As part of the wide-ranging reforms introduced by the Pension Schemes Act 2021, the Act allows the government to make regulations that impose climate change governance and disclosure requirements on trustees of large trust-based pension schemes (whether defined benefit or defined contribution schemes). In January 2021, the draft Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021 (Regulations) (see here) and accompanying draft statutory guidance (see here) were published for consultation, and they outline the actions pension scheme trustees should take in respect of climate risk. The consultation closed on 10 March 2021 and the responses are currently being considered.

What are the new climate risk requirements?

Under the Regulations, pension scheme trustees will be subject to new requirements to ensure that they have in place effective governance in respect of the effects of climate change. Specifically, it is proposed that pension scheme trustees will be required to take the following steps:

  • Trustee knowledge and understanding: The Regulations introduce new requirements that build on the standard trustee knowledge concept by requiring trustees of occupational pension schemes to have knowledge and understanding of principles relating to the identification, assessment and management of risks relevant to occupational pension schemes from the effects of climate change.
  • Governance and strategy: Trustees will have to establish and maintain oversight of the climate related risks which are relevant to their scheme, as well identify climate related risks and opportunities which they think will have an effect on their scheme's investment. Defined benefit scheme trustees need to consider the impact of climate related risks on the employer covenant and funding strategy over the short, medium and long term.
  • Scenario analysis: Another aspect of the ongoing monitoring of climate related matters is that trustees will have to undertake a scenario analysis considering at least two scenarios where there is an increase in the global average temperature (Increase Scenarios). Trustees will also have to select two emission-based metrics and one additional climate-related metric, then set a target against one of these metrics. They then have to measure performance once a year. For defined benefit schemes, trustees must assess the impact of funding strategies to those Increase Scenarios.
  • Risk management: Trustees will have to ensure that management of climate related risks is integrated into their overall risk management of the scheme.
  • Disclosure: In addition to considering these matters internally, trustees will be required to publish an annual "TCFD report" (Taskforce on Climate-related Financial Disclosures) containing certain details relating to the trustees' climate-related risk governance, strategy and risk management process. The report must be published within seven months of the end of each scheme year, be signed by the trustee chairperson and published on a publicly accessible website.

Although it is anticipated that trustees will engage experts to assist with the new requirements under the Regulations, the draft guidance notes that trustees will be expected to have "sufficient knowledge and understanding to interpret the results of any analysis and the know-how to take action in light of these results, or indeed to challenge assumptions, external advice and information". Further, the Pensions Regulator has pledged its support to helping trustees adapt to the incoming changes, and it has recently published its climate change strategy in which it set out its intended regulatory approach to climate risk-related requirements (see here).

Going forward, trustees will be expected to keep in mind the possible climate risks and impact of their decisions. For larger schemes, it can take a great deal of time and work to put the structures in place to facilitate a new line of investment. The Regulations envisage that the environmental impact of an investment will be considered throughout the process of planning for the future.

When will the Regulations come into force?

The new obligations will be phased in, and will apply to pension schemes as follows:

  • From 1 October 2021: to schemes with more than £5 billion in assets, as well as authorised master trusts1 and collective money purchase schemes (regardless of their asset level)2.
  • From 1 October 2022: to schemes with more than £1 billion assets.

Currently no decision has been made about when these requirements will apply to schemes with assets under £1 billion. The Department for Work and Pensions will review this in 2023 with a view to possibly extending the requirements to smaller schemes from late 2024 or early 2025. The Government is encouraging out of scope schemes to comply on a voluntary basis for the time being.

Penalties for non-compliance with new requirements

Failure to comply with the Regulations will lead to financial penalties, up to £5,000 for individual trustees and up to £50,000 for corporate trustees. If the breach is in relation to a failure to publish a TCFD report, the Pensions Regulator may impose a penalty of at least £2,500.

The pensions minister, Guy Opperman, described the proposals as "world-leading" and noted that the UK is "set to become the first major economy to require climate risks to be specifically considered and then reported on by pension schemes".

It remains to be seen how the Regulations will impact the pensions sector, but the message emanating from government is clear: pension schemes will need to start grappling with climate change risk and governance now