Consultation outcome

Chapter 3: Climate governance and TCFD

Updated 7 July 2021

This was published under the 2019 to 2022 Johnson Conservative government

1. This chapter makes proposals relating to the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), focussing on what they mean for trustees of occupational pension schemes and how they should be implemented.

2. The chapter is split out into sections reflecting the areas of the TCFD recommendations – Governance, Strategy (including Scenario Analysis), Risk Management and Metrics & Targets. For each area, we make proposals about our policy, what will feature in regulations and what will feature in statutory guidance.

Our regulatory approach

3. The TCFD recommendations and its framework are now ubiquitous across the financial sector as the method for embedding climate change into the governance, strategy and risk management of the organisation.

4. This chapter outlines how we propose to make governance and disclosure in line with the recommendations mandatory for those occupational pension schemes in scope. We consider the adoption of effective climate risk management, comprehensive governance processes and techniques such as scenario analysis and calculation of metrics to be as integral to the implementation of the TCFD recommendations as the disclosures themselves.

5. Our approach, and subsequent regulations, would reflect this, requiring, where appropriate, adoption of a process for management of climate-related risks and opportunities as well as requirements to publish evidence of this. Trustees would not be able to meet the overall requirements simply by disclosing that they have no policies or processes in place.

6. The final TCFD report included 11 recommendations. These are split into four sections: Governance, Strategy, Risk Management and Metrics & Targets.

Figure 8: Core elements of recommended climate-related financial disclosures

Governance

The organisation’s governance around climate-related risks and opportunities.

Strategy

The actual and potential impacts of climate-related risks and opportunities on the organisation’s businesses, strategy and financial planning.

Risk Management

The processes used by the organisation to identify, assess and manage climate-related risks.

Metrics and Targets

The metrics and targets used to assess and manage relevant climate-related risks and opportunities.

7. Whilst we propose to maintain the substance of the recommendations in final regulations, we would adapt the language of the recommendations themselves to fit with pensions terminology and legislative drafting conventions, where appropriate. The TCFD recommendations are the international industry standard and were designed to be adoptable by different sectors – we aim to maintain that consistency and comparability with other sectors in any requirements imposed for pension schemes.

8. However, in order that the regulations that will ultimately write the TCFD recommendations into pensions law are not unduly lengthy and prescriptive, we propose putting into statutory guidance a great deal of the guidance which underpins the TCFD recommendations.

9. Our proposal is that the 11 recommendations of the TCFD, highlighted in bold in Boxes 1, 3, 5, 7, 9 and 11 below, are implemented in regulations with some adjustments to the wording as necessary to translate the recommendations into clear legislative requirements. The TCFD’s supporting guidance to the recommendations – for example how schemes might set out their description of the role of the trustee board – would be included in new statutory guidance, to which the trustees must have regard^{[footnote 58]}. This guidance would set out a number of options or examples for trustees on how to meet the requirements of the regulations, including allowing them to take their own approach. This will avoid constraining innovation and the development of future industry standards. However, as the guidance would be statutory, trustees would be expected to explain briefly, in their reporting, their reasons for any material deviations from it. This expectation would be made clear in the guidance itself.

Data availability

10. Some aspects of TCFD recommendations require an evaluation of assets which is reliant on data quality and flow, from investee companies through aggregation and analysis by asset managers, investment consultants or other specialist service providers, to institutional investors. Data quality is improving, and the Financial Conduct Authority (FCA) consultation on disclosure by UK listed issuers will help to kick-start disclosures at their source^{[footnote 59]}. Action by other regulators in other jurisdictions would have a similar effect given the international investment portfolios of UK pension schemes.

Figure 9: Coverage and quality scores for disclosures by sector^{[footnote 60]}

Sector	Coverage	Quality
Agriculture, food and forest products	45%	21%
Asset owners and managers	36%	15%
Banks	59%	30%
Energy	66%	36%
Insurance	50%	24%
Manufacturing	57%	29%
Mining	51%	26%
Real estate, buildings and construction	51%	26%
Retail, health and consumer goods	48%	24%
Telecommunications and technology	56%	28%
Transport	65%	36%

11. Research by EY from 2019, shown in Figure 9, shows that progress has been made in the coverage of asset manager and asset owner climate disclosures globally and indeed, many asset managers and owners are in the process of building capability. However, the quality of current disclosures by asset managers and owners is the lowest of any sector, lower even than many carbon-intensive sectors. This may reflect underlying data flow issues. We believe our proposals will go some way to developing coverage and quality of such disclosures in the UK pensions market.

12. By focusing our proposed requirements on the largest schemes in the first instance, we anticipate that trustees will have the market power to require that disclosures continue to improve. Where pension schemes invest via private markets, we anticipate that the ability to carry out TCFD reporting will become a condition of contract and a point of competition for fund managers and general partners.

13. Models for estimating liabilities and implications for sponsor covenant are also evolving and improving^{[footnote 61]}. However, we recognise that the aspects of TCFD recommendations which are typically quantitative will be subject to disclosures from a range of jurisdictions, and there will be limitations to the comparability and consistency of data which pension scheme trustees receive.

14. We therefore propose that the scenario analysis recommendation, and the requirement to obtain data for the purpose of calculating metrics and setting targets, should be complied with ‘as far as trustees are able’. This is further explained below. Where there are assessments that trustees can make now, they should make them on the basis of the best data available. The financial risks of dangerous climate change to beneficiaries’ pension savings, and the opportunity to limit the damage, are too great to postpone.

15. By ‘as far as they are able’ we mean that trustees should request data from their asset managers and make reasonable efforts to obtain the data. We do not propose that trustees should be expected to pay excessive sums for access to the data. Engagement with stakeholders has told us that trustees are sometimes able to obtain the data for free. Where necessary, some small payment may be reasonable.

16. We recognise that few, if any, scheme trustees will be able to obtain full underlying data to inform the calculation of metrics or scenario analysis across their entire portfolio in the first instance. Pension schemes are internationally diversified, and some jurisdictions will have fewer disclosure requirements for the foreseeable future. However, the number of firms voluntarily committing to TCFD reporting is increasing^{[footnote 62]} and more and better data is becoming available.

