TCFD governance and reporting - what do trustees need to know?

Trustees of UK pension schemes have a legal duty to have knowledge and understanding of pensions law and the principles of investments and funding. The scope of this requirement in relation to sustainability has for many years been expressed in fairly general terms, but that is changing from 1 October 2021 as new requirements are progressively rolled out across the UK pensions industry.

The new duties include more detailed trustee knowledge and understanding (TKU) requirements specifically in relation to climate change, plus new governance and risk management processes and reporting requirements.

Here we look at what trustees of in-scope schemes will need to know.

A new and more specific TKU requirement on climate change

The new climate change governance and reporting regulations for UK pension schemes are part of a wider roadmap to implement the recommendations of the Taskforce on Climate-related Financial Disclosures across all parts of the UK economy. Under these regulations, trustees (or, where the scheme has a corporate trustee, the individuals exercising trustee functions) must have knowledge and understanding of:

• the identification, assessment and management of risks to occupational pension schemes arising from the effects of climate change, including risks arising from steps taken because of climate change (whether by governments or otherwise); and
• the identification, assessment and management of opportunities relating to climate change for occupational pension schemes, including opportunities arising from steps taken because of climate change (whether by governments or otherwise),

to the extent that these matters are relevant to meeting the reporting and governance requirements.

The level of knowledge and understanding of these matters must be appropriate to enable the trustee, or in the case of a corporate trustee the person exercising its functions, to properly exercise trustee functions.

What does that mean in practice?

Based on government commentary, the following principles apply:

• Equal weight is given to the understanding of both risks and opportunities in relation to climate change, and trustees should understand the materiality of climate change risks and opportunities in the context of both investment and funding.
• The knowledge levels required to properly exercise trustee functions will vary with scheme complexity and are expected to improve year-on-year with experience and the development of more resources.
• Proportionality remains important – climate change is one type of financial risk that trustees must manage, but without losing sight of others.
• Trustees are not expected to master technical detail or carry out climate risk assessments themselves – in most cases they will identify and commission experts to do this; but they need to be able to commission the assessments, understand the outputs of scenario analysis and other governance activities, and act on them. Trustees do not need to be able to interpret raw data: they can ask for results to be reported to them in a way that is understandable.
• Trustees are not required to look for skills gaps amongst those undertaking, advising on or assisting in the relevant governance activities (but trustees who would find it helpful to undertake a skills audit can choose to do so).

Guidance on meeting the requirements

Additional support for trustees can be found in non-statutory guidance (rather confusingly, this sits within the statutory guidance on the new regulations). This is ‘best practice’ guidance, so there is no requirement to provide an explanation in a scheme’s TCFD report if trustees choose to diverge from the guidance on this aspect. However, that’s not the whole story – see ‘Is TKU checked or verified?’ below.

What should trustees understand? The guidance suggests the following broad themes:

• how scenario analysis works;
• why climate change poses a material financial risk; and
• the relevance of climate change to overall risk management.

This understanding is vital since trustees cannot delegate their responsibility for identifying, assessing and managing climate-related risks and opportunities, although they will generally rely on experts to carry out the activities. Trustees must be able to take action in light of the results they receive, and must be able to challenge assumptions, external advice and information.

Trustees should also keep their knowledge and understanding of climate-related risks and opportunities up-to-date – in a rapidly-evolving field, this will be an ongoing exercise.

Is TKU checked or verified?

For schemes that are required to provide a Chair’s Statement setting out how TKU requirements have been met during the scheme year, climate change-related TKU will form part of that explanation. There is no separate or additional requirement for trustees to verify their TKU on climate change.

However, the guidance states that if the disclosures made in the TCFD report suggest that trustees have insufficient knowledge and understanding, the Pensions Regulator might consider whether action is needed – for example via an improvement notice.

Getting started

The Pensions Climate Risk Industry Group has published guidance on ‘Aligning your Pension Scheme with the TCFD Recommendations’ (this is due to be updated). Part 1 (Introduction) sets out an overview on understanding climate change as a financial risk to pension schemes, and the legal requirements for trustees to consider climate-related risks and opportunities. This is a useful (and reasonably concise) starting point; it also includes links for further reading.

The guidance underlines that the impact of climate change will not be the same for every pension scheme; trustees need to understand how types and levels of risk apply to different sectors and industries, and the impact these risks would have on their scheme over time, depending on the profile of a scheme’s specific investment portfolio. We suggest that trustees undertake introductory reading based on the guidance and arrange training with their investment advisers to consider the specific issues for their scheme(s) in greater detail.

Climate change issues also form part of the forthcoming requirement for specified schemes to have in place an effective system of governance, and the Pensions Regulator’s draft single code of practice suggests that in relation to this, governing bodies should:

• talk to their advisers and asset managers about how short and long-term climate change risks and opportunities are built into their recommendations; and
• understand what measures are being taken to reflect climate change risk within their investment portfolios.

Of course, trustees will also need to understand the details of the new legal duties on governance and reporting in relation to climate change, and how these apply in the context of their scheme. This series of articles provides an overview; we are happy to provide further training as appropriate.