UK Green Finance Inquiry report concludes climate change risk reporting should be mandatory

by Carol A Adams

Main points:

  • Pension fund Trustees have a Fiduciary Duty to consider long term financial risks of climate change
  • There’s a lack of regulatory mechanisms in place to ensure climate change risks are incorporated into investment decisions
  • Recommendations of the Taskforce on Climate related Financial Disclosures (TCFD) should be mandatory and enforced by 2022.

The Government, regulatory bodies and some pension funds have failed to take sufficient action to protect pensions from climate change risk.  That is the conclusion of the second report from the UK Government’s cross-party Environmental Audit Committee (EAC) following a Green Finance Inquiry.  The Inquiry, launched in November last year, received verbal and written evidence, including responses from pension funds about their approach and plans with respect to climate change risk.

The Committee was ‘deeply concerned’ with the lack mechanisms in place to ensure climate change risks are incorporated into investment decisions.  Key concerns were: ‘misunderstandings’ of the meaning of fiduciary duty; poor governance with respect to the application of fiduciary duty; and, lack of reporting (or plans to report) on climate related financial disclosures. Further,

We were deeply concerned to hear how structural incentives… promote the pursuit of short term returns by investment managers acting on behalf of pension funds, often leading to the neglect of longer-term considerations—including environmental sustainability and climate change-related risks and opportunities. (p16)

The report is critical of the Financial Conduct Authority (FCA) for failing to act on the Law Commission’s recommendations to clarify the duty of contract-based pension schemes to evaluate the long-term social and environmental impact risks of an investment. 

 …a minority of the top pension funds do not appear to have given climate change much strategic thought. This creates risks for beneficiaries. (p25)

The Law Commission clarified that considering social and environmental financial risks is necessary to fulfill a Trustee’s Fiduciary Duty.  Further, even where there is no known financial risk associated with negative social and environmental impacts the Law Commission notes that pension funds are legally able to avoid investments that have negative social and environmental impacts where they have good reason to believe that beneficiaries share their concerns and where decisions would not have a significant negative financial impact.  Whilst Trustees could consult with beneficiaries on this matter, the report quotes research showing that younger people are increasingly concerned about climate change.

 T‍he Government should clarify in law that pension schemes and company directors have a duty to protect long-term value and should be considering environmental risks in light of this. (p 16)

 Whilst the Minister of State for Energy and Clean Growth, the Rt Hon Claire Perry MP, gave evidence that the Government would seek to ‘make the [TCFD recommendations] stick’ in a way which was not ‘burdensome’ the report notes that the prevailing view from evidence received was that the recommendations should be mandatory.  It refers to my submission to the Inquiry noting it pointed out:

 … that there is ‘a significant body of academic research which finds that companies apply voluntary reporting recommendations and frameworks selectively’ and that mandatory disclosures which are not enforced, are not complied with. It cited poor reporting following the Companies Act 1985 which had required organisations with more than 250 employees to disclose details about their employment of disabled persons. (p28-9)

The CDSB’s submission similarly raised concern about the application of mandatory requirements arguing that reform and capacity building were required at the Financial Reporting Council (FRC) so that existing rules concerning the disclosure of material climate change risks were enforced.  Section 172 of the Companies Act 2006 requires already company boards to have regard to the impact of the company’s business on the community and the environment.

TCFD reporting is mandatory for all large asset owners by 2022.  This involves annual report disclosures on climate change risk in four areas:

 

  • Governance: Organisations should describe how climate related risks and opportunities are assessed and managed by an organisation’s management team and overseen by its board.
  • Strategy: Organisations should disclose the actual and potential impacts of climate related risks and opportunities on their businesses, strategy and financial planning. They should describe the resilience of the organization’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario.
  • Risk Management: Organisations should disclose how they identify assess and manage climate related risks.
  • Metrics and Targets: Organisations should disclose the metrics and targets used to assess and manage relevant climate related risks and opportunities where such information is material. They should disclose their greenhouse gas (GHG) emissions, and the related risks.

 

Furthermore, the report calls for the FCA, FRC and the Pensions Regulator to ‘get up to speed’ with monitoring climate change risk management.

Note:  All quotes are from: Environmental Audit Committee (2018) Green Finance: Embedding Sustainability in Financial Decision Making, House of Commons, UK Parliament.

 

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