17. A requirement for trustees to comply ‘as far as they are able’ will allow trustees to produce outputs from scenario analysis and calculations of metrics and targets for only part of the portfolio or using estimation or incomplete data sets. We believe that this will still be decision-useful information for trustees. The urgency of climate change means that the financial sector cannot wait until it has ‘perfect’ data before it starts putting it to use.

Overlap with existing requirements

18. We have considered the potential for overlap between these proposed new requirements in relation to the TCFD recommendations and those that trustees must already comply with in relation to climate change.

19. If the proposals in this consultation are adopted, TPR will give close consideration as to whether the forthcoming Governance Code it will issue under the Occupational Pension Schemes (Governance) (Amendment) Regulations 2018^{[footnote 63]} should provide for schemes meeting the TCFD requirements in line with our regulations to be deemed to have also met the standards in the Code, insofar as they relate to climate change. These will be standards relating to:

• the consideration of environmental, social and governance factors as part of an effective system of governance
• how trustees assess new or emerging risks, including risks relating to climate change and risks relating to the depreciation of assets as a result of regulatory change, as part of the carrying out and documentation of an own-risk assessment of the system of governance^{[footnote 64]}

20. We have also considered whether complying with any new climate governance requirements and required publication of information would also constitute compliance with corresponding parts of the Statement of Investment Principles (SIP) or implementation statement requirements. These requirements, which were introduced by regulations made in 2018 and 2019^{[footnote 65]} require trustees to state, among other things, their policy in relation to financially material considerations including environmental, social, governance (ESG) factors, including climate change, and to report on how and the extent to which they have followed them.

21. Ultimately, we have concluded that the information included in a SIP and implementation statement is much broader than that which would be included in a TCFD report. The requirements are also not a close fit with any individual TCFD disclosure or proposed underlying governance requirement. Disapplying the SIP and implementation statement requirements in relation to climate change on the grounds that the matter was satisfactorily covered in a TCFD report does not appear to be in members’ interests – it would mean the removal of a small proportion of text from the SIP and its replacement via a link to the entirety of a potentially much longer TCFD report.

22. We have therefore concluded that any duplication which does occur is limited enough that disapplication of some requirements would be disproportionate and unhelpful to the users of the documents.

Ongoing and discrete duties

23. The TCFD reporting recommendations themselves are uniformly annual. However, there is a distinction in the underlying governance activities between those which are ongoing and might be reasonably expected to be carried out continuously throughout the scheme year and those which can only feasibly be managed at discrete intervals.

24. For example, trustees should not be expected to only have oversight of climate-related risks and opportunities or ensure that the people managing the scheme assess and manage climate-related risks and opportunities a few times a year, whilst the duty falls away at other times. But it would appear disproportionate to require trustees to carry out scenario analysis on an ongoing basis throughout the year, or to calculate a greenhouse gas emission-related metric each day to reflect latest changes in the portfolio and the valuations and reported emissions of the holdings which make it up.

25. We propose that the split is as follows:

• ongoing activities – governance, strategy, risk management
• discrete activities – scenario analysis, metrics and targets

26. In relation to the discrete activities, we propose that the scenario analysis is carried out at least annually. Similarly, we propose that metrics and targets are chosen at least annually.

27. We propose however that emissions and non-emissions based data are obtained and calculated, and performance against targets is measured, at least quarterly. The goal here is that monitoring and tracking metrics, and performance of key metrics against targets, should happen more regularly than in the preparation of the annual report alone. A quarterly schedule aligns with the minimum frequency of trustee board meetings and the cycle of investment performance reviews for pension schemes.

28. In the proposed requirements below, duties which we propose are ongoing or discrete are distinguished, and the proposed minimum frequencies of discrete duties are given.

Governance Proposals

29. We propose that regulations should require trustees to undertake the following activities:

###Box 1a: Governance activities

G1	Establish and maintain, on an ongoing basis, oversight of climate-related risks and opportunities.
G2	Establish and maintain processes by which trustees, on an ongoing basis, satisfy themselves that persons managing the scheme are assessing and managing climate-related risks and opportunities.

30. We propose that regulations should require trustees to make the following disclosures:

###Box 1b: Annual Governance disclosures

G1.1	Describe the (board of) trustees’ oversight of climate-related risks and opportunities.
G2.2	Describe the role of those persons managing the scheme in assessing and managing climate-related risks and opportunities, only insofar as they relate to the scheme itself, and the process by which trustees satisfy themselves that this is being done.

31. The TCFD recommendations are focussed on placing development of a robust, embedded climate governance framework at the centre of an organisation’s operations. The framework itself is designed to be adoptable by all organisations and easily translatable into sector-specific arrangements.

32. For pension schemes, however, we believe that the Governance requirements in particular may require some adjustment in order to capture the varied nature of the management of an occupational pension scheme.

33. The role of the board, as described in the original TCFD recommendations^{[footnote 66]}, is easy to translate into the pensions landscape with the board representing the trustees. Ultimately, trustees are accountable for all strategic investment decisions and risk management approaches. It follows that the assessment of climate change risk and opportunities and the actions taken in relation to that assessment are the responsibility of the trustees.

34. In practice, many decisions are either informed by advice to the trustees from external advisers^{[footnote 67]} or from employees, whether directly of the scheme or the sponsoring employer, or are delegated to them altogether. The role of such persons in assessing and managing climate change risk and opportunities is central to the trustee’s attempts to fully embed climate change into their governance processes.

35. This delineation between the role of the trustees and those who manage the scheme is important; trustees might have appointed very well engaged external advisers who spend a great deal of time explaining to the scheme and its employees how they can properly manage climate change risk, but if the trustees do not take action or discuss the issue, then they are failing to address these risks and that disconnect should be highlighted. The reverse might also be true in circumstances where trustees’ advisers do not adequately address climate risk despite trustees’ instructions.

36. However, it is not proposed that the regulations will place any legal duties on the employees of the sponsoring employers or external advisers. Instead, the duty to put in place processes by which trustees can satisfy themselves that the persons managing the scheme assess and manage climate-related risks and opportunities, and the duty to report on their roles in line with G2, would be placed on trustees, as well as their own role in line with G1.

