in those sectors

To gain further insight, with support from their advisers, the trustees add some high-level qualitative views based on their knowledge of the business and the scheme investment arrangements to that analysis. This will help them understand what the practical impacts might be on their scheme investment and funding arrangements under a range of plausible climate scenarios.

Next steps

The trustees acknowledge that they will need to complete much more detailed analysis as they address the requirements of the climate change regulations.

The impact of scheme data

The trustees understand that they have a significant amount of work to do to address climate-related issues within their scheme investment arrangements.

They want to focus their time and resources on the investment managers, investment mandates and individual direct investments within their scheme that have the potential to have either the most material impact on their climate risk, or on their ability to carry out the climate risk analysis. They also want to engage to a greater extent in stewardship with the investments they hold.

To do this, they need relevant data.

Assessing and improving data quality

The trustees ask their investment adviser to provide an overview of what climate-related data is available and its current limitations. They also ask them to outline how the data might be expected to improve through purchasing better sources of data, improved statutory disclosure in the future, effective engagement with investment managers and others, and expected changes in the scheme’s investment holdings and implementation arrangements.

They also ask their investment adviser to highlight where engaging with investment managers and other service providers might help them address the data limitations that have the most material impact on their ability to identify, assess and manage climate-related risks and opportunities.

Analytical limitations

The trustees know that there are some significant challenges with the assessment of climate-related risk for some asset classes, such as private market assets. They are also aware that market practices for analysing climate-related risks and opportunities for some investment holdings, such as derivatives, have not yet been agreed upon.

They ask their adviser to:

  • produce a report setting out the extent to which they believe they can complete the analysis required by the climate change regulations
  • set out how the analytical limitations may affect some of the work they need to do to meet the requirements of the climate change regulations
  • identify any asset classes and holdings that present specific challenges in completing the analysis

The trustees understand that climate data is evolving, and analytical limitations are reducing. They also know they are expected to take a proportionate approach to managing climate-related risks and opportunities, particularly in relation to time and cost, when seeking to comply with the climate change regulations.

They ask their adviser to overlay their report with a view on the materiality of the individual climate-related issues they have identified. With this, the trustees can prioritise their efforts on the issues that are likely to make the most difference to their ability to accurately assess the level of climate-related risks and opportunities relevant to their scheme.

Next steps

The trustees use the advisers’ reports to develop a programme of engagement with their investment managers and service providers. They prioritise the data and analytical issues they expect to have the most material impact on either their climate risk or their ability to carry out that climate risk analysis.

Meeting the requirements on governance

Establishing and maintaining oversight

The trustees understand that they have ultimate responsibility for ensuring effective governance of climate-related risks and opportunities. They also know they must establish and maintain oversight of climate-related risks and opportunities.

The scheme’s Investment Sub-Committee (ISC) has previously developed the scheme’s Responsible Investment policy. They had also previously considered ESG issues – including some thematic climate aspects – to some extent, during the selection of investment managers for the DB sections and as part of ongoing monitoring and regulatory requirements.

The trustees are aware that they need to demonstrate that their own oversight of climate change risks and opportunities is sufficient. However, the trustees believe the ISC is best placed to lead on developing proposals to address the new climate change requirements regarding scheme governance and reporting. They agree to delegate primary responsibility to the ISC subject to the ISC:

  • clearly setting out the work they expect to do and when they expect to do it
  • reporting back regularly
  • working with the scheme’s investment, covenant, actuarial and legal advisers in developing the proposals
  • arranging for additional training for all the trustees to help with any important decisions arising from the proposals
  • bringing the final proposals back to the full trustee board for review and approval

In developing their proposals, they also ask the ISC to engage with the other trustee committees to highlight issues for consideration or development. They suggest that they form separate working groups when it is appropriate. The trustees then update the Terms of Reference for the ISC.

Updating of investment documentation

The trustees had previously discussed and agreed on a set of investment beliefs, which set out how they believed investment markets functioned and which factors could lead to good investment outcomes. Their investment strategy reflected those investment beliefs. It also helped to focus their investment decision-making and make it more effective.

The trustees review their investment beliefs regularly and in response to material developments to ensure that they remain relevant. The trustees now believe that climate change is a systemic risk that poses a material financial risk to the scheme, the sponsor and the investments held. The trustees agree that the ISC should develop some additional climate-related investment beliefs and a new climate change policy for discussion and agreement with the full trustee board.

The ISC, with support from the scheme’s advisers, updates the trustees’ investment beliefs and develops a separate climate change policy, which they intend to submit for discussion with the trustee board.

Investment beliefs

They add the following beliefs.

