Is Climate Change a threat to Pension funds?

By January 7, 2020Pensions

The Governor of the Bank of England made headlines following an interview with BBC Radio 4 on 30th December 2019. Mark Carney’s claim was that certain assets would eventually lose their value entirely due to climate change, and many pension funds invested in those assets (e.g. fossil fuels) are, therefore, at risk.

This has, understandably, caused concern amongst many retired people as well as those saving for future retirement, who are worried that their investments could be under threat.

What’s the link between climate change and pensions?

When you save money into a workplace or personal pension, it doesn’t simply go into a regular savings account. Instead, it goes into a set of investments, such as collective investments or unit trusts, together with capital from other investors. Each of these funds might contain a range of different companies which, as they grow, should provide a return on your investment.

Some of these businesses might be large or small, ranging across sectors or industries such as aerospace, transport, computing or energy. Each of these areas tends to come with a distinct carbon footprint (although different companies are likely to produce less or more, depending on their structure, operations etc). Businesses involved in fossil fuels or agriculture, for instance, tend to produce more CO2 than certain professional services.

Why does the Governor think certain assets might lose their value?

We need to take a step back for a minute to answer this question. Scientists across the world generally agree that a global temperature rise of 4C would have serious planetary effects, including 9m rises in sea levels, food shortages and unimaginable heatwaves. Mark Carney’s claim in the Radio 4 interview is that is: “If you add up the policies of all of companies out there, they are consistent with warming of 3.7-3.8C.” Carney’s belief seems to be that these companies (and the pension funds which invest in them) will face enormous political and consumer pressure in the 2020s, to address this dangerous trend. According to Peter Uhlenbruch at the Asset Owners Disclosure Project, those who fail to take action “May be facing significant exposure to unassessed climate-related transition and physical risks”, which could put beneficiaries’ savings at risk.

What is the financial sector currently doing to address all of this?

Under Mark Carney’s tenure as Governor (he is set to leave at the end of January 2020), the BoE introduced a radical new “climate change stress test” in 2019. The idea is to subject banks insurers and building societies to a similar stress test which they already undergo for their financials (e.g. financial stability), except the focus is on environmental sustainability. It is early days with this new scheme, but many commentators believe it will ultimately lead banks and other financial firms holding more capital to conduct specific types of business.

Two main types of risk are officially recognised by the BoE, regarding the potential financial impact in the UK of climate change. There is, of course, the direct physical risk posed by weather and temperature to infrastructure (e.g. flooding in England). Then there are also the risks posed by changing the UK more toward a low/zero-carbon economy. For instance, house prices could increase due to a requirement that each home insulated, or restaurants and supermarket sales could be impacted by an increase in the price of meat.

The climate stress tests introduced by the BoE are arguably a step in the right direction. Yet questions remain over how quickly financial firms and pension funds can adapt to this evolving regulatory landscape. At the time of writing, only a minority of institutions report on investments in fossil fuels, etc. Yet the BoE estimates that nearly “$120tn worth of balance sheets of banks and asset managers are wanting this disclosure.”

Should I be concerned about my pension?

At FAS, we would offer two pieces of advice at this stage. The first is not to panic about your pension, and the second would be to raise any concerns you have with us. The good news is that the BoE’s warning is likely to offer a huge incentive to the pension industry, encouraging them to invest more in companies which are accounting for changing consumer behaviour and regulations concerning climate change.

This content is for information purposes only. It does not constitute investment advice or financial advice. To receive bespoke, regulated advice regarding your own financial affairs and goals, please consult a member of our financial planning team.

 

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