37. Our proposals for the statutory guidance which trustees must have regard to when meeting this requirement are outlined in the box below:

###Box 2: Statutory Guidance on Governance

In meeting the requirement for trustees to maintain oversight of climate-relate risks and opportunities, we propose that statutory guidance would outline the following matters to which trustees must have regard:

• the role of trustees as ultimately accountable for the scheme’s handling of climate change-related risks and opportunities
• sufficient allocation of trustees’ time and resources for assessing climate-related risks
• integration of climate change into the scheme’s existing governance processes, including the processes and frequency by which the trustees meet to discuss, and are informed about, climate-related issues

In meeting the requirements to establish and maintain processes by which trustees satisfy themselves that the persons managing the scheme assess and manage climate-related risks, statutory guidance would set an expectation that this includes:

• employees of the scheme
• employees of the principal or controlling employer (as defined in regulation 12 of The Occupational Pension Schemes (Preservation of Benefit) Regulations 1991)
• external advisers who provide services to the trustees
• scheme funder or strategist (in the case of a master trust) (as defined in section 39 of the Pension Schemes Act 2017)

Statutory guidance would outline the following matters to which trustees must have regard, in relation to the role of such persons and describing those roles in their TCFD report:

• whether it is appropriate to assign climate-related responsibilities to external advisers, employees or committees within the management structure, and if so, what those responsibilities involve
• how and when such positions or committees should report to the trustees
• how trustees should describe/illustrate the structure of the scheme and the roles that such persons play in ensuring climate-related risks are managed
• the types of processes that trustees should put in place to ensure external advisers or employees of the principal or controlling employer to which management has been delegated, are informed about and monitor climate-related issues effectively

Statutory guidance would also set out that trustees should describe, in their TCFD Report, how they have approached each of the matters above.

Where they choose to deviate from the approach set out in the guidance, trustees would be expected to describe their reasons for doing so in the relevant section of their TCFD Report.

Consultation Question

Q4. We propose that regulations require trustees to:

a) establish and maintain oversight of climate risks and opportunities
b) establish and maintain processes by which trustees, on an ongoing basis, satisfy themselves that persons managing the scheme, are assessing and managing climate-related risks and opportunities

We also propose that regulations require trustees to describe:

c) the role of trustees in ensuring oversight of climate-related risks and opportunities
d) the role of those managing the scheme in assessing and managing climate-related risks and opportunities, only insofar as this relates to the scheme itself and the process by which trustees satisfy themselves that this is being done

We propose that statutory guidance will cover the matters in the box above.

Do you agree with these proposals?

Strategy Proposals

38. We propose that regulations should require trustees to undertake the following activities:

###Box 3a: Strategy activities

S1	Identify, on an ongoing basis, climate-related risks and opportunities that will have an effect on the investment and, in the case of defined benefit (DB), funding strategy of the scheme, over the short, medium and long term.
S2	Assess, on an ongoing basis, the impact of the identified risks and opportunities on the scheme’s investment and, in the case of DB, funding strategy.

39. We propose that regulations should require trustees to make the following disclosures.

###Box 3b: Annual Strategy Disclosures

S1.1	Describe the climate-related risks and opportunities those persons described in G1 and G2 have identified over the short, medium, and long term.
S2.2	Describe the impact of climate-related risks and opportunities on the scheme’s investment and, in the case of DB, funding strategy.

40. The Strategy section of the TCFD recommendations is most focussed on the long-term. The principles of the TCFD’s strategy disclosures promote continuous assessment of the ramifications of climate change for the trustees’ investment strategy.

41. Following on from the governance requirements, we propose that the regulations include a requirement that trustees identify climate-related risks and opportunities over the short, medium and long-term and report those risks and opportunities and their potential impacts in the scheme’s disclosures contained in their TCFD Report.

42. The time horizons used may vary by type of scheme and may be impacted by the time horizons of their liabilities. For example, closed defined benefit schemes, informed by when their members benefits will be paid, may tend to set shorter time horizons for investment purposes. Open schemes which are not proposing to wind up or consolidate, are likely to have a longer investment time horizon informed by the duration for which members’ savings are most likely to be invested, up to and through retirement.

43. It is proposed that regulations will require that across all three time horizons (short, medium and long-term), trustees identify and publish the climate related risks which might impact the investment return expected, and in the case of a DB scheme, which impact the funding strategy and therefore the level of members’ benefits that can be delivered over those timescales.

44. It is proposed that across the same time horizons, trustees will also be required to identify and publish the climate-related opportunities that have been identified and which they intend to take advantage of in providing a return for their members or in mitigating the climate-related risks identified.

45. It is proposed that statutory guidance will support trustees to identify such risks and opportunities by providing examples that trustees should consider and report on if material, such as:

• increased pricing of greenhouse gas emissions/carbon
• substitution of existing products and services with lower emission alternatives
• successful investments in new technology
• increase in the energy/heat efficiency of buildings and infrastructure
• litigation risk
• extreme weather exposure
• others that feature in the final report published by the TCFD^{[footnote 70]}

46. Ultimately, the materiality of these risks is for each individual board of trustees to determine but it is proposed that the guidance will include, for example, the suggestion that schemes consider and report on the likely risks split by transition and physical risks.

47. Once risks and opportunities are identified, we propose that trustees would be required to assess their impact on the scheme’s investment strategy and, where relevant, their funding strategy. Trustees would then be required to disclose this assessment. It is proposed that this assessment should be carried out at a portfolio level, but also, for dual section hybrid schemes, for individual sections. For schemes with multiple defined contribution (DC) defaults, it is proposed that scenario analysis should be carried out for each popular default. This expectation would be set out in statutory guidance.

48. The focus here should be how, for example, the potential emergence of low carbon opportunities and the decline of some traditional industrial sectors is factored into the scheme’s investment decision-making. This should also include the changes that have been made because of the identification and assessment of the given risk or opportunity.

