Considered in Grand Committee
My Lords, the draft Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021 were laid before this House on 8 June. I am pleased to introduce this instrument. Subject to approval, these regulations will deliver a key commitment set out in Government’s Green Finance Strategy for
“large asset owners to disclose in line with the TCFD”—
the international, industry-led Task Force on Climate-related Financial Disclosures—
“recommendations by 2022”.
These measures will see the UK become the first country in the world in which trustees of occupational pension schemes are statutorily required to consider, assess and report on the financial risks of climate change within their portfolios.
The regulations impose requirements on trustees of larger occupational pension schemes, authorised master trust schemes and, once established, authorised collective money purchase schemes for the identification, assessment and management of climate-related risks and opportunities. This includes requirements relating to governance, strategy and risk management as well as requirements to select and calculate climate-related metrics and to set and measure performance against targets.
Trustees will be required to meet these climate change governance requirements, which underpin the recommendations of the TCFD, and to report on how they have done so in line with the task force’s recommendations. Details of steps that should be taken to meet the requirements are included in the statutory guidance to which trustees must have regard. The regulations also confer compliance powers on the Pensions Regulator to enforce the new requirements.
Among other requirements, trustees will need to report on the risks that affect their portfolio, on how their investment strategy—and, in the case of defined benefit schemes, their funding strategy—would respond to different temperature rise scenarios, which will include consideration of the strength of the employer covenant, on the emissions attributable to their assets, their emissions intensity and their performance against targets that trustees have set.
The largest schemes and authorised schemes will be captured from 1 October 2021. From 1 October 2022, the regulations will apply to more than 70% of pension assets and more than 80% of pension members. The Government have committed to review the effectiveness of these regulations and statutory guidance in 2023. This will include the identification of any barriers, gaps and inconsistencies, as well as an assessment of whether the regulations remain appropriate and whether they should be extended to smaller schemes. I am satisfied that the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021 are compatible with the European Convention on Human Rights.
Climate change is the defining challenge of our time. Our response will determine the future health and prosperity of our world. It is a major systemic financial risk and a threat to the long-term sustainability of UK private pensions. That is why it is vital that we act now. With almost £2 trillion in assets under management, all occupational pension schemes are exposed to climate-related risks, and such risks present a significant threat to the retirement outcomes of millions of savers. This threat presents itself through the risks to investments of a warmer planet and those associated with the transition to a low-carbon economy, for which all investors must be prepared. If we do not take steps now to address the risks climate change will bring shocks and long-term sustained damage to our economy. It is therefore vital that we ensure that pension scheme governance is as robust as possible to withstand these risks in both the short and long term.
It is for this reason that the Government have sought to prioritise climate change risks and opportunities in this instrument over the broader risks associated with environmental, social and governance considerations. Climate change is unique in the severity of investment risks associated with its impact and the pervasiveness of such risks. It is also for this reason that the Government have wasted no time in consulting on these regulations and bringing them before the Committee for debate.
The instrument provides that trustees of schemes with £5 billion or more in relevant assets and all authorised master trusts will be required to meet the governance requirements from 1 October this year and to produce and publish climate risk disclosures within seven months of their scheme year end. By adopting a phased approach, which sees the requirements fall on the largest schemes first, we expect such schemes to utilise their governance expertise and capacity to set an industry standard to those with at least £1 billion in relevant assets, who will have to meet the same requirements from 1 October 2022.
The instrument requires trustees to put in place processes of governance and risk management to assess the impact of climate change on their investment strategy and, where applicable, their funding strategy. It also requires trustees to conduct scenario analysis, calculate climate-related metrics and to set and measure performance against targets. These activities are all about trustee action, and details of steps that should be taken to meet these requirements are included in statutory guidance to which trustees must have regard. They go way beyond disclosure alone and therefore do not materially overlap in intent or effect with existing ESG policy disclosure requirements.
Activities required by these regulations that rely on data from other participants in the investment chain, such as scenario analysis, calculating metrics and reporting against targets, must be carried out by trustees
“as far as they are able”,
which means that trustees should take all such steps that are reasonable and proportionate in the particular circumstances, taking into account the costs, or likely costs, to the scheme and the time required to be spent. Nevertheless, impacts from climate change are already being felt. Trustees must act now and should not wait for perfect data to emerge before taking action to manage climate-related risks and opportunities. There is more than enough data to begin work with.
