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TCFD governance and reporting – managing scheme governance and risk

This article is part of a series on new duties for UK pension scheme trustees to assess, manage and report on climate change risk. To read the rest of the series click here.

A note on timing

These requirements apply to trustees of the UK’s largest occupational pension schemes (with more than £5 billion in assets) and master trusts from 1 October 2021; other schemes with more than £1 billion in assets will fall within scope a year later.

Specific valuation and timing rules apply to determine whether/when a scheme will be in scope of these requirements. Please contact an Allen & Overy adviser if you need more information on this.

Trustees of UK pension schemes routinely consider risks of various kinds as part of their duty to operate an effective system of governance, including internal controls. The Regulator’s single code of practice will provide more guidance on different aspects of the effective system of governance, including consideration of environmental, social and governance factors in investment decision-making.

In relation to climate change-related risks and opportunities, the TCFD governance and reporting regulations set out additional requirements that are both broad and specific in nature. Here we look at the overarching principles and duties that trustees will need to comply with in relation to governance, strategy and risk management.

What are the new duties?

The overarching governance requirement is that trustees must establish and maintain:

  • oversight of climate-related risks and opportunities (CRRO) relevant to the scheme; and
  • processes to satisfy themselves that any person, other than a trustee, who undertakes ‘scheme governance activities’ (or advises/assists the trustees in relation to those activities) takes adequate steps to identify, assess and manage any CRRO that are relevant to those activities.

What are ‘scheme governance activities’? The statutory guidance refers to individuals who are responsible for managing CRRO and making scheme-wide decisions, including (but not limited to) decisions relating to investment, funding (including covenant) or liabilities. Individuals who assist the trustees with these matters are also in scope, including employees of the scheme/principal employer; investment consultants; fiduciary managers; actuaries and covenant advisers. Legal advisers are excluded and the government considers that asset management activities would not normally be in scope. Administrators may be in scope depending on the activities they undertake.

In terms of strategy, there is an ongoing duty to identify CRRO that will affect the investment and (for DB) funding strategy of the scheme over the short, medium and long term (appropriate time periods are determined by the trustees taking into account the scheme’s liabilities and obligations to pay benefits/keep monies invested), and to assess the impact of the identified CRRO on the investment (and funding) strategy. This will include specific requirements around scenario analysis, read more about this here. For DB schemes this duty will include considering the impact of CRRO on the employer covenant (including, for example, the impact of wider policy change), which is likely to involve dialogue with scheme employers.

The ongoing risk management requirements are that trustees must establish and maintain processes for identifying, assessing and managing climate-related risks (CRR – note that this element relates only to risks not opportunities) relevant to the scheme and integrate these processes into their overall risk management (for example, taking account of how these risks interact with other risks facing the scheme and ensuring that a consistent method for assessing risks is applied). This will include specific requirements around selecting and monitoring metrics, read more about this here.

Understanding the new duties

Identifying risks and opportunities

The risks to be considered by trustees include:

  • physical risks (which could be acute, like flooding or fires, or chronic, like a loss of biodiversity) that might damage supply chains or cause social disruption; and
  • transition risks (for example, potential policy, legal, technology, market and reputational risks that might arise as a result of a switch to a lower carbon economy).

Failing to account for physical or transition risks could also result in litigation risks.

Conversely, action to address climate change might contribute positively to anticipated returns or reduced risk in some instances, and climate change-related opportunities may include access to new markets and technologies. Of course, climate change is just one of many financial and other risks affecting the scheme; a proportionate approach is required to ensure that all risks affecting the scheme are appropriately managed.

Management of climate-related risks must be embedded into the scheme’s wider risk monitoring and management framework and processes. Trustees should consider how CRR may intersect with other risks, and how to manage all relevant risks in a proportionate and consistent way.

Applying the requirements to different scheme structures

The governance and the risk management requirements apply at a whole scheme level. The statutory guidance expects risk assessment processes to be applied at the asset class or key sector level as a minimum (but a more granular approach could be used to identify trends). Assessment processes should also be applied in relation to liabilities and the employer covenant – and the outcomes of these processes may influence trustees’ considerations of the appropriate time horizons.

The strategy requirements should be carried out (and reported on) at different levels, for example:

  • in a multi-section DB scheme, each DB section (but sections with similar asset, liability and funding characteristics may be grouped together);
  • for DC schemes: each ‘popular arrangement’ offered by the scheme. This means any arrangement in which £100m or more of the scheme’s assets are invested, or which accounts for 10% or more of the assets used to provide DC benefits (excluding assets that are solely attributable to additional voluntary contributions).   

Schemes may therefore need to carry out activities under the strategy heading multiple times, to cater for different sections and arrangements.

All asset types are within scope for the assessment of a scheme’s investment strategy, funding strategy (where it has one) and for scenario analysis. The guidance is clear that climate-related risks could affect the value of assets such as, for example, corporate and sovereign debt – no asset class can automatically be excluded. Similarly, trustees should consider the impact on scheme liabilities, even though this may only be possible at a high level.

Getting started

Trustees have ultimate responsibility for ensuring the effective governance of CRRO. They have flexibility to decide on the appropriate oversight and management structure and processes for their scheme, but must design these so as to enable them to be confident of meeting the statutory requirements, and to be proportionate (not excluding proper consideration of other risks). It is not open to trustees to assert that climate change-related risks are non-material for their scheme, as an alternative to complying with the risk management requirements. The statutory guidance acknowledges that trustees may rely on their sponsoring employer’s management teams to help them identify and assess climate-related risks, recognising that for many schemes this may provide a cost-effective resource.

In terms of governance activities, an important first step is to ensure that you have identified all relevant individuals undertaking or assisting with scheme-wide activities and that they are taking into account any CRRO relevant to those activities. Roles and responsibilities should be addressed at board, sub-committee and individual trustee levels and defined as appropriate. Relevant steps include:

  • checking and being satisfied that each individual has adequate climate-related risk expertise and experience;
  • engaging with each individual to check they have adequately prioritised climate-related risks;
  • considering documenting commitments to identifying and assessing CRRO (for example, within sub-committee terms of reference and via strategic objectives and service agreements with external advisers); and
  • obtaining regular updates about how each individual is identifying and managing CRRO (again, trustees’ expectations should be clearly documented).

Adequate time for discussion of CRRO should be allocated as an agenda item at board meetings. Governance arrangements should be dynamic, responding to ongoing monitoring or emerging risks.

Skills audits and training will be an important first step, particularly for schemes within the first wave. This series of articles provides an overview of the main requirements; we are happy to provide further training as appropriate.

Further resources: