Canada’s defined benefit pension plan sponsors are more concerned about broad-scale climate resilience in portfolios than they were before the coronavirus pandemic, according to a new report by the Global Risk Institute and the Smart Prosperity Institute.
“It’s increasingly clear that climate change’s impact is accelerating and that’s fuelling a movement toward sustainable finance,” says Katherine Monahan, a senior fellow at the SPI and one of the report’s co-authors. “Pension plan sponsors are making efforts in response to member concerns about the safety of funds and their environmental impact.”
According to the report, climate change presents three distinct types of risk to pension portfolios. The first type is physical risks, which stem from the impact climate change poses to assets. While this includes the threat rising sea levels present to beachside properties and the impact droughts could have on agricultural yields, not all examples are so obvious.
“Everything from large infrastructure projects to supply chains will be affected,” says Monahan. “To build resilience, plan sponsors have to figure out where these risks are in their portfolios and develop plans to address them. It’s an area of sustainable finance that isn’t as developed as other ones.”
Transitional risks, the second type identified in the report, relate to the cultural and political forces driving the transition to a low-carbon economy. Where assets have the potential to suffer as a result of climate-related legislation or consumers’ increasing aversion to carbon-intensive products, portfolios face this type of risk.
“If you think about transitional risks, you’re really thinking about how consumers and governments will perceive carbon-intensive assets in the future,” says Monahan. “If you’re more carbon intensive, you will have more transitional risk.”
Liability risks, the final type identified in the report, relate to the risk that plan sponsors will be held liable for assets failing to address the impact of climate change. The report noted there has been a swell in the number of lawsuits filed against fossil fuel companies, some of them related to pension funds.
“For example, in Australia, one of the trustees of the Retail Employees Superannuation Trust filed a case on the grounds of failure by the pension fund to adequately consider climate change risks,” wrote Monahan and co-author Anik Islam, a research associate with the SPI, in the report. “The case was settled out of court, but propelled new standards for pension funds pertaining to climate disclosures and policies to tackle climate risks. Meanwhile, a 2021 legal opinion from the Canada Climate Law Initiative provides a compelling argument for why fiduciaries should have the duty to address climate risks here at home.”
The report also set out a number of strategic recommendations for pension plan sponsors seeking to improve the climate resilience of their portfolios, including that they adopt plans to ensure portfolios are net zero by the middle of the century. To do this effectively, the report suggested plan sponsors seek third-party reviews of transition plans and require all investee companies to have credible plans for achieving carbon neutrality by 2050.
“All investments need to be climate aligned, but that doesn’t mean they’ve got to be net zero today,” says Monahan. “It’s OK to invest in a carbon intensive area today, but there needs to be a plan for achieving net zero by mid-century.”
The paper, which focused on Canada’s largest public sector pensions, noted some appear to treat their commitments to transition or invest in green as justification for continuing to hold carbon intensive assets. It doesn’t recommend adopting this approach.
“A few years ago, holding carbon-intensive assets was less problematic,” says Monahan. “Now we are aiming for carbon neutrality mid-century [so] having really clean, green assets doesn’t mean much unless your portfolio is on a path to be carbon neutral. That isn’t to say plans should avoid investing in climate solutions — we need those investments.”
While the report focused on the work of pension plans, it also considered the role that government agencies could play in the transition. It concluded they’re well-positioned to mandate climate reporting obligations and establish disclosure requirements to track progress on all climate commitments.
The report highlighted several moves made by governments in recent years. In 2019, the Canadian government endorsed a phased-in approach to recommendations from the Task Force on Climate Related Financial Disclosures. The British government became the first to require pension plan sponsors to identify, manage and report on the climate-related risks and opportunities.
In early 2022, the U.S. Securities and Exchange Commission proposed new climate-related disclosure rules. If passed, they’d require publicly traded organizations to disclose greenhouse gas emissions from sources controlled by the business and those released in their production. Companies with transition plans would be required to provide regular updates including supporting documentation.
“Because the U.S. is such an important market, if this passes, it would be game changing,” says Monahan.