Let me be clear: these measures do not direct trustee decisions or seek to increase pressure for blanket divestment of pension schemes from high-carbon sectors. It is not for the Government to direct trustees to sell or buy certain assets, and these proposals do not create any expectation that schemes must divest or invest in a given way. I reiterate that these measures require trustees to identify, manage and assess climate-related risks. Ultimately, trustees retain primacy in any investment decisions they make following that assessment, whether it be the targets they set out or their wider investment strategy.
The effects of this instrument will be significant and transformative. By the end of 2023, the risks and opportunities climate change poses to £1.33 trillion-worth of pension savings will be assessed and published for all to see. Critically, this develops a system of accountability that we have never had before, and trustees will be required to show how climate change is likely to affect their portfolio.
To conclude, these measures cement the UK’s leadership in green finance. We were the first major economy to pass a net-zero emissions law, and now these measures on climate change risk and pensions are the first of their kind globally. I am sure noble Lords will agree that it is only right that pension scheme trustees take action to address climate change-related risks and protect the retirement savings of hard-working people. I commend this instrument to the Committee, and I beg to move.
My Lords, I am in favour of these regulations and I take this opportunity to thank and congratulate the Minister and her colleagues, to whom she has given much of the credit, on the work they have done on climate change. I will pass on the opportunity to say something more generally about the Government’s record on the issue, but here we are on the right track. This is not the end of the journey, of course, because there is always further to go.
Today, it is appropriate to pay tribute to all the work that was done in the Lords during the passage of the Pensions Scheme Bill. I was frustrated in my wish to take part, but no matter. The level of expertise as well as of concern about the issue was outstanding. I have thought of naming names, but having gone back and reread the debates it was interesting that there was clearly a collective effort in the House and behind the scenes. Those who took part know who they are, not least those taking part in today’s debate, and they are owed a sincere vote of thanks.
The adoption of these requirements is one element in a wider push to ensure that the effects of climate change become routinely considered in business and investment decisions. The adoption of these recommendations would also help a range of institutions better demonstrate responsibility and foresight in their consideration of climate issues. That will lead to smarter and more efficient allocation of capital and help smooth the transition to a more sustainable, low-carbon economy.
We must therefore welcome the recent move by the FCA to consult on a climate-related financial disclosure regime for asset managers, life insurers, and, not least in this context, FCA-regulated pension providers. That will be consistent with the recommendations of the task force on climate-related financial disclosure. The FCA states that its proposals aim to increase transparency and enable clients and consumers to make considered choices while remaining proportionate for firms. These proposals will need to be considered carefully as the term “proportionate” can hide a multitude of problems, but let us see.
One issue that arose during the passage of the Bill was the Government’s claim that their intention was to ensure effective governance of climate change risk but not to direct trustees’ or managers’ investments. The Minister reiterated that point in her remarks. This was specifically with reference to the proposed requirement that the governance of schemes align with the Paris Agreement’s objective of global warming of well under 2 degrees Celsius. During those debates, the Minister expressed the view that this could be tantamount to directing schemes’ investment, which the Government had ruled out. I have some difficulty here because my understanding is that progress towards the Paris target is now legally binding, not a matter of personal preference. The distinction being made is, in practice, without a difference. Ultimately this is going to affect investment decisions, or we will fail in the objective of combating climate change.
Another issue that arose in the debates on climate change during the passage of the Bill was use of the words “may” and “must”. I am pleased to report that in the regulations “must” is in the lead with 50 occurrences compared with 30 for “may”, but I am unclear what this means in practice. As a rough generalisation, it appears that “may” is used more in the context of enforcement, which means that discretion of some sort is being exercised by the appropriate regulator. It would be good if we had the possibility—at an appropriate stage, not now—for interested parties to discuss how this discretion will be exercised, which bodies will have enforcement taken against them, which will not, and what criteria are to be applied in making that choice.
Lastly, this is just to demonstrate that I am paying attention. Can the Minister assure us that the loss of a hyphen in the term “ear-marked scheme” between where that is defined in the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996 and these regulations is of no significance?
My Lords, like the noble Lord, Lord Davies, I very much support this statutory instrument and welcome the measures that the regulations introduce. As has been said, the statutory instrument introduces new requirements for trustees of certain occupational pension schemes to make sure that these schemes are conducted with respect to the effects of climate change. Also, there is a requirement for reports to be published and powers given to the Pensions Regulator to ensure compliance.