  • The scientific consensus supports the finding that limiting global warming to 1.5°C would require:
    • rapid and far-reaching transitions in land, energy, industrial buildings, transport and cities
    • emissions of carbon dioxide to fall by around 45% from 2010 levels by 2030 and to reach net-zero by 2050
  • If average global temperatures rise above 1.5°C, as outlined in the Paris Agreement in 2015, many climatic impacts will switch from being destructive to catastrophic.
  • Climate change is a financially material risk, presenting both opportunities and risks to members’ long-term outcomes.
  • Every investment decision should include an assessment of the impact of climate change risks and opportunities.
  • The transition to a low-carbon economy will require significant amounts of private capital. Private market investments should be one key area to focus on when seeking to identify climate change opportunities to invest in.
  • Climate change is only one dimension of ESG and only one aspect of risk and opportunity.
    • Climate change should not be considered in isolation. It should be fully integrated with scheme ESG and risk management policies.
  • The response to climate change presents significant transition risks. Different stakeholders will be affected in materially different ways. Consequently, the trustees should consider:
    • social impacts and the risks and opportunities they represent when making investment decisions that are informed by climate risks and opportunities
    • engaging with their investment managers on the topic of a Just Transition
    • encouraging investee companies to take account of social issues and risks when making climate-related investment decisions
  • If global warming is to be limited, real-world carbon emissions will have to reduce. However, implementing a low carbon portfolio footprint (in the short term), through selective divestment and investment, will not change the underlying systemic risks on its own as:
    • carbon-intensive sectors need significant investment to transition
    • a decarbonised world is likely to lead to more positive outcomes for members than a decarbonised portfolio on its own
    • active engagement on climate change and other environmental factors can have a significant impact on future outcomes for members
  • Although engagement on climate change and other environmental factors can be effective, there are limitations to engagement. In some cases, it may be appropriate to consider exclusion and divestment, subject to:
    • considering how the risk of holding those investments might increase as the global economy transitions to net-zero carbon emissions or due to policy or consumer actions
    • any decisions to either disinvest where there are concerns about climate-related risks or to invest where there is a climate-related opportunity not being driven purely by climate-related issues. These decisions must take all other relevant considerations into account and be consistent with the scheme’s investment objectives and in accordance with the trustees’ fiduciary responsibilities

Climate Investment Policy

The trustees support:

  • seeking investment opportunities that take into account the objectives of policymakers, as set out in the Paris Agreement, to limit the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels
  • the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD)
  • the development of robust climate change policy frameworks – both in the financial sector and in the real economy – by policymakers
  • active collaboration with the wider investment community and investor coalitions on climate change issues
  • engagement, with clear objectives, time horizons and consequences as an effective tool
  • investment in companies that can demonstrate that they:
    • have identified how they might be affected by both the physical and transition risks arising from climate change
    • have set clear objectives
    • are delivering against those objectives and remain well-placed in an economy that is expected to transition in line with the objectives of the Paris Agreement
  • the development of industry practices and consistent data and analytical approaches to enable effective risk management of climate change issues
  • the effective management of climate-related risks and opportunities affecting the scheme and its investment and funding policies within the context of their fiduciary responsibilities

The trustees expect their investment managers to:

  • understand and integrate financially-material climate-related risks into their analysis and investment processes
  • engage with companies on climate-related issues
  • be able to provide a robust investment rationale where high carbon emission companies are held as part of a portfolio or strategy
  • seek to support – through their investment decisions – the transition to a low carbon economy, provided the investments made fit within the risk and return parameters the trustees have set in the investment managers’ mandates, so are consistent with the trustees’ fiduciary duties
  • have clear policies on engagement, including on the use of exclusions or divestment
  • continue to improve the quality, clarity, and consistency of climate-related data they provide in relation to the funds in which the scheme invests
  • actively collaborate with the wider investment community on climate change issues

The trustees intend to:

  • set a net-zero emissions target by 2050, in line with the Paris Agreement's objective of limiting the rise in temperature to 1.5°C by 2050
  • review the 2050 target as knowledge, data and analysis of climate-related issues improve, and adjust it, if appropriate, in line with the scheme’s investment objectives and their fiduciary responsibilities
  • develop a clear plan, with robust interim targets set at five-yearly intervals, to achieve the net-zero emissions target
  • review the investments they are holding or expect to hold in the future to ensure that they are in line with their net-zero emissions target
  • develop, with support from their advisers, a formal policy for effective engagement on climate-related matters, including timescales for engagement and details of when restrictions and exclusions might be applied to their investment mandates, where the fund structures allow
  • actively collaborate with the wider occupational pension scheme community, for example the Institutional Investors Group on Climate Change, the Occupational Pension Stewardship Council, the UK Sustainable Investment and Finance Association and others
  • review and evolve their climate policy regularly in light of market developments

The ISC also make the following proposals to the full trustee board.

