The International Centre for Pension Management (ICPM) has put out a paper on climate change and on the difference it makes for investments.
The issue of climate change has, in recent years, gone from “being considered a niche issue to one of potentially major financial consequences for all investors,” one that has already impacted and will increasing impact “companies, investment portfolios, and capital markets.”
There are three particular issues that asset owners, including pension funds, must face: climate change is driving physical and policy changes; stakeholders increasingly expect that pension managers will address the issue; and the Task Force on Climate-related Financial Disclosures (TCFD) has raised expectations both on disclosures and on related behavioral changes over time.
The TCFD was created in 2015 at the initiative of Mark Carney, Governor of the Bank of England and chairman of the UK Financial Stability Board, and Michael Bloomberg, former mayor of New York City (2002 – 2012) and CEO of Bloomberg LP.
The ICPM report was written both by and for pension fund managers, and it is organized by the 10 potential actions that such managers can take to integrate climate change into their investment process. The actions are:
- Bring your board and the organization as a whole to climate competence;
- Establish appropriate governance structures and processes;
- Create a common understanding across the fund as to how and where this global change may affect asset values;
- Understand where you are—how the fund is currently managing risk and availing itself of opportunities;
- Set objectives and strategy;
- Communicate objectives and strategy both internally and externally;
- Integrate climate change into existing risk management processes;
- Start with small steps to gain experience and build knowledge;
- Define and measure progress;
- Monitor movements (for example, in regulations and technology) and ensure that the strategy moves along with them.
One of the case studies in the white paper involves the Ontario Teachers’ Pension Plan, which in 2016 created a climate change working group within its Investment Division. The result was “a set of climate change scenarios and signposts,” but “the process was equally about creating a shared understanding and common lexicon across the plan for assessing climate change risk,” the ICPM says.
Carbon creates supply chain risk as well as physical climate change risk. Assets that require the emission of carbons into the atmosphere for their value risk measurement and management throughout the investment lifecycle.
Define and Measure Progress
For the remainder of this precis we will focus on the final two steps.
A fund might want to create key performance indicators (KPIs) to quantify its climate change progress. Examples of KPIs that focus on the achievement of desired investment outcomes include: the proportion of deals that consider climate-related impacts; the number or outcome of discussions under the heading of “climate change engagement;” changes in carbon reduction or carbon-friendly investments.
Climate risk needs to be addressed in quantitative terms not only at the investment level but at the portfolio level to understand exposure and influence new deals.
Ensure Strategy Keeps Up With Developments
As to the tenth item on the above list, the authors acknowledge that staying on top of developments is a “multi-faceted challenge,” but they suggest an analytical framework, STEEP. This means: Societal, Technological, Economic, Environmental, and Political.
Results of STEEP monitoring should be “part of the board and C-Suite agenda at least once a year.”
In this connection, the authors of the paper also offer an appendix, called Resources/References. The people responsible for the STEEP monitoring should draw upon the work of the many existing climate investment groups, including: Asia Investment Group on Climate Change; the Investors Group on Climate Change (Australia/New Zealand); Institutional Investors Group on Climate Change (Europe); Ceres Investor Network on Climate Risk and Sustainability; and the Global Investor Coalition.
These groups serve “as coordinating bodies for stewardship, policy engagement and information sharing.” The appendix also references the Portfolio Decarbonization Coalition, which “is a small group of investors who are seen as climate leaders, with the objective of finding solutions to decarbonizing the economy.”
The report notes, too, that Mercer Investment Consulting “has undertaken a range of work on the implications of climate change for pension funds.”