49. Our proposals for the statutory guidance to which trustees must have regard when meeting this requirement are outlined in the box below:

###Box 4: Statutory Guidance on Strategy

In identifying and assessing the impact of climate-related risks and opportunities on the investment and, in the case of DB, funding strategy of the scheme over the short, medium and long-term, we propose statutory guidance would set out the following matters to which trustees must have regard:

• the levels at which the identification and assessment of risks and opportunities should be carried out - for example, the individual sections of a scheme with DC and DB sections – as well as additional analysis that could be carried out, for example, in relation to different asset classes
• how to understand and assess the scheme’s climate risks and opportunities across short, medium, and long-term time horizons
• examples of climate-related risks and opportunities that could have a material financial impact on scheme assets
• definitions to help trustees understand whether the climate-related risks are transition or physical risks
• examples of the factors trustees might consider to determine which risks and opportunities could have a material financial impact on their investment strategy and funding strategy
• guidance on how climate-related risks and opportunities could be factored into their investment strategy and funding strategy and the implementation of those strategies

Statutory guidance would also set out that trustees should describe in their TCFD Report how they have approached each of the matters above.

Where they choose to deviate from the approach set out in the guidance, trustees would be expected to describe the reasons for doing so in the relevant section of their TCFD Report.

Consultation Question

Q5. We propose that regulations require trustees to identify and disclose the climate change risks and opportunities relevant to their scheme over the short, medium and long term, and to assess and describe their impact on their investment and funding strategy.

We propose statutory guidance will cover the matters outlined in the box above. Do you agree with these proposals?

Scenario Analysis

50. We propose that regulations require trustees to undertake the following activities:

###Box 5a: Scenario analysis activities

S3

At least annually, as far as they are able, assess the resilience of the scheme’s assets, liabilities and investment strategy and, in the case of DB, funding strategy to climate-related risks in at least 2 climate-related scenarios, including at least one scenario that represents an eventual global average temperature rise of between 1.5 and 2°C on pre-industrial levels.

51. We propose that regulations require trustees to make the following disclosures.

###Box 5b: Annual Scenario analysis disclosures

S3.1	Describe the resilience of the scheme’s investment and, in the case of DB, funding strategy, as far as trustees are able, in at least two climate-related scenarios, including at least one scenario of between 1.5 and 2°C.

52. Scenario analysis is considered perhaps the most complex part of the TCFD recommendations for an organisation to undertake. In doing so, schemes will need to assess the resilience of their assets, liabilities and strategies to different climate-related scenarios. For DB schemes, this will also include consideration of their sponsor’s covenant and how climate change may pose risks to this. We believe that, ultimately, scenario analysis is an important and useful tool for pension schemes to understand the strategic implications of climate-related risks and opportunities. Many of the medium and long-term impacts of climate change are not easily assessed with standard risk management processes and their limited time horizons. The results of scenario analysis, when plainly communicated, can help to build strategies that are more resilient to future climate-related risks and take advantage of opportunities.

53. We propose that regulations require trustees to conduct scenario analysis as far as they are able to do so and that they then publish the results. The government is well aware that there may be some practical barriers for some schemes undertaking scenario analysis. For example, some investee firms do not yet carry out such analysis and if they do, the variety of assumptions, methodologies and scenarios used by firms may present hurdles to producing full analysis at the portfolio-level. We propose that statutory guidance will set out what trustees may be expected to do to conduct the analysis, including in circumstances where their efforts are hindered by an external factor such as a lack of available data. It is our expectation that trustees would endeavour to work around data gaps and external factors to do the best scenario analysis that they are able to, rather than deciding not to conduct any analysis at all.

54. It is notable that climate scenario analysis is being encouraged across the financial sector, even whilst acknowledging that the methodologies and data that are available are not perfect. For example, the Network for Greening the Financial System (a network of central banks and supervisors) published, in June 2020, technical guidance on scenario analysis that recommends and explains how to undertake scenario analysis whilst nevertheless recognising that “the use of climate-related scenario analysis is relatively new and methodologies are still developing.”^{[footnote 71]} The Climate Financial Risk Forum (CFRF), co-chaired by the FCA and the Prudential Regulation Authority (PRA), has also published detailed and practical guidance for the financial industry on scenario analysis as part of its guidance on climate-related financial risk management.^{[footnote 72]}

55. Although many large organisations are driving progress in this area, most pension scheme trustees are only beginning to explore its use. However, it is possible to assess the impact of various global warming scenarios on the strategy of an organisation without modelling and data – indeed the TCFD recommendations speak to the value of this qualitative type of analysis^{[footnote 73]}. The government does not propose to prescribe whether scenario analysis should be qualitative or quantitative; what matters is that trustees begin to give full consideration to the financial implications of climate change on their future strategy. This understanding will be valuable for pension scheme trustees in understanding the climate risks to which the scheme may be exposed, including in relation to their liabilities and funding strategies.

56. While we appreciate the current barriers to quantitative scenario analysis, it is our expectation that most benefit will be gained if quantitative scenario analysis is completed as soon as reasonably possible. We anticipate that, over time, many scheme trustees may decide to adopt the quantitative scenario analysis which is continuing to develop and improve. In this form, a model (or a combination of other analytical techniques) simulates the impact on the portfolio’s projected performance into the short, medium and long-term of various scenarios of warming or climate transition.

57. Trustees may seek to use the services of an external provider to do this analysis. In recognition of the possible limitations, for example those caused by a lack of data or by cost, we anticipate that the proposed statutory guidance would help trustees understand the level of endeavour expected of them in seeking to carry out scenario analysis ‘as far as they are able’ to do so. We also propose that the guidance will set out what trustees are expected to disclose where they have faced significant barriers to conducting scenario analysis.

58. The TCFD recommends that organisations disclose how resilient their strategies are to a range of plausible climate-related scenarios. In particular, it recommends that they use a ‘2°C or lower scenario’ in addition to others most relevant to their circumstances. In accordance with this recommendation, we propose that regulations require that two or more climate-related scenarios are considered by trustees, at least one of which must be a scenario of 2oC or lower. Schemes will need to assess their assets/liabilities and investment/funding strategy against these scenarios.

59. A range of scenarios will allow trustees to capture both transition and physical risk. Transition risks occur through the shift to a lower carbon economy and arise from measures taken to drive change, such as policy interventions, technology changes and market shifts. Physical risks are those linked to changes in the environment as a result of climate change, such as increased flooding, droughts and other weather extremes. In a 4°C scenario, only a small amount of transition occurs in the short or medium-term so therefore the physical risks dominate. In contrast, a smooth transition to 2°C or lower still sees some significant physical risks, but the structure of the economy will change immensely and swiftly bringing very large transition risks and opportunities for pension schemes.