  • The trustees update the scheme’s Statement of Investment Principles and Responsible Investment policy to reference the new climate policy.
  • The trustees integrate climate-related risk and opportunities into their:
    • business plan and meeting cycle
    • risk register
    • risk management framework and monitoring dashboard
  • The trustees should engage with their scheme’s sponsor on an ongoing basis to understand how they are addressing climate-related issues relevant to their business and how the sponsor’s ability to support the scheme might be affected by climate-related issues in the future.
  • A climate risk and opportunity dashboard is developed for the scheme.
  • Climate and ESG-related capabilities are given high weighting during the selection of future investment service providers.
  • They consider the ability to provide climate-related data and analytics appropriate for climate-related reporting during the selection of future investment service providers.
  • Any future risk transfer exercises, such as buy-in transactions, should take into account the insurers’ climate and ESG-related capabilities and their ability to provide climate-related data and analytics.

The ISC also highlight that the application of all these proposals will be subject to the requirements of the trustees’ fiduciary responsibilities.

Existing investment arrangements

The scheme currently:

  • invests the DB assets across a range of asset classes, sub-asset classes, investment managers and fund types
  • retains a fiduciary manager for a legacy portfolio of alternative assets in the very mature DB section, which was taken on following a scheme merger
  • uses a wide range of derivatives, including interest rate swaps, futures and forwards, and equity and credit derivatives in the DB sections and a limited range in the DC section
  • holds some other risk management products, including a buy-in policy in the very mature DB section
  • retains a platform provider in relation to the DC section

The trustees know that reviewing the capabilities of their existing investment managers, fiduciary manager, investment service providers and investment and risk product counterparties will take a lot of resource. They ask their investment adviser to prepare a high-level report that:

  • assesses the capability of their existing providers of investment management and fiduciary management services to identify and assess climate-related risks and opportunities relevant to the scheme
  • sets out their effectiveness and suitability in relation to the management of climate-related investment mandates
  • identifies the extent to which current gaps in the individual services provided are material to climate-related risks and opportunities relevant to the scheme
  • identifies where the service provider may be able to offer alternative products, for example, funds managed against climate transition aligned benchmarks
  • sets out which investment managers and asset class investments would be expected to be retained and which would be replaced in the short term, as part of their ongoing development of the investment strategy
  • sets out which investment managers and asset class investments might be subject to review in the short term due to performance-related issue

Using that report, the trustees complete the following actions.

  • They identify some service providers who may need to be reviewed or divested from in the future. This is based on their having a limited capability to assess climate-related risks and opportunities or other issues relating to their performance or both.
  • They set priorities for engagement with their service providers based around those services likely to have the most material impact on climate-related risks and opportunities relevant to the scheme.
  • They write to all ongoing service providers setting out their high-level expectations. They indicate that they plan to work with them on climate-related issues over the near term.

Assessment and oversight of service providers and advisers

The trustees understand they must establish and maintain processes to satisfy themselves that their service providers and advisers (excluding legal advisers) take adequate steps to identify and assess climate-related risks and opportunities that are relevant to the scheme for the matters on which they are advising.

The scheme’s external investment adviser has previously provided the ISC with details of how they think they performed against the Investment Consultancy Sustainability Working Group (ICSWG) Competency Framework template. The ISC were satisfied with that submission. However, they believe the competency of the adviser should be annually reviewed as their own climate-related knowledge develops and general industry knowledge, analysis, and resources improves.

The ISC:

  • update the objectives they set for their investment adviser
  • request that ongoing investment performance and risk monitoring reports are updated to allow fully for:
    • climate-related risks and opportunities, including those arising from policy developments
    • investment manager developments in relation to climate-related issues
    • investment manager engagement and voting activity in relation to climate-related issues
    • developments in the quality and quantity of climate-related data provided by their investment managers and investment service providers
  • propose some adjustments to the investment adviser’s service contract

The trustees ask their scheme’s covenant and actuarial advisers to set out:

  • how they identify and assess climate-related risks and opportunities relevant to the scheme for the matters on which they are advising
  • their capability and resourcing in relation to climate-related issues on which they advise
  • how they propose to adjust their reports to the trustees in the future
  • what changes (if any) they believe are necessary to their current services agreements

The ISC then considers the covenant and actuarial advisers’ submissions in the context of the new governance requirements under the climate change regulations. They are then submitted to the trustees for further consideration and review. The trustees then propose some adjustments to their covenant and actuarial advisers’ service agreements.

