It is two years since the Climate Change Governance and Reporting Regulations – more commonly known as the TCFD or Taskforce on Climate-related Financial Disclosures regulations – started to apply to the largest occupational pension schemes in the UK.

Many of the schemes in the first wave (schemes over £5bn and master trusts) are working on their second annual report, or have just published it, and many second wave schemes (schemes over £1bn) are working on their first report.

The DWP is due to review the regulations by the end of this year, so I’ve looked at how well the regulations are working in practice and share my thoughts on how they could be improved.

So how well are the climate regulations working?

It is certainly the case that climate change is now a much greater focus for £1bn+ schemes and master trusts. Trustees (and their advisers!) have been on a steep learning curve as they’ve got to grips with climate-related risks, scenario analysis and metrics. There are new governance arrangements in place, with clearer roles and responsibilities in relation to climate change, and risk registers have been updated to ensure explicit consideration of climate change.

However, there is a concern that – despite all the activity – trustees seem to have made relatively few changes to the way they are actually managing their schemes and so there may not have been much reduction in climate-related risks to members’ benefits. It is still early days and, hopefully, as new processes bed in, the balance of effort will naturally shift from governance and reporting to action.

When the new rules were introduced, the Department for Work and Pensions (DWP) announced that it would review the rules in the second half of 2023.  This is an opportunity to improve the rules’ effectiveness and encourage greater focus on action, rather than crossing our fingers and hoping it will happen naturally.

How might the climate requirements be improved?

When you first look into the climate requirements, the thing that immediately strikes you is how detailed they are. The statutory guidance that accompanies the regulations runs to 54 pages. The level of detail no doubt reflects DWP’s desire to help trustees understand what is expected from them in this unfamiliar area. It also reflects the large volume of reporting expectations which has led to reports that are 34 pages long on average, according to The Pensions Regulator’s review. The first thing on my wishlist for DWP’s review is therefore simplification of the statutory guidance, in particular removing some of the detail from the reporting expectations.

If you were to ask trustees which aspect of the requirements they find most burdensome, beyond the reporting itself, I expect many of them would say it’s the need to collect and review four climate-related metrics for all their assets, as far as they are able. The “as far as able” provision is helpful, but nonetheless it’s hard to escape the feeling that some of the time could be better spent. There is also a worry that some of the required metrics are not the most useful ones for trustees. Despite the addition of a portfolio alignment metric last year, most of the focus is still on greenhouse gas emissions data that is backwards-looking and a fairly poor proxy for climate risk exposure. As data availability improves, I hope the DWP will allow trustees to shift their attention to more decision-useful metrics.

With that in mind, I would like DWP to rethink its approach for metrics, so trustees can concentrate on the aspects that are most useful for managing the climate-related risks and opportunities to their scheme. As a first step, I suggest moving the requirements for specific metrics from the regulations to the statutory guidance, so they become recommendations instead of mandatory requirements and can be updated more easily as market practice evolves. A second step would be to recast the key aspects as principles and position the rest of the material (to the extent it is retained) as helpful information rather than recommendations (ie things trustees “could” rather than “should” do). I’d also like to see:

•  exclusion of gilts, LDI and buy-ins from the metrics requirements, since the prescribed metrics do not provide useful insights regarding climate risk exposure;
• permission for trustees to focus on the most material mandates and the relevant metrics for those mandates (for example, report a larger suite of metrics for the most material mandates and omit smaller mandates in run-off); and
•  as the metrics improve, encouragement to make greater use of forward-looking assessments, climate solutions metrics (noting the huge investments needed to achieve the energy transition) and physical risk metrics (bearing in mind the likelihood of failure to meet the 1.5°C target and that there are increased physical risks even if the 1.5°C target is achieved).

I tend to find that the risk management section of reports is surprisingly light, given its centrality to the purpose of the regime. That is perhaps symptomatic of the relatively limited actions that many schemes have undertaken to date. I would therefore like to see greater emphasis on trustees managing the risks and pursuing the opportunities that they have identified. It is perhaps notable that the main regulation in this area states that “trustees must establish and maintain processes for the purpose of enabling them to manage effectively climate-related risks which are relevant to the scheme”, which results in a focus on processes rather than actually managing risk well. Moreover, there is no equivalent wording relating to opportunities.

I would also like DWP to encourage greater consideration of funding and covenant aspects. Whilst these are covered in the statutory guidance, it is common for the bulk of TCFD activity to take place within investment committees, with relatively little consideration of actuarial and covenant advisers. In addition, The Pensions Regulator should embed climate considerations into its forthcoming funding code and covenant guidance for defined benefit schemes.

Will the TCFD rules be extended to smaller schemes?

That is a question that trustees of many sub-£1bn+ schemes want answered. DWP has said it will use the review “to determine whether to extend to smaller pension schemes from late 2024 or early 2025”. Given the onerous nature of the current rules, I expect most trustees are hoping that DWP will decide not.

Climate change poses severe risks to the stability of the financial system, not to mention society as a whole, so it would be understandable if DWP concludes that more schemes should be subject to explicit requirements to manage climate-related risks. If so, I encourage them to use a risk-based approach to define the schemes in scope, for example by limiting the extension to schemes open to accrual as well as retaining a minimum level of assets. I also strongly encourage them to explore ways in which the requirements can be simplified, particularly the reporting aspects.

What next?

For now, larger schemes must obviously continue to follow the TCFD rules as they stand. However, I urge them to remember the underlying purpose – to improve the management of climate-related risks and opportunities on behalf of their members – and focus on that. If you have any thoughts on my suggestions – or have suggestions of your own – please do share them with me, to inform our input to DWP’s review over the coming months.