60. We propose that statutory guidance will help trustees understand how to select a range of possible scenarios, including by discussing the difference between ‘orderly’ and ‘disorderly’ transitions. For example, orderly transitions anticipate that global climate change goals are met in measured way, whilst a disorderly transition may meet that target only after sudden and unanticipated responses take effect. A disorderly transition may give rise to different types of risks even though it may achieve the same climate change goal as an orderly one.

61. The requirement that trustees conduct scenario analysis, as far as they are able, against a scenario that is 2°C or lower means that they must choose one scenario which represents an end warming result above pre-industrial temperatures of somewhere between 1.5°C and 2°C inclusive. The 2°C or lower target is a key consideration for schemes as it allows them to include, as a scenario, the transition to a low-carbon economy. It is also the scenario set out in the TCFD recommendations.

62. However, the ambitions of the Paris Agreement go further than this and trustees are free to select lower temperature goals for their scenarios.

63. It is proposed that the detail of the warming scenarios, such as the specific emissions trajectories or technological assumptions that schemes should use will not feature in regulations. Instead, we propose that the statutory guidance outlines examples of scenarios that are available as well as broader characteristics that schemes may use to bring out both the transition and physical risks and opportunities. This includes characteristics such as the emissions trajectory of the scenario (or, how abrupt or smooth / orderly or disorderly the transition is), as well as assumptions around the economy including the future of particular industries. We propose that statutory guidance will incorporate some of the material from the chapters on scenario analysis in the TCFD’s technical supplement to the Final Report^{[footnote 74]} and the PCRIG consultation, subject to the outcome of that consultation^{[footnote 75]} .

64. Our proposals for the statutory guidance to which trustees must have regard when meeting the proposed requirements on scenario analysis are outlined in the box below:

###Box 6: Statutory Guidance on Scenario Analysis

In assessing, as far as they are able, the resilience of the scheme’s assets, liabilities and investment/funding strategy to climate-related risks and opportunities in at least two climate-related scenarios, we propose statutory guidance would set out the following matters to which trustees must have regard:

• the levels at which scenario analysis should be carried out - for example, the individual sections of a scheme with DC and DB sections, or the individual fund-level
• how the trustees may approach the use of scenario analysis, whether qualitative or quantitative, to understand the resilience of the investment strategy, and where relevant, funding strategy, to climate-related risks and opportunities
• how trustees should go about selecting scenarios most appropriate to their scheme’s investment horizons including references to examples of existing scenarios and scenario analysis tools which are available to schemes
• how trustees should approach external factors which limit their ability to do scenario analysis, such as data gaps, and what is expected of trustees in terms of undertaking scenario analysis ‘as far as they are able’
• how to use the process and outputs of scenario analysis to inform trustees’ understanding of the impact of climate-related risks and opportunities on the investment/funding strategy and examples of possible steps they could take to ensure their strategy addresses risks and opportunities

Statutory guidance would also set out that trustees should describe, in their TCFD Report, how they have approached each of the matters above

Where they choose to deviate from the approach set out in guidance, trustees would be expected to describe the reasons for doing so in the relevant section of their TCFD Report.

Consultation Question

Q6. We propose that regulations require trustees to assess the resilience of their assets, liabilities and investment strategy and in the case of DB, funding strategy, as far as they are able, in at least two climate-related scenarios, one of which must be a 2°C or lower scenario and to disclose the results of this assessment We propose statutory guidance will cover the matters outlined in the box above.

Do you agree with these proposals?

Risk Management Proposals

65. We propose that regulations require trustees to undertake the following activities:

###Box 7a: Risk Management activities

R1	Trustees must adopt and maintain, on an ongoing basis, processes for identifying and assessing climate-related risks.
R2	Trustees must adopt and maintain, on an ongoing basis, processes for managing climate-related risks.
R3	Trustees must ensure, on an ongoing basis, integration of climate-related risks into their overall risk management.

66. We propose that regulations require trustees to make the following disclosures:

###Box 7b: Annual Risk Management disclosures

R1.1	Describe the processes that the trustees have put in place for identifying and assessing climate-related risks.
R2.2	Describe the processes that the trustees have put in place for managing climate-related risks.
R3.3	Describe how these processes are integrated within their overall risk management.

67. Similar to Strategy, embedding climate change risk management into the business-as-usual operations is a process of stages, and is covered by R1 through to R3 above. We propose that trustees should assess their scheme’s exposure to climate-related risks and then manage the risks they identify. Disclosure should follow the same process, with reporting describing the process for identifying risks, the process for managing the risks identified and how this process is integrated or embedded within the scheme’s overall risk management.

68. Risk management is ultimately about accounting for what climate change might mean for pension schemes. Scheme trustees should be asking themselves “Which climate change risks are most material to us?”, “How do we take account of transition and physical risk in our wider risk management?” and “How does it affect our risk appetite?”

69. For R1, this means scheme trustees will be required to have an effective process for identifying climate-related risks and assessing their likely impact on their scheme’s investment. Disclosure requirements would then mean scheme trustees have to report a description of this process. Statutory guidance will support trustees in not only ensuring they have the most appropriate processes in place but also suggesting the types of risks that trustees should be alive to.

70. Under R2, we propose regulations require trustees to put in place processes to manage the risks identified through the processes referred to in R1, if they don’t already have such a process, and to disclose how this management take place.

71. Statutory guidance would then expand on this, setting out factors that trustees take into account when deciding how to prioritise the various risks that they identify based on materiality, including likelihood and financial impact. We also propose that statutory guidance should include the list of risks that the TCFD published alongside the Final Report as risks the trustees should consider^{[footnote 76]}.

72. This list includes policy risks such as limits on greenhouse gas (GHG) emissions and greater regulation of products and practices but also wider market shifts such as changing consumer preferences in favour of goods and services with a lower carbon footprint. The list also extends to opportunities that scheme trustees might want to consider and manage their exposure to. These include increasingly efficient buildings and government-sanctioned incentives for production or development of low emission goods and services.