Next Steps

The trustees:

  • review the proposals from the ISC and suggest some changes
  • delegate responsibility for implementing the investment and risk-related proposals to the ISC
  • request progress updates to be provided at future trustee meetings
  • review and agree on the proposals from the covenant and actuarial adviser, subject to some changes
  • agree that, because knowledge, data, analytical techniques and practices in this area are evolving rapidly:
    • the ability of their advisers to support them on climate-related issues relevant to the scheme should be subject to annual review
    • the processes and oversight arrangements they put in place concerning climate-related risks and opportunities should be subject to annual review
  • agree that climate-related capabilities should be given high weightings in future investment service or selection exercises for risk transfer providers, subject to the ISC and trustees operating in the context of their fiduciary responsibilities for any such appointment

Meeting the requirements on strategy and scenario analysis

The trustees understand that they must, on an ongoing basis, identify climate-related risks and opportunities which they consider will have an effect over the short term, medium term and long term on the scheme’s investment strategy and, where relevant, the scheme’s funding strategy.

Following their work on developing the base case, the trustees believe that the appropriate short, medium, and long-term periods for the individual sections of their scheme should be set as outlined in the tables below.

Short-term

Section Time period (years) Reasoning 
Very mature defined benefit 3 They intend to buy in additional liabilities with an insurer and more generally, to restructure their investments to align with those that an insurer might hold.
Immature defined benefit 5 They expect to take high-level, climate-related investment and funding decisions over this period, pending changes in the quality of climate change data and in climate regulations.
Defined contribution 5

Medium-term

Section Time period (years) Reasoning 
Very mature defined benefit 5 They expect to take high-level, climate-related investment and funding decisions over this period, pending changes in the quality of climate change data and in climate regulations.
Immature defined benefit 10 They believe that significant changes will need to be made by 2030 to limit global warming to 1.5°C above pre-industrial levels.
Defined contribution 10

Long-term

Section Time period (years) Reasoning 
Very mature defined benefit 10 This time period is in line with the duration of the liabilities of the very mature DB section.
Immature defined benefit 24 This time period is in line with the duration of the liabilities of the immature DB section.
Defined contribution 30 In line with a target of net-zero around 2050.

The trustees agree to review these periods annually in light of scheme and industry developments.

The trustees also need to assess the impact of the climate-related risks and opportunities they have identified on their investment and funding strategy on an ongoing basis. They make the following requests.

They ask their investment adviser to include an update on material climate-related risks and opportunities that will affect the investments for each section of the scheme, across the time periods selected for each section, in their ongoing investment performance and risk monitoring reports. They ask that the update also includes:

  • identification of any material new climate-related risks or opportunities, for example, following the introduction of new climate policies in any key markets, sectors, countries, or regions
  • a high-level assessment of the potential impact of any new material climate-related risks and opportunities
  • a recommendation for any actions the trustees should consider to either take advantage of those opportunities, or to understand, manage or mitigate those risks

They also ask their investment adviser to include, where possible, an assessment from several of their investment managers on the outlook for the sectors the employer operates in and its position within those sectors, over the different time horizons selected for the DB sections.

They ask their covenant adviser to include an assessment of the impact on the employer covenant of climate-related risks and opportunities across the time horizons for each DB section, and monitor this in their regular covenant updates.

They ask their scheme actuary to include an assessment of the potential impact of climate-related risks and opportunities in their funding strategy updates for the DB sections.

Scenario analysis

The trustees arrange for their advisers to run a workshop on scenario analysis covering:

  • the application of quantitative or qualitative scenarios
  • options for completing the analysis, including the use of third-party providers
  • the difference between a ‘top-down’ and ‘bottom-up’ approach to scenario analysis
  • the data requirements for the different approaches (and the extent of any current limitations on data availability affecting the scheme)
  • the availability and credibility of representative scenarios
  • the limitation and utility of current scenario modelling
  • factors that might influence the choice and range of scenarios, including:
    • the level of global average temperature increase to use
    • the type of transition, for example, orderly or disorderly
    • the types of climate-related risks that might have more impact over different time periods, for example, physical risks at longer horizons
    • the trustees’ climate-related investment beliefs
  • integration of the investment impacts with the potential effect on the scheme’s funding strategy under different scenarios, including the impacts on
    • the scheme’s liabilities
    • the employer covenant
  • how scenario analysis might be applied to their scheme and the individual sections within it

Following the workshop, the trustees agree to further actions.

