LGPS: Setting a course to net zero

26 October 2021

The pressure to demonstrate a commitment to net zero builds every day as regulators, politicians and campaigners respond to the climate emergency.

Pension funds are no exception. The government already requires large corporate funds to act on the principles of the Task Force on Climate-Related Financial Disclosures (TCFD) and Local Government Pension Schemes (LGPS) are likely to face similar requirements in the near future.

Mercer held a webinar in September to discuss the road to net zero for LGPS funds. The event was well attended by representatives from about 40 funds, with combined assets of £168bn, and four of the eight pools. The overall picture was of funds working hard to get to grips with rapid change.

We asked attendees three questions to gauge how ready funds are and how they view the path to net zero. The results produced a couple of surprises and the discussion was illuminating.

We would have expected most respondents to say they were reviewing their data but 45% said they had adopted a target and were starting to implement it and another 18% had adopted a target but without starting to implement.

It’s worth bearing in mind that by attending the webinar the participants may have been weighted towards those taking action. But this is still a surprisingly positive reading that underlines the rapid changes taking place.

On the face of it the 10% who are not yet considering a path to net zero looks disappointing, but we expect that number to fall quickly. For example, we are increasingly seeing some councillors elected on a climate change mandate and rising pressure from activist groups. We are helping a number of councils respond to these challenges with the first steps towards a net zero target.

Remember also that getting to grips with climate change is complex and consumes time and resources. Progress can be delayed by infrequent meetings and the changeover of pension committee members after elections.

Which option best describes where your fund or pool is on the course to net zero?

LGPS

Jennifer Devine, Wiltshire’s head of pension fund investments, stressed the value of member and employer surveys and described the balancing act required to take account of those views. Work on net zero is continuing to expand, she said.

Schemes that correctly put their fiduciary duty first may have been hesitant about setting a net zero target but once trustees are presented with scenarios it becomes clear that this duty is aligned with reducing climate risk.

If you have been reluctant to start on the path to net zero now is the time to act. Regulatory, political and fiduciary pressures are coalescing to make this shift inevitable.

By when do you expect the fund you represent to target net zero?

LGPS

An overwhelming two-thirds of respondents expect to set their target at 2050, in accordance with the Paris Agreement. We believe this is realistic, in line with best practice and as expected.

What is surprising is that almost one-third of funds are aiming to achieve net zero at least a decade before 2050 – with 15% targeting 2030. This is an extremely challenging target for a universal asset owner invested across industries and balancing the changing risks and opportunities of net zero.

We suspect some of these funds may have set a target that corresponds with their council’s goal to make council operations net zero. However, in a few years’ time this may prove to have been over-optimistic and it is important that progress is tracked regularly. We would encourage funds targeting a date of 2040 or earlier to review best practice, monitor progress frequently, and reassess what is possible.

Paul Convery, who chairs Islington’s pensions subcommittee, provided valuable insight in the webinar. Islington has moved rapidly over the past five years to incorporate climate factors into its fund’s strategy and is seen as an early mover.

Paul said the fund considered matching the council’s target of achieving net zero for its operations by 2030. But they realised that achieving net zero while meeting their fiduciary duties was not feasible in that timeframe. This is particularly true because some holdings that currently have a significant carbon footprint could become part of the solution as they transition.

Islington therefore opted for 2050 while setting interim targets to keep it on track and accountable over that period. It’s better to set a measured target and overdeliver than to be overambitious and forced to backtrack.

Targets may well get tougher as progress is made towards 2050 and climate risk continues to climb the agenda. The two most likely scenarios are that scope 3 emissions are included or that the agreed target date is brought forward. While aiming for 2050, funds should monitor the market and be ready to shift to an earlier target.

These results are surprising and suggest there will be lots of opportunities for active asset managers as funds target net zero. We would have expected far more than 2% of respondents to opt for passive only but funds clearly think active management will be important for portfolios to stay on top of the risks and opportunities created by the transition.

This makes sense when considering the shifts taking place at companies with big carbon footprints and the opportunities springing up to invest in green revenues. Big oil companies do not look like green investments now but, under pressure from investors, the likes of Royal Dutch Shell and BP have made commitments to invest in new forms of energy and could become part of the solution.

Paul Convery said Shell and BP were in Islington’s top 10 investments because the fund has chosen to engage rather than wholly divest for the time being. Taking part in the investment opportunities created by the transition will also involve more than tracking an index. For example, see the recent $600m investment made by Generation Investment Management, co-founded by former US vice president Al Gore, in Octopus Energy.

How do you expect your fund to implement a transition plan in respect of the equity exposure?

LGPS

Almost 85% of respondents expect to implement their transition plan through a combination of passive and active management. The size of active managers’ role in that mix will depend on them embedding climate factors into the investment process as funds continue to flow into sustainable investments. For passive managers the transition won’t be easy and will require lots of innovation.