73. The TCFD recommendations require trustees to both consider and then disclose how such processes interact with the scheme’s overall risk management processes, as would our proposed regulations. This is to ensure that trustees consider mainstreaming climate risk management in the same way they do traditional, long-established forms of management of risks such as exchange rate or other investment risks. For many trustees, part of this risk management process will involve delegation to asset managers to manage the day-to-day risk. However, trustees must ensure that they understand the risks, monitor their managers and are ready to question and challenge their services.

74. Our proposals for the statutory guidance which trustees must have regard to when meeting this requirement are outlined in the box below.

###Box 8: Statutory Guidance on Risk Management

With regard to processes for identifying and assessing climate-related risks, we propose that statutory guidance would set out the following matters to which trustees must have regard:

• the types of processes trustees should put in place in order to identify the climate-related risks that the scheme is exposed to, including emerging regulatory and supervisory requirements related to climate change (for example, limits on emissions) as well as other relevant factors
• the types of processes trustees should implement for assessing the potential size and scope of identified climate-related risks
• how trustees should work with asset managers and others to ensure that identified risks are recognised and assessed by others in the investment chain

With regard to processes for managing climate-related risks, we propose that statutory guidance would set out the following matters to which trustees must have regard:

• determining which climate-related risks are most material to them in terms of the financial impact they will have on their existing investment portfolio
• the types of decision-making processes trustees should put in place to monitor, and to mitigate, transfer, accept, or control the risks identified
• working with asset managers and others to ensure that identified risks are managed and addressed in the investment chain
• embedding climate-risk related considerations into the scheme’s wider risk monitoring process

Statutory guidance would also set out that trustees should describe, in their TCFD Report, how they have approached each of the matters above

Where they choose to deviate from the approach set out in the guidance, trustees would be expected to describe the reasons for divergence in the relevant section of their TCFD Report.

Consultation Question

Q7. We propose that regulations require trustees to:

a) adopt and maintain processes for identification, assessment and management of climate-related risks
b) Integrate the processes described in a) within the scheme’s overall risk management

We also propose the regulations require trustees to disclose:

c) the processes outlined in part a) above

We propose statutory guidance will cover the matters outlined in the box above.

Do you agree with these proposals?

Metrics and Targets Proposals

Metrics

75. We propose that regulations require trustees to undertake the following activities:

####Box 9a: Metrics activities

M1	Select at least one appropriate greenhouse gas emissions (GHG) based metric and at least one other non-emissions-based metric to assess scheme assets against climate-related risks and opportunities and review the selection on an ongoing basis.
M2	At least quarterly, calculate at least one GHG emissions-based metric (for example, Weighted Average Carbon Intensity) to assess scheme assets against climate-related risks and opportunities. At least quarterly, calculate at least one other, non-emissions-based metric to assess scheme assets against climate-related risks and opportunities.

76. We propose that regulations require that trustees to make the following disclosures.

####Box 9b: Annual Metrics disclosures

M1.1	Disclose the emissions-based metric(s) and non-emissions-based metric(s) that the scheme has calculated and that is used by trustees to assess the climate-related risks and opportunities relevant to the scheme.
M2.2	Describe why, if trustees have only been able to obtain partial or estimated data, their data does not cover the whole portfolio.

77. Metrics are a crucial step towards embedding the TCFD framework. However, the government acknowledges the difficulties involved for trustees. We propose to require that trustees produce metrics for their schemes in two areas: emissions-related (such as Weighted Average Carbon Intensity) and other characteristics, not specifically linked to emissions but related to governance, investment strategy or risk management, as described in paragraph 93 below.). This approach is reflected within M1 and M2 in the box above.

78. It is useful to consider this process as a chain. A trustee should:

• select the characteristics that they want to quantify (for example, carbon intensity or the percentage of the portfolio in “green” investments)
• obtain the data on those characteristics, as far as they are able (for example, scope 1, 2 and 3 emissions)
• calculate a metric, of their choosing, to measure or communicate that characteristic using the data they were able to obtain (for example, weighted average carbon intensity or Weighted Average Carbon Intensity (WACI))

And, as set out in the ‘Targets’ section to come:

• consider setting a target for this metric (for example, a reduction of 25% by 2030)
• publish the metric – and the target, if they have set one

79. Along with scenario analysis, being able to accurately calculate emissions-related metrics for a portfolio is an aspect of the TCFD recommendations that is dependent on data flows. Similarly, non-emissions-related data, such as the level of investment in ‘green sectors’^{[footnote 77]}, may need to be obtained from some asset managers.

80. Pension schemes, sitting at the top of the investment chain, require investee companies to calculate and disclose, for example, GHG emissions and for asset managers to be able to aggregate this information at the fund level in order for trustees to then aggregate emissions and other climate-related data across the portfolio. The part of the process over which trustees have control is therefore heavily dependent on others.

81. Government, along with regulators, continues to review the levers it holds to promote greater data disclosure and recognises that capabilities are developing quickly. Indeed, the FCA has signalled that it is considering how best to enhance climate-related disclosures by regulated firms, including asset managers. This work is being carried out in coordination with Department for Work and Pensions (DWP) and other regulators and government departments. In determining its approach, the FCA will take into consideration data required by pension scheme trustees to meet obligations under the proposed statutory guidance. The FCA will clarify its position in due course. Clearly, however, this data flow remains incomplete in a significant number of cases currently.

82. To reflect this, we again propose an approach in regulation that trustees are required by regulations to obtain data on the emissions of their various investments, as well as any other data they need to calculate metrics, ‘as far as they are able’.

83. This is similar to our proposed approach to scenario analysis and is reflected in the wording in Box 9. We have considered a ‘comply or explain’ approach but, in the case of pension schemes, our conclusion is that this is more likely to result in some ‘boiler-plate’ explanations as to non-compliance by trustees that would prevent the reasoning behind partial or non-disclosure of metrics being shared. It may also discourage partial disclosures or estimates which are nevertheless decision-useful.