  • Some initial qualitative scenario modelling, based around an increase in the price of carbon of different amounts, at different time periods, and allowing for how this might affect the employer’s business.
  • As far as they are able, some more detailed scenario analysis using a range of representative scenarios set out by the Network for Greening the Financial System, based on three initial scenarios.
    • An orderly 1.5°C scenario. This will meet the requirement under the climate change regulations to undertake one scenario with a global average temperature increase within the range of 1.5°C to 2.0°C above pre-industrial levels. They decide to use 1.5°C as this aligns with their net-zero ambition.
    • A disorderly 2.0°C scenario. They believe broader action on climate change may need to happen, for example, around 2028 to 2030, if the actual level of global decarbonisation achieved is significantly less than that required by 2030 under the Paris Agreement.
    • An orderly 2.5°C scenario. This is closer to the best estimates of 2.6°C to 2.7°C warming by 2100 that some market commentators believe will be the outcome from COP26. They believe that this scenario will also give them some insight into the potential physical impacts and risks that longer-term, high temperature scenarios might have.

After the initial scenario modelling, the trustees have developed an understanding of the following areas.

  • What the potential impact of a range of alternative global average temperature increases might be on the scheme’s assets and funding strategy.
  • How the effects may vary across:
    • different time horizons
    • individual asset classes, sub-asset classes and material holdings
    • liabilities with different characteristics, for example, fixed versus inflation-linked
  • How steps taken by governments, for example, setting a price for carbon or accelerating policy developments, could influence scenario outcomes.
  • The potential impacts of different temperature scenarios on the employer’s business, considering any mitigating actions or transition plans that management is implementing.
  • The type of amendments to their existing investment strategy and the implementation arrangements for that strategy, that might improve the scheme’s resilience.
  • The changes in their scheme funding arrangements or contingent security provisions that they might need to consider with their employer in the context of the potential impact of climate change on the employer covenant over time.
  • How the DC investments might perform under different scenarios and what the impact of climate-related risks and opportunities might be if no changes were made to the current investments.
  • What the impacts might be on the individual member pots, under different scenarios, for a selection of members of different ages, for each popular arrangement1 within the DC section.

Next steps

The trustees:

  • discuss the implications of the output from the modelling with their advisers and employer
  • consider, with their advisers, whether they need to run any additional scenarios
  • agree on some changes to the current investment strategy and implementation arrangements for the DB and DC sections
  • use some of the results of the modelling in their communication with scheme members about work the trustee has done on climate risks and opportunities
  • agree to review the scenario modelling annually and update it at the end of a three-year period or earlier if there are material developments affecting the scheme, available data, or analytical techniques

Footnote for this section

[1] A popular default arrangement is considered to be one in which £100m or more of the scheme’s assets are invested, or which accounts for 10% or more of the assets used to provide money purchase benefits (excluding assets which are solely attributable to Additional Voluntary Contributions) - Governance and reporting of climate change risk: guidance for trustees of occupational schemes

Meeting the requirements on risk management

The trustees understand that they must:

  • establish and maintain processes that will enable them to identify, assess and effectively manage climate-related risks which are relevant to the scheme
  • ensure that management of climate-related risks is integrated into their overall risk management of the scheme

The trustees and their advisers believe that these requirements have now been met following their review of their governance and oversight arrangements. They believe this for the following reasons.

  • The terms of engagement for their advisers now require them to report specifically on climate-related risks, where relevant to the scheme.
  • They have set specific climate-related objectives for their investment advisers.
  • Where possible under the fund structures, their investment manager reports have now been amended to highlight material climate-related risks and opportunities.
  • The regular investment and risk performance reports they receive from their investment advisers identify and assess climate-related risks and opportunities which are relevant to their scheme over the short, medium, and long-term time periods they have agreed for each section.
  • They expect their investment advisers to complete a more detailed annual review of climate-related risks and opportunities relevant to their scheme. They also expect to receive similar reports on employer covenant and funding from their covenant adviser and scheme actuary.
  • They have had training on climate-related issues, and their advisers have put together a plan for future ongoing training.
  • Climate-related issues are now a regular standing item on the trustees’ meeting agenda.
  • They had considered, with support from their advisers, whether they need new risk management tools to support management of climate-related risks or whether existing tools could be adjusted to reflect the unique characteristics of these risks.
  • They had mapped climate-related risks into existing risk categories, including financial, operational and strategic risks, and types. They had also integrated climate-related risk into their:
    • IRM monitoring framework and dashboard
    • risk register
  • The management of risks, including climate-related risks, is also now a regular standing item on the trustees’ meeting agenda. This enables them, with support from their advisers, to consider whether additional actions to reduce risk need to be taken.