These measures were widely supported during the passage of the pensions Bill; I echo the thanks of the noble Lord, Lord Davies, to the team who put so much work into them. They are much-awaited first steps, however, and we hope that they will have a far-reaching effect throughout the industry and the financial sector. Trustees and fund managers will need to become very knowledgeable about the financial risks of climate change and matters relating to it, and more particularly about the targets in the Paris Agreement. As a former trustee I must say that, for many, there will be a steep learning curve in being able to manage the requirements of these regulations. There is a reference to respondents who expressed concerns on the availability of data, key to climate change, in the notes on the consultation—the data will, of course, be important. The Minister said that there is plenty of data; there is, but the analysis of it will be demanding.
Trustees and fund managers will need a range of information to discharge these duties. What information will be made available about, for example, the eligibility of companies for investment? Has any progress been made about disclosure requirements on companies for current greenhouse gas emissions, and the projected impact of their business plans, assets and activities on future emission levels? Are there plans, for example, to create a register of low and zero-carbon investment opportunities at all levels of the investment chain, making it easier for everyone—from asset managers to pension fund managers and individuals—to understand the green options available and provide opportunities to promote and invest in innovation and creativity in green industry and commerce?
The finance sector needs to operate within a framework that steers resources into climate-friendly investments and away from climate-negative activities; for example, avoiding support for investments that may become stranded assets through activities such as opening new oil and gas fields or coal mines, which cannot operate in the long term and therefore will not deliver returns to investors if the net-zero target is to be met. This requires a series of actions by government and financial sector regulators, ensuring better flows of information about climate risks and green investment opportunities for investors, lenders, insurers and other stakeholders, while providing the impetus for the financial sector to play its part in driving the action that reflects risks and opportunities in combating climate change and creating a low-carbon economy. I look forward to the Minister’s response.
My Lords, I welcome this important instrument. I thank the Minister for her introduction and the other noble Lords for their contributions.
The Explanatory Memorandum notes the evidence suggesting
“that we are currently on track to see 3°C of warming by the end of the century.”
That level of warming would cause changes that fundamentally shift how the planet behaves, including the breakdown of the global ocean circulation system, rainforests turning to savannah, ice sheets disintegrating, the spread of deserts and the collapse of farmable land. This could result in mass migration, famine, war and death. It could not be more serious.
As the Minister reminded us, climate change is expected to have a significant impact on pension schemes and their almost £2 trillion in UK assets due to both the physical and transition risks. It is good that we are starting to see action taken within the industry, such as Aviva announcing that its auto-enrolment default funds will aim to achieve net zero by 2050—that is some £32 billion of capital—or the BT pension scheme setting a goal of net zero by 2035 for its whole portfolio of about £55 billion. There is lots of good practice emerging in public sector DB schemes.
With the climate emergency getting ever more serious, today’s action is long overdue, so it is good that the Pension Schemes Act from which this SI derives addresses climate risk. Pensions Minister Guy Opperman described the proposals as “world-leading”, and the Minister today noted that the UK is set to become the first major economy to require climate risks to be specifically considered and reported on—but I gently say to the Minister that the grandstanding is a little ungracious and that no reference was made to the fact that the Bill was made greener only by cross-party working in our House.
When the Pension Schemes Bill was introduced as a Lords starter, rather than net-zero provisions there were zero climate provisions in the legislation—a gaping hole we highlighted at Second Reading. The Government then introduced amendments in Committee but they had to be strengthened through cross-party negotiation, led by my noble friend Lady Jones of Whitchurch and the noble Baroness, Lady Hayman, to ensure that trustees and managers had to take account of the Paris Agreement and domestic targets such as net zero. As a result of that work, “climate change” was mentioned in domestic pensions legislation for the first time. We are really pleased with this achievement.
Turning to the detail of the instrument, I have a number of questions—the Minister would be disappointed if I did not, but none of them should be very unexpected, so I hope she will be ready and able to answer them. First, the Pensions Regulator will put requirements on trustees to drive change among investment managers. But the regulator has acknowledged that without standardised and enforced data throughout the investment supply chain, trustees would find it difficult to access the good-quality data they will need to produce the qualitative and quantitative outputs required by the new governance and reporting requirements.