84. To support the effectiveness of the ‘as far as trustees are able’ approach, we propose that regulations will require trustees to explain in their TCFD Report why the data they have chosen to disclose does not fully cover the portfolio or extend to all scopes of emissions. We do not wish to make this an onerous or unnecessarily lengthy section of the Report but see this as key to helping readers understand the level of completeness any results represent, and any possible inaccuracies that occur as a result of estimates or modelling. Secondly, we see it as useful information for both government and industry to gather, to understand the data issues that exist, empirically. Statutory guidance would set out the kinds of explanations it would be relevant for trustees to include, including how detailed those explanations are expected to be.

85. We do however acknowledge that some trustees will want to be ambitious and disclose emissions data or calculate metrics that do fully cover the portfolio, possibly relying on estimation where data gaps exist. This kind of innovation is something we wish to encourage and which is in keeping with the principles behind the TCFD recommendations. We propose that statutory guidance will state that trustees should be transparent about the methodologies used and detail where estimation has taken place and the various data gaps that remain.

86. To be clear, we do not propose that the requirements on calculating metrics, once data has been obtained, and disclosing them would be subject to the ‘as far as trustees are able’ approach. Whilst it may be difficult for schemes to acquire data that fully covers all asset classes in which they have confidence, we propose that the initial selection and the calculation of metrics on the basis of the data that is acquired, is solely down to the trustees. We do not anticipate other difficulties beyond the acquisition of data that would limit the ability to make such calculations.

87. In relation to specific metrics, we had initially considered requiring scheme trustees to calculate and report their Weighted Average Carbon Intensity (WACI). Following informal engagement with stakeholders, however, we now see less value in prescribing a specific metric in regulations. Whilst doing so could promote consistency and comparability, the underlying data and methodology used could still vary, meaning that it may be possible to calculate other emissions measures across a wider share of the scheme’s portfolio.

88. However, we do recognise that WACI is more appropriate, in some respects, than other, simpler metrics. Indeed, for asset owners, a metric that adapts to the percentage of the assets or the portfolio that is invested in low or high-carbon companies is much more decision-useful than others that do not. WACI is a useful way to track the carbon intensity of a pension scheme’s portfolio as influenced by strategic investment decisions, and less influenced by changes to a company’s market capitalisation or other factors outside the control of the trustees.

89. We propose that statutory guidance will state that trustees should choose WACI as their emissions-based metric which they must calculate and disclose. As with other material deviations from the statutory guidance, should trustees decide to employ a different emissions-based metric, they would be expected to explain why they have done so in their TCFD Report.

90. When it comes to WACI or other emission-based metrics, we acknowledge that trustees are heavily dependent on the flow of data but also on disclosure by companies etc. of Scope 1, 2 and 3 emissions, described below. The latter of these, can, in many cases, be the largest.

• Scope 1 – All direct emissions from the activities of an organisation or under their control. Including fuel combustion on site such as gas boilers, fleet vehicles and air-conditioning leaks
• Scope 2 – Indirect emissions from electricity purchased and used by the organisation. Emissions are created during the production of the energy which is eventually used by the organisation
• Scope 3 – All other indirect emissions from activities of the organisation, occurring from sources that they do not directly control. These are sometimes the greatest share of a carbon footprint, covering emissions associated with business travel, procurement, production of inputs, use of outputs, waste and water

91. We propose imposing identical requirements in relation to Scope 3 emissions to those we impose for Scope 1 and Scope 2: to obtain Scope 3 emissions ‘as far as trustees are able’ to do so, and to calculate metrics using this data. We propose that statutory guidance will also highlight the difficulties with Scope 3 and encourage trustees to be transparent about such difficulties, including where estimation might be used instead, in their TCFD Report.

92. We also propose that the emissions-related metric is calculated and reported at portfolio level, separately for the DC and DB sections of dual section hybrid schemes and, where schemes have multiple DC defaults, for each popular default. As with scenario analysis, it is proposed that this expectation would be set out in statutory guidance.

93. It is proposed that statutory guidance would also lay out suggested non-emissions-related data that trustees can acquire and related metrics they can calculate, to monitor and manage their exposure to climate-related risks and opportunities. This data cannot be on just any characteristic – statutory guidance would list out the types of data and metrics that can usefully be deployed. Trustees would be expected to include a minimum of one of the metrics on the list, although generally it would be reasonable for trustees to calculate and report on more than one. It is proposed this list would include but not be limited to:

• how many investee firms have issued an emissions target
• the percentage of the portfolio invested in ‘green’ opportunities
• the level of engagement that the scheme trustees, through their asset managers, have undertaken with the companies in which they are invested on climate risk

94. The statutory guidance would also encourage trustees to explain in the TCFD Report how they use their chosen metrics, including those linked to emissions, in their investment decision-making and to which material risks and opportunities, as disclosed under S1 and S2, the metrics relate.

95. Our proposals for the statutory guidance to which trustees must have regard when meeting this requirement are outlined in the box below.

####Box 10: Statutory Guidance on Metrics

With regard to the proposed requirements for trustees to:

• select at least one appropriate emissions-based metric and at least one non-emissions-based metric to assess the scheme’s assets against climate-related risks and opportunities and review the selection on an ongoing basis
• obtain data relating to the metrics as far as trustees are able
• calculate and disclose the emissions-based metric(s) and the non-emissions based metric(s)

It is proposed that statutory guidance would set out the following matters to which trustees must have regard:

• the levels at which metrics should be calculated and reported – for example, the individual sections of a scheme with DC and DB sections, or the individual fund-level
• a list of the metrics from which at least one emission-based metric and at least one non-emissions-based metric should be selected to measure and manage climate-related risks and opportunities – including the expectation that the Weighted Average Carbon Intensity (WACI) should be used for the emissions-based metric
• in relation to emissions-based metrics, calculating GHG emissions in line with the GHG Protocol methodology to allow for aggregation and comparability across asset classes and funds and between schemes
• incorporating performance metrics into remuneration policies, where this is done
• the historical periods used in calculation of metrics to allow for trend analysis
• setting out reasons for any difficulties in acquiring adequate data
• describing the methodologies used to calculate or estimate metrics
• how the metrics are used in investment decision-making

Statutory guidance would also set out that trustees should describe, in their TCFD Report, how they have approached each of the matters above.

Where they choose to deviate from the approach set out in the guidance, trustees would be expected to describe the reasons for divergence in the relevant section of their TCFD Report.