They also:

  • asked their investment adviser to provide specific advice on:
  • the climate risk exposures (and opportunities) of the investment arrangements that they have implemented within each scheme section, over the short, medium, and long-term time periods they have agreed
  • whether the long-term time horizons they selected for each section to identify and assess risks are long enough to take account of the timescale over which climate-related risks need to be considered
  • how they expect the scheme’s investment strategy and implementation arrangements to develop in the future
  • the materiality of data and analytical gaps relating to climate risk in their current investment arrangements, and how they might develop a prioritised programme of engagement to address those-gaps
  • had discussions with their employer with regard to their transition plans and agreed on a programme of periodic progress updates
  • arranged for several of the scheme’s investment managers to provide periodic industry sector updates about climate-related risks and opportunities for the sectors their employer operates in
  • asked their covenant adviser to undertake an assessment of the impact on the employer covenant of climate-related risks and opportunities and monitor this as part of their regular reporting
  • had developed, with support from their advisers, a climate risk and opportunity dashboard at an asset class level, which is relevant to the nature of their current scheme arrangements and how they are expected to develop
  • Next steps

    The trustees agree to monitor their risk management processes on an ongoing basis, complete a formal review on an annual basis, and make changes where appropriate.

    Meeting the requirements on metrics

    The trustees understand that they must select a minimum of one absolute emissions metric, one emissions intensity metric, a portfolio alignment metric, one additional climate change metric and, as far as they are able, in each scheme year:

    • obtain the scope 1, 2 and 3 greenhouse gas emissions of the scheme’s assets – although obtaining scope 3 emissions is not mandatory in the first year of complying with the climate change regulations
    • use that data to calculate their selected absolute emissions metric and an emissions intensity metric
    • obtain the data to calculate their selected additional climate change metric, and use that data to calculate it
    • use the metrics they have calculated to identify and assess the climate-related risks and opportunities which are relevant to their scheme

    The trustees also understand they can choose different metrics for different parts of their portfolio. They know they can select an alternative additional climate change metric to those listed in the DWP’s guidance if they explain why.

    The trustees select two emissions metrics, portfolio alignment metric, and a range of additional climate change metrics. This is a result of having reviewed the following issues with their advisers.

    • The nature of the investments held and the data limitations.
    • The range of metrics available and how they might be applied to different sections within the scheme.
    • The extent to which they could aggregate their metrics across fund exposures using internally consistent methodologies.
    • The different decarbonisation trajectories they could adopt for their scheme and the types of actions that would need to be taken to meet those trajectories.
    • The kinds of additional climate change metrics that would be most useful for them to consider for each section of the scheme, given the nature of the investments held and the current data limitations.
    • The limitations of each of the available metrics, including consideration of:
      • the potential for errors in any modelling which is used to fill gaps in reported data
      • the range of uncertainty in individual additional climate change metrics
      • the potential impact on outputs of data availability and comparability between data inputs

    The trustees currently have material investment exposure to:

    • sovereign bonds, liability-driven investment (LDI) funds and a wide range of derivative strategies
    • investments in certain pooled funds and collective investment vehicles – such as LLPs and funds in some overseas jurisdictions – where the reported look-through in relation to the underlying investment holdings is currently very limited
    • an insurance buy-in policy, they also expect their exposure to buy-in policies to increase in the medium term as they intend to undertake further buy-in transactions

    The trustees know there are some challenges in analysing the emissions metrics for certain investments, including some sovereign bonds, some forms of derivatives, LDI portfolios and certain pooled funds and collective investment schemes (such as LLPs and funds in some overseas jurisdictions). As part of their strategic allocation to private markets, they also have material holdings in alternative assets, including asset-backed securities, where the availability of climate-related data is currently limited. The trustees understand that they are:

    • expected to collect the data and calculate the metrics as far as they are able
    • allowed to take an approach that is proportionate to the time and cost required to obtain relevant data
    • expected to take a proportionate approach in managing climate-related risks and opportunities in the context of the scheme’s other risks

    The trustees want to understand how far current limitations in data and analysis will affect their ability to assess climate-related risks for the affected parts of their portfolio. They also want to understand how material the impact of those limitations might be. With this information, they can take an informed view and prioritise resources.