There is an issue because the two regulators, TPR and the FCA, are not fully aligned in time, and TCFD disclosures aligned to the Task Force on Climate-related Financial Disclosures are not currently required throughout the investment chain. As my noble friend Lord Davies mentioned, the FCA is currently consulting on proposals to introduce climate-related financial disclosure rules and guidance for asset managers, life insurers, FCA-regulated pension providers and issuers of standard listed equity shares; to require firms to reveal how they will take climate-related risks into account in managing investments on behalf of clients; and to produce a baseline set of disclosures in respect of their products and portfolios. But the FCA proposals will not be released until 2022, so we do not know how they will align with the TPR requirements.
In his Mansion House speech on 1 July, Chancellor Rishi Sunak announced the sustainability disclosure requirements to be introduced for businesses and financial products. The Treasury has said that these are intended to bring together and streamline existing climate reporting requirements and that the Government will work with the FCA to create a new sustainable investment label—a quality stamp.
Here come two important questions on this issue. First, can the Minister clarify how these sustainability disclosure requirements will interact with the rules for trustees arising from these regulations on reporting on climate risk? Secondly, can trustees rely on an FCA quality stamp as a reliable and acceptable source of data for meeting their disclosure requirements under these regulations?
Next, a word about scope. The Minister mentioned that these new governance requirements will apply initially to trustees of schemes with relevant assets of £5 billion or more, then from October next year they will bring into scope trustees of schemes with relevant assets of £1 billion or more. TPR estimated that the first phase would capture 102 pension schemes, or roughly 42% of all UK pension assets. The second phase would capture an estimated 351 schemes. The provisions would then, by the end of phase 2, cover approximately 71% of all UK pensions assets.
Here comes the third question: what, if anything, will be done to manage climate risk for the other 29% of pension assets? Will there be any requirements on them at all, or any action in relation to them? Some respondents to the TPR consultation argued that the DWP should commit now to bringing more schemes into scope in 2024. I get that they want a review, but why did the Government reject that commitment in principle to bring more schemes in? Also, what support will be given to trustees to help them meet these new obligations?
I have two final quick questions. One is on cost. The annual net direct cost to business is suggested as £6.2 million—roughly £12,000 for a scheme in year 1 and about £10,800 thereafter. Is the intention to provide any transitional funding, or will the Government monitor these costs so that they can decide whether help is needed for smaller schemes when they are brought into scope? Finally, will there be a central collection and monitoring process to review information from all industry reports to get a broad picture of the progress that schemes are making?
These changes are very welcome, but we still have a long way to go to ensure that the pensions industry and the Government manage climate risk better and reach net zero by 2050. I congratulate all those who worked so hard to get this instrument before us today. I hope that the example of the pensions Bill, where cross-party pressure in this House led the Government to a better place, is one that will set a trend for the future. I look forward to the Minister’s reply.
My Lords, I sincerely thank the noble Lord, Lord Davies, and the noble Baronesses, Lady Janke and Lady Sherlock, for their positive and direct questions on these regulations. I also start with an apology: it was remiss of me not to acknowledge the excellent cross-party work that got the pensions Bill on to the statute book. It was a very good example of how the House works well together. I hope that it will continue.
I say to the noble Lord, Lord Davies, that I am very happy to meet and to hold discussions on discretion. My office will seek to organise that.
I will try to deal with some of the questions raised. The noble Lord, Lord Davies, asked about the UK’s statutory commitment to net zero, and said that it needs to be reflected in pension scheme policies. The UK signed up to the Paris Agreement and to net zero, and to making the necessary changes in taxation, spending and regulation to achieve that target. We are making the changes to achieve that. We have not signed up to mandating every organisation and household to set net-zero targets, but we are encouraging organisations to commit to net zero in a way that works for them and to publish a plan to do so.
The noble Lord, Lord Davies, also asked what TPR’s strategy will be to ensure compliance with these new measures. TPR must issue a mandatory penalty in cases where the TCFD report is not published on a publicly available website that is accessible free of charge, as required by the regulations. In all other cases where TPR believes requirements are not being met, it has a range of enforcement options, including the discretion to issue a penalty notice. TPR also has the opportunity to publish the names and details of any breaches, which can be a powerful deterrent. TPR today published its consultation and compliance penalties. The consultation will be up for response until 31 August.
On to the homework set for me by the noble Lord, Lord Davies, on the issue of the hyphen. I will go away and find out. I will write to the noble Lord and place a copy in the Library.
