Unlocking the power of pension funds for net zero
| David Fairs is a Partner at LCP and former Executive Director for Regulatory Policy, Analysis, and Advice at the UK Pension Regulator. Valerio Micale is an Associate Director at Climate Policy Initiative, leading on the Net Zero Finance Tracker. |
With vast pools of patient capital, pension funds are critical—yet underutilized—sources of finance for the climate transition, including to support the UK’s commitment to reach net zero by 2050.
However, recent debate around UK pension funds has largely focused on their investments being used to boost the economy and consolidation across Defined Benefit and Defined Contribution arrangements to facilitate that. These aspects are also critical to tackling the climate crisis.
Research from CPI reveals how European pension funds are progressing on setting climate targets and taking action. While the UK can be pleased it is not one of the laggards in the dataset of more than 340 schemes representing USD 7.8 trillion in assets, it could also take lessons from other countries to accelerate action.
UK PENSION FUNDS: MIDDLING PERFORMANCE
CPI’s Net Zero Finance Tracker (NZFT) shows a moderate performance from the 96 UK pension funds it tracks on setting climate targets and implementing policies to achieve them. Legislative efforts have driven progress, placing the UK in the top five European countries for taking action, behind only Sweden, Denmark, Norway, and the Netherlands.
Although the UK’s regulatory framework, including mandatory climate-related disclosures since 2021 for schemes of over £5bn and 2022 for those over £1bn, has driven progress, some schemes may still approach these requirements as a compliance exercise.
HOW POLICY IS DRIVING CHANGE
Recent regulations, including the roadmap for mandatory disclosures, have prompted larger pension schemes to start addressing climate risks and opportunities. These have required establishing appropriate governance, strategies, targets, and metrics specifically related to climate. Inevitably, some schemes fully embraced requirements while others took a compliance-driven approach.
A UK Pensions Regulator review of the first set of 71 disclosures in 2023 noted that 43 included a formal net zero target. However, these targets were new, and few schemes had clear implementation plans.
While there is no legal requirement for trustees to set net-zero targets, the Pensions Regulator has highlighted this as an “appropriate step”. A second review published this year noted that 19 of the 30 TCFD (Taskforce for Climate-Related Disclosures) reports reviewed included some form of net zero goal, with 13 setting a formal target.
The UK’s regulatory push is replicated in other countries across Europe. However, the challenge around climate-related financial disclosures is that they don’t necessarily drive change, especially at the pace needed for asset owners like pension schemes to have a meaningful impact on action to limit temperature rises.
PROGRESS WITH AREAS FOR IMPROVEMENT
CPI’s survey of 342 European pension funds shows that progress is being made but with clear areas for improvement. Many pension schemes, particularly large funds, have set targets. But these will only support the net zero transition if backed by clear and credible implementation strategies.
The number of tracked European pension funds with a climate investment target has increased from none in 2019 to 35 in 2023, representing some USD 2.2 trillion in assets under management or owned, though only three publicly disclose such goals.
Meanwhile, 60 schemes were targeting a part or all assets for fossil fuel phase-out, exclusion, or divestment in 2023, marking a significant shift from the two with such targets in 2019.
In terms of schemes that have taken implementation action, the numbers have grown from 26 to 100 with action being taken mostly on governance, engagement, and disclosure of climate risk, investment data, and emissions data.
Despite the observed progress, this still leaves a significant number of pension funds without any reported target or action.
THE WAY AHEAD
The research shows that regulatory efforts are indeed driving pension funds response, particularly in Nordic countries, but also confirms some intuitive beliefs:
- Schemes with strong targets tend to do better on implementation.
- Large schemes tend to address climate more comprehensively and proactively.
- Members of net-zero coalitions tend to score higher than those that are not.
There are opportunities for pension funds to strengthen their net-zero performance in the following key areas:
- Strengthening their engagement on climate issues with corporates by clearly outlining voting guidelines and escalation strategies for their asset managers.
- Driving demand of net-zero investment products and work with asset managers to improve the environmental performance of existing funds.
- Broadening their influence beyond their owned assets by extending their due diligence and assessment of asset managers—those indirectly influencing most of the asset deployment happening on the ground – to include general investment philosophy, overall sustainability practices, and the management of other assets.
In addition, regulators will be essential in driving pension schemes’ response by encouraging asset managers’ stewardship by mandating their reporting on engagement. They can also encourage the adoption of stringent metrics and mandate the adoption and disclosure of emissions and transition plan metrics for corporations to increase the data availability required to inform capital allocations.