Constructing an index that is forward-looking is a demanding task and passive managers will have to open up their funds to more engagement and stewardship. The Transition Pathway Initiative, launched by the Church of England Pensions Board and the Environment Agency Pension Fund, already identifies forward-looking indicators. Expect more progress here and on stewardship after BlackRock’s introduction of additional voting options for its fund clients.

Time to take action

Our survey indicated that most LGPS funds are on the path to net zero. Those that aren’t are either taking the first steps or will be forced to do so by regulation and stakeholder pressure. Some may find they have set overambitious targets that will need to be reconsidered and revised.

Even for those funds that are furthest along the path, there is still much work to do. Aligning with the transition is a complex task that consumes resources, and the market is changing quickly as new opportunities open up.

Each fund needs to think hard about where it is on the journey to net zero and what will be required – in terms of information, resource and support – to get there. Demands, for example on stewardship and engagement, are likely to increase. How much support will you need from the pool, the council and advisers?

Our survey also has implications for asset managers. On a conservative estimate, tens of billions of pounds of LGPS funds are waiting to be aligned with the transition. Allocating that money will be a complex matter. Managers who innovate and embed climate-related factors to help funds achieve their goals will be the winners.

In a fast-changing world, don’t wait to be told by regulators. Funds should set realistic targets while seeking to get ahead of regulation. The forces driving the shift to net zero require constant appraisal of strategies and portfolios. The time to act is now.

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LGPS: Setting a course to net zero

The pressure to demonstrate a commitment to net zero builds every day as regulators, politicians and campaigners respond to the climate emergency.

Pension funds are no exception. The government already requires large corporate funds to act on the principles of the Task Force on Climate-Related Financial Disclosures (TCFD) and Local Government Pension Schemes (LGPS) are likely to face similar requirements in the near future.

Mercer held a webinar in September to discuss the road to net zero for LGPS funds. The event was well attended by representatives from about 40 funds, with combined assets of £168bn, and four of the eight pools. The overall picture was of funds working hard to get to grips with rapid change.

We asked attendees three questions to gauge how ready funds are and how they view the path to net zero. The results produced a couple of surprises and the discussion was illuminating.

We would have expected most respondents to say they were reviewing their data but 45% said they had adopted a target and were starting to implement it and another 18% had adopted a target but without starting to implement.

It’s worth bearing in mind that by attending the webinar the participants may have been weighted towards those taking action. But this is still a surprisingly positive reading that underlines the rapid changes taking place.

Remember also that getting to grips with climate change is complex and consumes time and resources. Progress can be delayed by infrequent meetings and the changeover of pension committee members after elections.

Which option best describes where your fund or pool is on the course to net zero?

Jennifer Devine, Wiltshire’s head of pension fund investments, stressed the value of member and employer surveys and described the balancing act required to take account of those views. Work on net zero is continuing to expand, she said.

Schemes that correctly put their fiduciary duty first may have been hesitant about setting a net zero target but once trustees are presented with scenarios it becomes clear that this duty is aligned with reducing climate risk.

If you have been reluctant to start on the path to net zero now is the time to act. Regulatory, political and fiduciary pressures are coalescing to make this shift inevitable.

By when do you expect the fund you represent to target net zero?

An overwhelming two-thirds of respondents expect to set their target at 2050, in accordance with the Paris Agreement. We believe this is realistic, in line with best practice and as expected.

Paul Convery, who chairs Islington’s pensions subcommittee, provided valuable insight in the webinar. Islington has moved rapidly over the past five years to incorporate climate factors into its fund’s strategy and is seen as an early mover.

Islington therefore opted for 2050 while setting interim targets to keep it on track and accountable over that period. It’s better to set a measured target and overdeliver than to be overambitious and forced to backtrack.

How do you expect your fund to implement a transition plan in respect of the equity exposure?

Time to take action

Our survey indicated that most LGPS funds are on the path to net zero. Those that aren’t are either taking the first steps or will be forced to do so by regulation and stakeholder pressure. Some may find they have set overambitious targets that will need to be reconsidered and revised.

Even for those funds that are furthest along the path, there is still much work to do. Aligning with the transition is a complex task that consumes resources, and the market is changing quickly as new opportunities open up.

In a fast-changing world, don’t wait to be told by regulators. Funds should set realistic targets while seeking to get ahead of regulation. The forces driving the shift to net zero require constant appraisal of strategies and portfolios. The time to act is now.

Speak with a Mercer LGPS expert

Related

LGPS: Setting a course to net zero

TCFD and the LGPS: don’t panic but don’t delay

TCFD and the LGPS: are you ready?

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