Katherine Apps and Gethin Thomas on climate change and pensions

On 27 January 2021 the Government published its long awaited response to the consultation, 'Taking action on climate risk: improving governance and reporting by occupational pension schemes', which ran from 26 August 2020 to 7 October 2020 in parallel to the final passage of the pension Scheme Bill, passed through Parliament on 19 January 2021.

In earlier drafts of the Bill it had been envisaged that trustees and scheme manager's substantive fiduciary and investment duties would change, requiring investment strategies to address climate change.  However, during its passage, the nature of the duty changed, instead creating a power to make regulations addressing governance imposing duties to publish information.

The Government has now published two sets of draft regulations implementing the proposals, and launched a further consultation on the draft legislation and draft statutory guidance that would enact the policy proposals. This consultation closes on 10 March 2021.

The two draft statutory instruments are:

  1. The Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021, ("Climate Change Regs ") and;
  2. The Occupational Pension Schemes (Climate Change Governance and Reporting) (Miscellaneous Provisions and Amendments) Regulations 2021 ("Misc Regs")
The Government has explained that the long-term objective of the climate change risk powers set out in the Pensions Scheme Bill is to 'to protect members' benefits against the physical risks of climate change and ensure that scheme trustees and managers are properly taking into account the risks and opportunities associated with the transition to a lower-carbon economy'.

The proposed implementation timetable of the new regulations is speedy (for the pensions context). The first duties they impose will apply from 1 October 2021 in relation to "earmarked schemes" with relevant assets equal to or exceeding £5bn (Climate Change regs 2(1)-(2)).

In summary, four broad categories of climate change governance requirements are proposed to be imposed under part 1 to the Schedule:

  1. Governance: Trustees must establish and maintain oversight of the climate-related risks and opportunities which are relevant to the scheme. In particular, trustees must establish and maintain processes for the purpose of satisfying themselves that any person who: (i) undertakes governance activities of the scheme (other than as a trustee) or (ii) advises or assists the trustees as to governance activities (other than a legal advisor), takes adequate steps to identify, assess and manage climate-related risks and opportunities which are relevant to the scheme, in respect of which they are undertaking, advising or assisting.
  2. Strategy: Trustees must identify and assess, on an ongoing basis, 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 the scheme has a funding strategy, the funding strategy. Notably, trustees must, as far as they are able, undertake scenario modelling to analyse at least the impact of certain increases in global average temperature on the scheme.
  3. Risk management: Trustees must establish and maintain processes for the purpose of enabling them to identify, assess and manage climate-related risks which are relevant to the scheme. Trustees are required to integrate the management of those risks into their overall risk management of the scheme.
  4. Metrics and targets: Trustees must calculate a number of metrics in respect of the scheme's impact on the climate, set targets based on those metrics, and assess the performance of the schemes against those targets. These metrics include: (i) the total greenhouse gas emissions of the scheme's assets, and (ii) the total carbon dioxide emissions per unit of currency invested by the scheme.
'Climate-related risks' are not currently specifically defined in the draft regulations.

The trustees of a trust scheme to which the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021 apply would be under a duty to produce a climate change report each scheme year, which contains the information specified in Part 2 of the schedule. In particular, it must describe how the trustees have complied with the governance requirements prescribed by the regulations. The report must be published on a publicly available website, free of charge. Schemes will have seven calendar months from the scheme year end date to do so (Climate Change Regs reg 3, sch part 2).

The Pensions Regulator would have enforcement powers to ensure compliance with the governance requirements which would be imposed by the regulations.

  • First, the Pensions Regulator may issue a compliance notice if it is of the opinion that: (i) a person has not complied with those requirements, or moreover, (ii) a third party was responsible for another person's non-compliance. The compliance notice would direct the person to take, or refrain from taking, certain steps, with a view to remedying the non-compliance, within a certain period of time (Climate Change Regs reg 4).
  • Secondly, the Pensions Regulator may issue a penalty notice. It may do so either where they are of the opinion that the person has: (i) failed to comply with a compliance notice, or (ii) contravened a provision under Part 2 of, or the Schedule to, the Regulations. Equally, the Pensions Regulator must issue a penalty notice where a person has failed to publish a climate change report, on a publicly available website free of charge. The amount of the penalty must not exceed £5,000 if imposed against an individual, or £50,000 against a corporate body. A penalty notice must be issued to all the trustees of the scheme and specify their joint and several liability for the penalty. Any penalty required by a penalty notice is recoverable by the Pensions Regulator. Penalty notices are subject first to internal review then appeal to the FTT (and occasionally directly to the UT).
The scope of the regulations raises a number of unresolved questions, in particular:
  1. The Supreme Court has recently emphasised in R (on the application of Palestine Solidarity Campaign Ltd) v Secretary of State for Housing, Communities and Local Government [2020] UKSC 16 that trustees have primacy in investment decisions, and it is not for the government to direct trustees to sell or buy certain assets. The Government has stated that its view is that these proposals do not create any expectation that schemes must divest or invest in a given way. Rather, it contends that the climate change risk powers in the Pension Schemes Bill can only be used to secure that there is effective governance of occupational pension schemes with respect to the effects of climate change and to require associated disclosures. However, how the regulations will, in practice, interrelate with the fundamental fiduciary duty of the managers and trustees will remain to be seen. Although the Pension Schemes Bill was amended to remove a provision which expressly altered that fiduciary duty – will these new changes, which are focussed on "how" not "what " make it more likely that certain investments will no longer be held (eg fossil fuels)?
  2. Might the new publicity and reporting requirements lead to greater challenges from active or deferred members or unions? Might environmental charities, or interest groups start to use these powers and duties as a basis for commercial pressure, or legal challenges?
  3. Pursuant to the Pensions Scheme Bill, the Pensions Regulator will be equipped with a more coherent set of investigative powers, as well as a power to impose a hefty fine where a person has knowingly or recklessly provided false or misleading information to it. The draft regulations provides a new front on which the Pensions Regulator will be required to scrutinise the management of schemes. Might these open up a new front of challenges to the regulator?
Katherine Apps and Gethin Thomas regularly act in pensions matters. For further information please contact Elliott Hurrell: