The Pensions Regulator: ‘Funds need to move away from short-term focus on costs’

As Britain's pension scheme community gathered for the annual investment conference of the Pensions and Lifetime Savings Association (PLSA), which took place in Edinburgh last week, Net Zero Investor caught up with industry veteran Mark Hill, who knows most pension funds across the UK inside out.

After all, Hill is the climate and sustainability lead at The Pensions Regulator, the non-departmental public body in the UK which was set up in 2005 to regulate work-based pension schemes in Britain.

Improving the way pension schemes are run is one of your major tasks. What would you say is UK pensions biggest challenge currently?

We are focused on protecting savers’ money, enhancing the pension system to make it more competitive and deliver better value, and innovating to provide better outcomes for savers. This includes protecting savers’ pensions from the risks associated with climate change and taking advantage of opportunities associated with a transition to a net-zero economy.

We recognise that climate change is a significant risk and potentially major systemic risk but it’s not the only risk schemes are facing.  Our newly appointed CEO – Nausicaa Delfas – spelled out TPR’s vision for industry to work together to enhance the pensions system, support innovation in the interests of savers and protect their money. Value for money will be a key theme for TPR and we believe that industry needs to move away from a short-term focus on cost to deliver real, long-term, holistic value for savers.

A proposed joint framework, currently being developed by the Department for Work and Pensions, Financial Conduct Authority and TPR, should increase transparency and competition in the market and drive-up standards across the board. Our upcoming general code, which will be an opportunity for trustees to make sure that their scheme is fit for the 21 Century.

Tell us a bit more about this new code.

Sure, the code will bring together and update 10 existing codes of practice into one set of clear, consistent expectations on scheme governance and administration. While the new code will look different – with expectations set out in short, focused modules – many of the standards set out are not. However, we have taken the opportunity to include modules on stewardship and climate change. The new format will make it easier for governing bodies to find TPR’s expectations and ask themselves whether, and how, they are meeting those expectations.

You previously said 'always dare to ask silly questions about investment strategies'. Can you elaborate on that a bit, and give us an example?

Climate change is a systemic risk. It poses financially material risks to sponsors of DB schemes, to the value of funds and their investments, as well as a risk to economic stability and the long-term survival of the planet. However, it’s a relatively new area for trustees. We want trustees, even where they feel their advisers and asset managers are doing a satisfactory job, to challenge them to improve their processes where appropriate.

Ultimately, if a scheme’s advisers do not sufficiently consider the risk and opportunities from climate change trustees can vote with their feet by re-tendering with mandated climate-related criteria or by appointing specialists. Asking questions and applying pressure on investment managers to pay more attention to climate change in the building of portfolios and investment selection should drive those looking to attract investment to accelerate their plans to make their business more sustainable.

Climate may be a relatively new area for pension schemes but, ultimately, how do you see the role of pension schemes in influencing or steering the net zero agenda?

Our review of a selection of pension schemes’ annual climate report showed that of the 71 reports analysed, 43 had set a formal net zero target. This represents around £450 billion of assets under management and more than 18 million savers. Of those schemes with a formal net zero target, five aim to reach this by 2040 or earlier, one by 2045 and the remainder by 2050. We welcome the popularity of these targets and believe they can be an appropriate step for trustees by helping to position their investment portfolio to be robust to potential economy-wide changes from a climate transition.

It also signals support of the goals of the Paris Agreement, which, if met, would reduce longer-term systemic risks to scheme investments from the physical effects of climate change. As these targets are new, most trustees are yet to work out the full details of they will be achieved. As trustees gain a better understanding of how to approach the transition to net zero, we would expect to see more detailed transition plans being developed.

At the same time, we are clear there is no requirement for trustees to set a net zero target. Targets are primarily used by trustees to track their efforts to manage climate change risk exposure and take advantage of climate change opportunities.

Another hot topic at last week's PLSA conference was active stewardship. How can pensions find the right balance – prioritising, where they’ll make the most impact?

If trustees fail to consider risks and opportunities from climate change, or exercise effective stewardship, they face the risk investment performance will suffer, which could negatively impact savers. Trustees should allocate appropriate time and resources to assessing the financial risks and opportunities associated with climate change relative to the size and exposure of their scheme. Our research shows that, for defined contribution (DC) schemes, 98% of members were in a scheme that had assessed financial risk and opportunities associated with climate change.

However, the same research shows trustees of smaller schemes were less likely than larger ones to have allocated time and resources to climate change, talked to advisers and asset managers about how climate-related risks and opportunities are built into their engagement and voting policies and joined collaborative engagement efforts on climate change.

And you recently reviewed a number of schemes?

Yes, our review of a selection pension scheme annual climate reports, (also known as TCFD reports) found good examples of trustees using stewardship to manage climate-related risks. These reports often set out trustees’ approach to stewardship as a risk management tool, with some specific examples of engagements with companies that took place on behalf of the trustees during the year. Trustees looking to improve their stewardship could therefore benefit from reviewing the climate reports published by other schemes.

We will continue to work alongside government and other financial regulators in our work on climate-related risks and opportunities, and stewardship practice. This includes supporting the Department for Work and Pensions’ review of mandatory climate related disclosures and review of requirements on disclosures on stewardship activities, which is expected this year

Some trustees already have a legal duty to report on stewardship and engagement activities through an implementation statement. We are set to review a selection of these statements in the summer and the outcome of this review will be shared with industry to highlight good practice.

How do you regulate and limit investment risks within UK pensions in order to protect people's savings and pensions?

We do oversee trustee’s governance arrangements, including how investment risks are identified and managed and reported on through relevant disclosures, such as statement of investment principles (SIPs), implementation statements and annual climate (or TCFD) reports. Authorised schemes and those with relevant assets of £1 billion or more must publish an annual climate change report.

We have previously said we would be unlikely to issue penalty notices to trustees of schemes that are required to publish their climate related reports in the first tranche, except where the report has not been published on a publicly available website, accessible free of charge, within seven months of the relevant scheme year end a mandatory penalty or it is clear the trustees have not made a genuine effort to comply with the regulations, a discretionary penalty.

In future, we will consider issuing penalty notices where reports fail to meet regulations. In February, we announced a new campaign to make sure trustees are meeting their environmental social governance (ESG) and climate change reporting duties.

As part of the campaign, TPR will launch a regulatory initiative in the spring to check whether trustees are publishing important data on ESG. Emails are being sent to DB, DC and hybrid schemes making clear that TPR is analysing scheme return data to monitor compliance. A review of a cross-section of SIPs and implementation statements will follow in the summer.

We also warned trustees of schemes in scope that enforcement action may be taken against them if they fail to publish their SIP or implementation statement. TPR has the power to impose a fine up to £50,000, where the trustee is a corporate body. We have also published guidance for trustees to help them understand and meet their reporting duties.

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