Pension funds need net-zero ‘paradigm shift’

Pension fund net-zero transition plans are dramatically underestimating the risks and opportunities presented by climate change, experts say.

A new report from the Economics of Energy Innovation and System Transition (EEIST) project, led by the University of Exeter, argues for fundamental change in the way the investment industry thinks about climate change.

The report calls on pension funds and other asset owners to adopt “decision-useful climate scenarios” – using plausible real-world narratives to develop and implement bespoke transition plans.

This would protect assets and support the net-zero transition – so pension funds would be investing in a world their beneficiaries would want to live in.

“Our paper sets out how pension funds can fundamentally reassess their strategic risk indicators,” said co-author Jack Oliver, from the University of Exeter.

“Pension funds must rise to this challenge, even if it means changing the way investment decision-making is framed.

“Using EEIST’s ‘risks and opportunities’ approach, we recommend pension funds examine their plans to assess how far they reflect plausible future events, given the radical uncertainty financial markets face from climate change – much of which simply cannot be modelled.

“By doing this, they will thrive on the way to a net-zero world.”

Oliver said current models assume that existing trends will continue gradually – but “tipping points” in the climate, green economy and elsewhere could cause rapid transitions even within the current decade.

For example, historically valuable shares in fossil fuel companies could quickly lose value, and climate tipping points such as the dieback of the Amazon rainforest could dramatically alter human economies and societies.

Mike Clark, Fellow of the Institute and Faculty of Actuaries (IFoA) and Founder Director, Ario Advisory, said: “Leading pension funds and other asset owners are moving well beyond the constraints of standard finance theory.

“Further, they are starting to recognise the weaknesses of the official climate scenarios which fail to meet their pressing needs.”

He added: “Many funds are now seeking to align their assets to a halving of greenhouse gas emissions before the decade is out. Official scenarios offer next to no guidance on how to achieve that.”

Inspired by EEIST’s Ten Principles for Policy Making in the Energy Transition, the report proposes ten transition planning principles for pension funds.

These principles provide a framework for transformational net-zero decision-making and embedding the associated internal change in the strategic governance of risk and opportunity.

The report is entitled: “Net-zero transition planning for pension funds and other asset owners: Applying EEIST’s risk and opportunity analysis.”

Case study

The Universities Superannuation Scheme (USS) and the University of Exeter have entered a collaborative project on the development of ‘decision-useful climate scenarios’. The goal is to develop improved ‘climate scenario analysis’ that is more useful to investors. The work will support USS’s efforts to incorporate climate and transition considerations in their investment strategy and risk management processes.

In its latest Task Force on Climate-related Financial Disclosures (TCFD) report, USS states: “We believe that through collaboration we can develop an approach to climate scenario analysis that integrates a deep understanding of climate science with its interaction with macroeconomic and financial markets outcomes over different time horizons. This is particularly important because the climate challenge and policy response are likely to represent one of the key drivers of the macro and investment environment over the next 20-30 years.”