The vast majority of UK adults want their investments to do good as well as provide a financial return, yet pension funds remain firmly locked into fossil fuel funding
Climate change poses significant risks to UK pension savers. It should be top of mind for the pension schemes and trustees responsible for investing funds in members’ best interests. The risks from climate change are physical, financial and systemic, and people across the country are already facing more frequent intense weather events such as flooding and extreme heat, and disruption to food supplies.
According to the Intergovernmental Panel on Climate Change, climate risks will worsen without urgent action to limit global temperature rises. On current projections the world will face significant problems due to climate change within the lifetime of most UK pension savers, who typically invest across decades. It is also likely that there will be a wealth-damaging market correction driven by climate-related factors during many savers’ lifetimes.
However, most UK pension schemes are actively contributing to the climate crisis by remaining major investors in fossil fuels. Recent research from Make My Money Matter estimates that UK pension funds have more than £88bn invested in the fossil fuel industry. With some notable exceptions, UK pension funds make only modest allocations of capital in clean energy despite the urgent need for private capital to flow to the green transition.
At ShareAction, we have seen how a lack of clarity over the legal responsibilities or fiduciary duties of pension trustees is resulting in schemes investing in ways that are not optimal for UK savers. Pension funds tend to interpret their legal duties as beginning and ending with maximising short-term financial returns, neglecting factors that are not easily monetisable such as environmental, social and governance factors and systemic risks including climate change.
Meanwhile, the Institute and Faculty of Actuaries warns that many climate-scenario models used by pension schemes and their advisers are significantly underestimating climate risk.
To make it worse, there is a problematic mismatch between the long-term interests of pension savers and the fact that investment intermediaries managing their money are typically incentivised to deliver short-term returns.
Of course financial returns are important, but the current focus risks completely disregarding all the other factors that are deeply important to pension savers and their quality of life, from the threat of climate crisis to their personal ethical views about how investments affect the world and the environment in which they live.
There is consistent evidence that the majority of savers want these factors to be considered by those investing on their behalf. The Financial Conduct Authority’s Financial Lives survey in May 2022 found that 81 per cent of UK adults would like the way their money is invested to do some good as well as provide a financial return.
Broad shift in investing behaviour
To truly serve the best interests of UK pension savers we need to ensure pension trustees have the confidence to consider risks, returns and impacts properly.
Despite years of discussion of this area of law and various clarifications provided by official bodies, these have not led to the broad shift in investing behaviour by pension funds we urgently need. Instead, too often we see an abundance of reckless caution, with trustees, investment consultants and advisers focusing on short-term returns and neglecting significant long-term risk factors such as climate change.
As the Financial Markets and Law Committee noted last month, although it is possible for sustainability factors to be considered under current fiduciary duty, there are uncertainties and difficulties in achieving this. The committee also stated that current legal and regulatory requirements are not sufficient to fully address all the risks posed by climate change.
That is why ShareAction has been calling for a formal evolution of fiduciary duty and has provided oral and written evidence to the Work and Pensions Committee setting out why the government needs to update the law to create a clear legal framework for pension saving that is fit for the 21st century.
We believe nothing less than a change to the legal definition of fiduciary duty will be sufficient to provide the clarity that empowers trustees to take real action to consider social and environmental impacts alongside risk and return.
We are urging the select committee to ask the Department for Work and Pensions to embed the FMLC’s recommendations into official guidance, including that provided by the Pensions Regulator, and to explore options to change the law. We are also calling for the next government to make this a legislative priority. We believe the relevant legislation could be updated quickly and easily.
In the face of the huge physical, financial and systemic risks posed by climate change, it is crucial that pension trustees are able to consider properly such risks and put savers’ long-term interests at the heart of investment decision-making.
Claire Brinn is UK policy manager at ShareAction