    They ask their investment adviser to prepare a report setting out their high-level assessment, including:

    • the scale and nature of the individual exposures, showing:
      • sovereign bonds by country, type, and term
      • derivatives by type and nature and with short and long positions identified separately
    • the separate identification of sustainable investments
    • identification of net-zero targets set by sovereigns whose bonds are held and by corporates that they have material exposures to
    • the calculation limitations that apply to individual portfolio holdings and their impacts
    • identification of any asset or sub-asset classes for which methodologies to attribute greenhouse gas emissions have not yet been developed, for example, interest rate swap derivatives
    • the extent to which their buy-in provider discloses emissions data relating to their UK business and, in particular, their UK pension bulk annuity book
    • the potential for industry analytical practices to develop in the short term
    • the potential for third-party providers to support with input and analysis to complete aspects of the analysis
    • alternative or approximate approaches they could take to estimate the exposures, for example:
      • where available data is limited, using estimated or proxy data to identify carbon-intensive hotspots in their investment arrangements
      • modelling or estimation techniques to fill in missing data gaps, where they have most of the data for particular asset classes
      • qualitative rather than quantitative techniques for certain asset classes for which data or modelling tools are limited or uncertain
    • alternative sources of information they might use to inform the level of risk underlying individual holdings or mandates

    The trustees discuss the report with their adviser. They understand that:

    • they have significant exposure to a wide range of sovereign issuers in the DB sections and limited sovereign exposure in the DC section
    • their main sovereign positions are held with the UK and US, with material holdings in some other sovereign jurisdictions
    • they hold extensive interest rate and inflation rate swap positions as part of their LDI fund
    • they have limited exposure to other short positions, mainly through pooled fund strategies

    They ask their adviser to calculate for each section of the scheme and as far as they are able:

    • two emissions-based metrics, including:
      • an absolute emissions metric, based on total greenhouse gas emissions
      • an emissions intensity metric, based on carbon footprint
      • a portfolio alignment metric, based on limiting temperature increase to 1.5 degrees
    • a range of additional alternative climate change metrics, which they believe will provide insight and help them develop their approach and improve their management of climate-related issues

    The trustees also ask their adviser to:

    • advise on the extent of the risks and opportunities the metrics have identified which are relevant to the scheme
    • document how they believe that:
      • they have met the ‘as far as they are able’ requirements in relation to data collection and calculation of the metrics
      • their analysis has been limited and how they might be able to improve it in the future
    • highlight any aspects of the portfolio that should be prioritised for engagement to:
      • improve the data and/or
      • develop calculation methodologies
    • in order to improve their ability to assess and analyse the underlying climate-related risks

    The trustees hold a significant amount of sovereign bonds, with around 60% in UK government bonds and the rest invested across a range of sovereigns.

    They agree to use the Climate Change Performance Index as an additional climate change metric. They use this as a benchmark to identify the climate performance of individual sovereigns and identify material exposures to sovereigns with medium to very low ratings. They then discuss with their advisers whether they should:

    • make any changes to investment holdings
    • prioritise engagement with some investment managers
    • adjust investment mandate limits (where possible)
    • use other sovereign investments to perform the same investment or risk management role that their current sovereign investments perform as part of the overall investment strategy for the scheme

    Reviewing the metric selections

    The trustees know they need to review their metric selections from time to time, as appropriate to the scheme, and that climate data, analytical techniques and industry practices are rapidly evolving.

    They agree that they will review them annually and take appropriate advice as to whether they should retain their existing metrics or select some new ones. They also agree they should particularly consider selecting new metrics following any material:

    • changes in the investment strategy, as some metrics may be more appropriate to different investment portfolios
    • risk transfer transactions
    • changes in their existing climate-related objectives or the setting of new climate-related objectives
    • improvements in the quality and coverage of climate-related data available to the trustees, which may facilitate alternative analysis
    • improvements in the quality, coverage and capability of market metrics or the development of more appropriate forms of those metrics
    • relevant legal or regulatory changes

    Next steps

    The trustees review and discuss possible changes to the investment strategy and implementation arrangements with their advisers. They discuss how they might improve climate-related data and analysis in subsequent scheme years. They also discuss, agree, and prioritise a programme of engagement with their investment managers to improve the level and quality of climate-related data. They agree that they should consider the availability of climate-related data and metrics during any investment manager or insurer buy-in transaction selection exercises.

    Meeting the requirements on targets

    The trustees understand that they must:

    • set a target for the scheme in relation to at least one of the metrics they calculated
    • in each scheme year:
      • measure, as far as they are able, the performance of the scheme against that target
      • consider whether the target should be retained or replaced

    The trustees also understand that the targets set:

    • are not legally binding
    • should not conflict with their fiduciary duties or their investment policies as set out in their Statement of Investment Principles

    The trustees and their advisers discuss how they expect the scheme’s investment arrangements in each of the individual DB and DC sections to develop in the short term. They consider the potential effect of those developments on the choice of targets in individual sections.

    Before they carried out climate-related analysis on their scheme, the trustees had the following expectations.

