The Financial Markets and Law Committee (FMLC) has issued new guidance for pension funds on their fiduciary duties, following sustained calls and legislative interventions from peers calling for more clarity.
These duties exist to ensure that those who manage other people’s money consider the long-term risks to, and consequences of investment decisions. They are largely set by historic case law and cause frequent confusion about the way in which system-level risks such as the climate and nature crises should be taken into account.
During the passage of the Financial Services and Markets Act last year, cross-party peers called for new measures to clarify fiduciary duties in the context of climate risks and the transition to net zero.
In response Government committed in its 2023 Green Finance Strategy to run roundtables with stakeholders to identify whether further clarification was needed. In the meantime, the FMLC’s guidance, published on the 6th February, has made an important contribution, clarifying a number of points for pension fund decision-makers, including:
Climate risk is always material – Whereas some wider economic or systemic climate change-related issues may have been characterised as "too remote and insubstantial" in the past, pension fund trustees will need to reappraise this in a context where, for example, physical, transition and litigation risks are now apparent and material.
Pension fund risks and returns are bound up in the health of the wider economy, which is itself dependent on the environment - Financial factors therefore need to be considered at a number of levels: at the level of a specific asset or investment, at a portfolio level, and at the level of whole economies material to the pension fund.
You can’t ignore it, even when you can’t measure it – Given the potential significance to financial risk and return, it would be very difficult to accept that pension fund trustees, advisers or investment managers might responsibly take the position that uncertainty about the subject of climate change and its causes and consequences meant that it could be left out of account.
Pension funds need to go beyond statutory minimums – Can pension fund trustees leave the relevance of the subject of climate change to what is required by current legislation and regulation? The answer is straightforwardly “no”, because that approach would not address all the risk.
Diversification is not enough – With climate-change related risks that are systemic, it is unlikely that diversification alone of a portfolio will be enough to avoid all the risks in the same way that non-systemic risks might be diversified away from. This implies that pension funds have a legal duty to carry out stewardship with the companies in whom they invest and with policymakers, where this help to further manage risk.
Pension schemes can better manage climate risk by investing in firms who themselves take climate risk seriously – “The risks and uncertainty for pension fund trustees may be less if an investment strategy looks for investees who approach, or would as a result of investment approach, sustainability and the subject of climate change in a manner that supported the approach of the pension fund.”
Peers will be asking Ministers how they plan to respond to the FMLC’s conclusions, not only through the convening of promised roundtables, but also through incorporation into regulator guidance or statutory guidance issued by the Secretary of State.
