Trustees must take an ‘always on’ approach to TCFD reporting

Climate change isn’t ‘new news’, but the physical effects of rising global emissions are increasingly being felt in everyday life. In the last year, global supply chains were disrupted by severe drought in the Panama Canal, European wheat crops were impacted by high temperatures and low rainfall, and this week Dubai has been partly submerged in a year’s worth of rainfall within 24 hours. It is hard to imagine many companies across the globe will remain unscathed by climate change over the next few decades. Increasing physical risks are now a certainty and this will increasingly drive government responses, despite these being pushed back in some jurisdictions recently. Indeed, climate change is regularly reported to be high on the list of CEO worries.

It seems only logical therefore that regulators across the globe are requiring and guiding companies to report on climate risk; investors, and other stakeholders, need to understand how climate risks are being assessed and mitigated. Why then should pension schemes be any different?

For two decades, the trustees of UK DB schemes have diligently assessed the risks facing the employer covenant to understand funding resilience and prepare themselves for events that may throw the journey plan off course; a decline in company performance and cash flows for example, or a company takeover. Climate change is one more risk to consider and whilst it’s not a new risk, it can be complicated to assess and is often considered to be a ‘longer term’ problem, which we believe has led to it being historically overlooked and underestimated.

The Taskforce for Climate-Related Financial Disclosures (TCFD) framework provides trustees with a platform to guide their analysis and strategic thinking on climate change whilst assuring members (and sponsoring employers) that these risks are being adequately accounted for. Whilst the majority of TCFD reports include assessment of covenant risk, the Pensions Regulator’s (TPR) latest review places more emphasis on the need to assess covenant, highlighting the inclusion of covenant as ‘good practice’ and omission as an ‘issue’. The review goes so far as to remind trustees that “the Department for Work & Pensions’ statutory guidance includes a mandatory requirement for trustees of DB schemes to consider the impact of climate-related risks and opportunities on the sponsoring employer’s covenant.”

So how can trustees develop their covenant analysis? We know that increasing physical risks and responses are a certainty, for example through increased frequency and severity of extreme weather events. Qualitative scenario analysis that focuses on time horizons relevant to the journey plan, as suggested by TPR in its review, can be more useful to trustees in assessing these risks compared to quantitative analysis extending out to 2050 or 2100. Trustees can assess the sponsoring employer’s operational preparedness based on plausible future events, much as they would contingency plan for a corporate event such as a takeover. This could be a year-by-year walkthrough considering the potential impact of physical events such as storm surges impacting ports and disrupting key supply routes, or key manufacturing facilities being damaged by wildfires. Understanding how events could impact the sponsor and funding availability for the scheme will only improve trustees’ preparedness and resilience.

TPR’s review also comments on the need to develop reports, whilst ensuring they remain proportionate to the scheme’s funding position and journey plan timeline. Analysis of physical risks is unlikely to change substantially year-on-year, other than where sources have updated their methodologies or underlying data. Transition risks, however, are anything but static with continuous changes in climate policy across the globe which can have significant impacts on corporates. In the last year alone we’ve seen updates on the EU and UK Carbon Border Adjustment Mechanisms (CBAM), delays in bans of new vehicles with internal combustion engines in the UK, announcement of a global maritime emissions trading system and legally binding pledges to meet net zero in some cities that surpass national targets. Such changes can affect companies across their value chains; impacting supply chains, operational costs, investment and capital allocation decisions, and influencing customer behaviour. Trustees cannot therefore assume that because the analysis has been done once, that it shouldn’t be revisited.

Undertaking a more detailed review of physical and transition risks in year 1 of reporting to provide a baseline for risk assessment going forward is key. As new information comes to light, a detailed first piece of analysis can be updated in a proportionate matter to reflect changes and evidence the trustees’ continued commitment to monitoring and managing climate risk. Without a baseline to work from it is difficult to assess the impact of changes (to the regulatory environment, company ambitions or new scientific views), and whether the trustee needs to respond through amendments to the journey plan or other protective measures.

TCFD reporting isn’t in itself the answer to addressing climate risk – it should simply serve as the evidence that trustees have taken the appropriate steps to address a risk that is becoming increasingly important over time. We hope that TPR’s latest review will encourage and support trustees to continue developing this area of risk management, and perhaps next year the review won’t have any omissions of covenant analysis to comment on.