The noble Baroness, Lady Janke, asked about the register of green investment options. Again, I will need to write to her on that issue.
The noble Baroness also asked about the status of the statutory guidance, and asked why there is also non-statutory guidance. In complying with the requirements in this instrument, trustees are required by new Sections 41A and 41B of the Pensions Act 1995 to have regard to statutory guidance prepared by the Secretary of State. This requirement does not apply to the trustee knowledge and understanding provisions, which will be made under different powers; the guidance accompanying those provisions is therefore not statutory guidance but is intended as best practice. Trustees are not required to have regard to it but they are encouraged to do so. Trustees of other schemes may also find the statutory guidance helpful when implementing climate change risk governance and reporting on a voluntary basis.
The noble Baroness, Lady Janke, talked about the lack of available data and reporting standards. The present data coverage does not prevent schemes taking steps to assess their exposure to climate risks, and the quality is improving. Our TCFD reporting requirements, as well as the requirements of others—including the Financial Conduct Authority and BEIS—will accelerate this progress significantly.
The noble Baroness, Lady Sherlock, asked whether trustees will be reliant on data from others to do proper analysis. She also asked whether the same requirements are being applied across the investment chain. The Government have already announced their intention to make TCFD-aligned disclosures mandatory across the economy by 2025, with a significant portion of mandatory requirements in place by 2023. This will produce regulatory alignment through the investment chain, which will capture asset managers, workplace personal pension schemes, UK-registered large private companies, insurance companies and banks by the end of 2023. This will increase the flow of data, which is vital for trustees to embed effective climate risk governance. The DWP has worked closely as part of a cross-government task force to ensure consistent climate-related financial disclosures up the investment chain.
The noble Baroness, Lady Sherlock, said that lots of schemes have not taken action. Actually, 85% of DC pension savers are in a scheme that has set a net-zero target.
The noble Baroness asked why we have limited the threshold for being in scope at £1 billion. All savers have the right to benefit from effective governance and the reporting of climate change risk, regardless of the size of the scheme, but the Government do not wish to impose disproportionate burdens on trustees. Schemes with £1 billion or more in assets have the resources in place to allow them to implement and report on the range of governance and assessment measures set out in the regulations to a high standard, with a high probability of overall benefit to the members. The largest schemes can set an industry benchmark, drive demand for products, improve data flow and, ultimately, drive down costs for smaller schemes seeking to do TCFD reporting in future. The Government have committed to reviewing the effectiveness of the TCFD requirements in the regulations and statutory guidance in 2023. This will assess whether the regulations remain appropriate and whether they should be extended to smaller schemes.
The noble Baroness also asked what smaller schemes not in scope should be doing to manage their climate risk. Trustees do not need statutory requirements to begin meaningful action. They have a fiduciary duty to protect their members’ interests, and everyone should act now. As well as the statutory guidance, the DWP played a key role in producing and publishing the Pensions Climate Risk Industry Group guidance, which is a useful resource for all trustees whether they are in the scope of the new requirements or are just starting out.
The noble Baroness talked about the requirements announced in the Chancellor’s Mansion House speech. We will write to her on those.
Of course, the important issue of cost was discussed; indeed, it was mentioned by the noble Baroness, Lady Sherlock. We will monitor and review the cost, including in terms of what support is needed by trustees to fulfil their obligations.
Finally, the noble Baroness, Lady Janke, said that too many trustees do not have the necessary skills and asked what we are doing about it. Subject to the approval of this instrument, we intend to make regulations requiring trustees to have sufficient knowledge and understanding of the identification, assessment and management of climate-related risks and opportunities to enable them to exercise their functions properly. Those regulations were published in draft alongside our consultation response in June.
The noble Lord, Lord Davies of Brixton, reminded us that this is just the start. It is. I am sure that we will work together to put these regulations into action and review them as time goes on.
I conclude by reiterating the effect of this instrument. It will ensure that the largest occupational pension schemes, as well as authorised master trusts and authorised collective defined contribution schemes, have measures in place to identify, assess and manage climate-related risks and opportunities. The better management of climate risk will be in our interests, whether as pension savers or as pension takers and whether our interests are financial, environmental or social. I commend this instrument to the Committee.
My Lords, that completes the business before the Grand Committee this afternoon. I remind Members to sanitise their desks and chairs before leaving the Room.
Committee adjourned at 5.30 pm.