    • For their very mature DB section, they would enter into more insurer buy-in transactions in the short to medium term. They would also realign the scheme assets to better reflect the type of portfolio an insurer might hold, given the ambition to fully buy in the liabilities for that section over the medium term.
    • For the immature DB section, they would increase their allocation to alternative and private market investments to 30% from their current portfolio holding of around 10%. This would be subject to the availability of suitable assets for the scheme which would meet the expected net return, expected risk, expected time horizon and portfolio concentration limits.
    • For the DC section, they would look for opportunities to increase their exposures to illiquid assets, given market developments and the potential for those opportunities to improve member outcomes. They would also carry out a survey of members before their next investment strategy review. This would identify any specific member needs or requirements.

    More generally, the trustees understood that the regulatory requirements to disclose climate-related information should significantly improve the availability of climate-related data across different scheme sections over the next year.

    Taking all of this into account, the trustees ask their investment advisers to recommend which metrics they believe would be appropriate to consider using as the basis for a suitable target for each section, given any intended investment changes and the expected improvements in data coverage. They also ask their adviser to set out the reasons why they believe those individual targets might be suitable.

    The trustees discuss the report with their advisers and agree to set targets relating to the following metrics.

    • For the very mature DB section, they agree to set a target related to emissions intensity and use carbon footprint as their metric. This reflects their expectation that, for future buy-in transactions, insurers will consider the extent to which investments being offered by the trustees in settlement of the transaction are climate-aligned.
    • For the immature DB section, they agree to set a target related to one of their selected additional climate change metrics, which is based on improvements in the quality and quantity of climate-related data coverage. They are aware that their current climate-related data coverage is limited given the complexity of the current investment arrangements.
    • For the DC section, they agree to set a target related to another additional climate change metric, based on portfolio alignment, as they believe that metric is likely to be more easily interpreted by members.

    The trustees ask their investment adviser to recommend:

    • the appropriate levels at which to set the individual targets
    • the time horizons over which they should set the targets
    • the interim targets they believe would be appropriate to adopt

    They also ask them to set out how much, if at all, any limitations in the trustees’ ability to obtain data and calculate metrics have affected the choice of metric and the level of the target set.

    They set the current scheme year as their reference base year for assessing progress against their targets and agree on how they will measure the performance of the scheme against those targets.

    The trustees have already agreed to set a net-zero target of 2050 for their scheme. They have an ambition to accelerate that target as they gain more experience of climate-related issues and of the implications and path dependencies of implementing a net-zero portfolio earlier than that date. The trustees agree that:

    • any targets set are not legally binding, and they should not conflict with their fiduciary duties, or the investment policies stated in the Statement of Investment Principles
    • once they have fully developed their net-zero alignment plan, they will consider how they can align any future targets set for individual scheme sections with that plan
    • they will measure on an annual basis, as far as they are able, the performance of the scheme against any targets
    • on an annual basis, they will review and take the appropriate advice on whether the target should be retained, replaced or potentially accelerated, taking into account the performance against that target

    Next steps

    The trustees embed the targets in their scheme governance, strategy, risk management processes and their contracts with investment service providers. They set out in their internal processes that the targets are not legally binding and should not conflict with the trustees’ fiduciaries duties or their investment policy objectives.

    Documenting their approach

    The trustees understand that some of the activities required by the climate change regulations are:

    • subject to an 'as far as they are able' requirement
    • expected to be based on taking reasonable and proportionate steps, which take into account the expected likely costs and time required

    The trustees also understand that they are expected to take a proportionate approach in managing climate-related risks and opportunities in the context of the scheme’s other risks.

    The trustees agree that, together with their advisers, they should document:

    • a clear explanation of what they have been able to do, what they have not been able to do and why
    • some analysis by asset class setting out their current climate-related data coverage and how they expect that coverage to develop in future years
    • the extent to which they can reasonably approximate any current gaps in the climate-related data
    • any intended changes in the scheme’s investment strategy or implementation arrangements that affected the data collection or data analysis they completed. For example, deciding not to collect data and carry out analysis on an investment in a fund which the trustees were already in the process of divesting from

    They document why they believe their adopted approach met the requirements of ‘as far as they are able’ and was reasonable and proportionate. The trustees also complete a lessons-learned exercise with their advisers to improve their processes the following year for:

    • collecting data
    • carrying out analysis
    • reviewing the output
    • preparing their TCFD report

    Completing and publishing the report

    The trustees are now satisfied that their scheme’s governance framework meets the requirements of the climate change regulations.

    As they prepare their climate change (or TCFD) report, the trustees are careful to both meet the requirements of the climate change regulations and have regard to the DWP’s statutory guidance.

    They publish their report and notify their members in accordance with legal requirements, as referenced in section 4 of DWP’s statutory guidance.

    Publishing your report