Will climate change get trustees hot under the collar?

Wildfires in California and Greece, heatwaves in Japan and Siberia, and a drought across every Australian state all point to the fact that 2018 is an exceptionally warm year, potentially the warmest on record. And although most (but not all) agree on the causes, it seems evident that something is happening. The picture presented by NASA suggests it’s getting worse, as seventeen of the 18 warmest years since 1884 have happened since 2001.

The trajectory of climate change can still be altered should we decide to do so today

The Economist cover story last week argued that we are losing the battle to control climate change. Since the Paris agreement to limit global warming to 2 degrees celsius above pre-industrial levels, governments have sought to reduce dependency on fossil fuels and to promote the use of renewable energy. Yet in many parts of the developing world, coal remains a staple source of energy. And just this week, Shell announced a new deepwater project in the Gulf of Mexico that could produce oil at $35 per barrel, around half the current price. At this rate, we will easily overshoot the 2 degree target. 

However it’s not all bad news. In 2017 the UK had its first year in more than 200 in which our national energy was not, in part, coal fired. And the advent of more efficient electric vehicles has seen demand double every year since 2012, with a new Automated and Electric Vehicles Bill in the 2017 Budget to create a national network of charging points.

The trajectory of change can still be altered should we decide to do so today but the response from pension trustees to these developments has been mixed. Those with defined contribution (DC) responsibilities have been keen to ensure their default choice reflects both member interests (particularly among younger cohorts) and the sustainability of the investments (as advocated by CP13). Indeed, the Law Commission’s guidance that “where ESG (environmental, social and governance) risks and opportunities are financially material, trustees should take account of them” is now a frequent topic on trustee agendas.

For DB schemes, however, the picture is more nuanced. The Environmental Audit Committee, a parliamentary body, found a mixed response from the largest 25 schemes when it asked them to detail their approach to the risks posed by climate change. And now we learn that fourteen schemes have been threatened by legal action from an environmental campaign group if they fail to consider climate change and its implications on their portfolio.

But is it trustees’ fault that many schemes have yet to act? The recent Department for Work and Pensions (DWP) consultation on clarifying and strengthening trustees’ investment duties is a start. LGIM is supportive of the proposal to embed ESG considerations into the Statement of Investment Principles. The onus will be on trustees to state their policy as it applies to ESG and some boards will be bolstered by the Law Commission’s determination that “there is no impediment to them taking account of factors that are, or may be, financially material”.

We believe that trustees have both an opportunity and an obligation to create the world we all want to retire in

The devil here is in the detail. Trustees looking for hard evidence of financial materiality may be frustrated by inconclusive data, particularly on a back-test basis. Depending on the ESG factor it may not be possible to extrapolate the implications for risk or return. As a consequence trustees may believe that to take an ESG stance in the absence of such proof runs counter to their fiduciary responsibility and that doing nothing is the best course. We disagree. The danger of inaction means that companies are not held to account – with potential consequences for schemes and their beneficiaries.

LGIM would welcome further discussion with the DWP and others to engage on the definition of materiality to ensure that schemes can and do act. In the meantime, the data is getting better and we can show that the alternative – investments with ESG embedded – doesn’t require trustees to sacrifice return. New research published this week by Axioma showed that companies with better ESG scores outperformed their benchmarks in the four years to March 2018 by between 81 and 243bps. Will that be enough to tempt trustees? A 2017 survey of 31000 people aged 18-35 in 186 countries rated climate change as their no.1 concern. We believe that trustees, along with governments and other asset owners, have both an opportunity and an obligation to create the world we all want to retire in.