Consultation Question

Q8. We propose that regulations require trustees to:

a) select at least one GHG emissions-based metric and at least one non-emissions-based metric to assess the scheme’s assets against climate-related risks and opportunities and review the selection on an ongoing basis
b) obtain the Scope 1, 2 and 3 GHG emissions of the portfolio, and other non-emissions-based data, as far as they are able
c) calculate and disclose metrics (including at least one emissions-based metric and at least one non-emissions-related metric) used to quantify the effects of climate change on the scheme and assess climate-based risks and opportunities

We also propose that regulations require trustees to disclose:

d) why the emissions data that is estimated does not cover all asset classes, if this is the case

We propose that trustees will not be required to use a specific measure to assess the effects of climate change on the scheme’s portfolio.

We propose statutory guidance will cover the matters outlined in the box above.

Do you agree with these proposals?

Targets

96. We propose that regulations require trustees to undertake the following activities:

####Box 11a: Targets activities

M3	At least annually, set at least one target to manage climate-related risks for one of the metrics calculated in accordance with M2, which can be an emissions-based metric, or a non-emissions-based metric.
M4	At least quarterly, measure, as far as trustees are able, performance against the target(s).

97. We propose that regulations require trustees to make the following disclosures:

####Box 11b: Annual Targets disclosures

M3.1	Disclose the target(s) selected in accordance with M3.
M4.1	Disclose performance measured against the selected target(s) in accordance with M4.

98. The targets that trustees set will be related to the metrics they have used and the emissions they have disclosed. They are linked in the TCFD recommendations and we are proposing to follow that approach. Therefore, the requirement to set and disclose targets naturally flows from the requirement to determine and disclose metrics.

99. Targets are the mechanism through which trustees should convert the backward-looking or present-day metrics into forward-looking goals that set a path for the scheme’s strategy, taking into account transition risks and minimising exposure to physical risks.

100. We believe that target-setting should be mandatory and propose that regulations require at least one target to be set either for emissions or emissions-based or non-emission-based metrics that the scheme has calculated. Whilst we had considered making target-setting subject to the ‘as far as trustees are able’ approach, we concluded that there are no additional difficulties associated with setting targets.

101. We propose that trustees should also be required to measure performance against their targets and include this measurement in their first and future TCFD reports. Of course, this, much like the data that feeds into the metrics themselves, is dependent on reliable, timely data from others and so we propose to make this requirement to measure and publish performance against targets, ‘as far as trustees are able’.

102. Statutory guidance would set out the benefits to schemes of setting targets against which to measure performance, including as a clear signal to members of the trustees’ intent. However, we do not propose to mandate particular metrics for which targets should be set, or the ambition or timing of targets – the setting and meeting of targets should be something in relation to which trustees set their own timetable.

103. Our proposals for the statutory guidance to which trustees must have regard when meeting these requirements are outlined in the box below:

####Box 12: Statutory Guidance on Targets

With regard to the proposed requirements for trustees to set and disclose the targets used by the scheme to manage climate-related risks and to measure, as far as they are able, their performance against those targets, it is proposed that statutory guidance sets out the following matters to which trustees must have regard:

• whether the target is absolute or intensity based
• time frames over which the target applies
• base year from which progress is measured
• key performance indicators used to assess progress against targets

The expectation that, where not apparent, trustees will provide a description of the methodologies used to calculate targets and measure performance against them, including any estimations used to measure performance.

Statutory guidance would also set out that trustees should describe, in their TCFD Report, how they have approached each of the matters above.

Where they choose to deviate from the approach set out in the guidance, trustees would be expected to describe the reasons for divergence in the relevant section of their TCFD Report.

Consultation Question

Q9. We propose that regulations require trustees to:

a) set at least one target to manage climate-related risks for one of the metrics trustees have chosen to calculate, and to disclose the target(s).
b) calculate performance against the target(s) as far as trustees are able and disclose that performance

We propose statutory guidance will cover the matters outlined in the box above.

Do you agree with these proposals?

1. See the Pension Schemes Bill, Part 5, Clause 124, sections 41A(7) and 41B(3) (p.119). ↩

2. CP20/3: Proposals to enhance climate-related disclosures by listed issuers and clarification of existing disclosure obligations. ↩

3. How can climate change disclosures protect reputation and value? Extract from the 2019 EY Global Climate Risk Disclosure Barometer. Reproduced with permission. ↩

4. See, for instance, Institute and Faculty of Actuaries. Resource and Environment Issues: A Practical Guide for Defined Benefit Pensions Actuaries and Resource and Environment Issues for Pensions Actuaries: Supplementary Information on Resource and Environment Issues and their Implications for Sponsor Covenant Assessments. ↩

5. The TCFD Status Report in 2019 reviewed reports for over 1,100 reporting companies. ↩

6. SI 2018/1103 – see Regulation 3 ‘Code of Practice’. ↩

7. See regulation 3(2)(f) and 3(8)(h). ↩

8. SI 2018/988 and SI 2019/982 – see regulations 4, 5 and 2, 3 respectively. ↩

9. TCFD Recommendations (June 2017). ↩

10. Advisers include investment consultants, scheme actuaries, scheme lawyers and covenant advisers. ↩

11. Section B, Recommendations of the Task Force for Climate-related Financial Disclosures, Final Report (June 2017). ↩

12. Guide to Climate Scenario Analysis for Central Banks and Supervisors, (p.7). ↩

13. Climate Financial Risk Forum ↩

14. ‘D. Recommended Approach to Scenario Analysis’, Section 3 (p.27), Annex: Implementing the Recommendations of the TCFD (June 2017). ↩

15. Technical Supplement to the Final Report on Scenario Analysis, ‘The use of scenario analysis in disclosures of climate-related risks and opportunities, (June 2017). ↩

16. Aligning your pension scheme with the TCFD recommendations. ↩

17. Section B, Recommendations of the Task Force for Climate-related Financial Disclosures, Final Report (June 2017). ↩

18. Note that any future regulation or statutory guidance is, intentionally, unlikely to clarify what is considered a ‘green’ sector or investment for these purposes. There is significant work underway on this internationally, including the EU taxonomy. ↩