This article is an on-site version of our Moral Money newsletter. Sign up here to get the newsletter sent straight to your inbox.
Visit our Moral Money hub for all the latest ESG news, opinion and analysis from around the FT
Debates about responsible investing often come down to simple choices about timeframes. Is it better to max out returns each financial year or to protect value over decades by guarding against risks linked to the energy transition?
This question is facing asset managers and owners as they address their legal obligation to protect the financial interests of their clients.
Now, as regulators and public institutions like the European Central Bank warn that climate breakdown would rock the foundations of the entire financial system, a further question is coming to the fore.
Should pension funds, asset managers and banks also look to shore up the long-term stability of the systems they are part of, by pushing investee companies to transition away from fossil fuels?
It’s still very much an open question, according to my recent reporting, which reminded me how fluid the definition of fiduciary duty still is. — Kenza Bryan
Climate-related Legal risk
The tough question facing pension funds
It was not the most festive of Christmas cards. In letters seen by Moral Money, the non-profit environmental law organisation ClientEarth wrote to the trustees of the UK’s 12 largest pension funds last week with a stark warning: they could be in breach of their legal duties if they fail to take climate risk more seriously.
Pension funds in the UK have about £88bn ($111bn) invested in the fossil fuel industry — nearly a quarter of which is through bonds — according to the responsible investing campaign Make My Money Matter.
“The money flowing into the fossil fuel industry from the bond market is immense,” said Catriona Glascott, one of the lawyers behind ClientEarth’s campaign. But “at the moment there’s not much influence an asset owner can have over the life of the bond”.
The letter asks trustees to stop providing capital through bond purchases to energy companies unless these companies start following through on a credible transition plan.
Its main argument is that investors owe it to the pensioners who entrust them with their money to think harder about what effective climate engagement looks like. This is because climate risk is so tightly tied up with broader financial risk. Climate-related risks could include a class-action lawsuit against an energy company, or a slower-moving transition risk like an oil rig declining in value over the next decade.
ClientEarth points to an established requirement that pension funds consider financial risks over the entire duration of the investment. This, the non-profit group argues, means that trustees must consider the impact their investments could have on the planet. “Every incremental increase in global temperature makes climate impacts more severe, catastrophic tipping points more likely and . . . gives rise to increased financial risk,” its letters said.
The Universities Superannuation Scheme, which has more than £75bn under management and was a recipient of the letter, said it took its legal responsibilities seriously. “[We] will be providing some insight to ClientEarth into how we are seeking to mitigate the various financial risks that affect our portfolio, including climate change,” the USS said. But it added that it was “not convinced” Client Earth’s proposals on bonds were “in the best financial interests” of its scheme.
Client Earth also wrote to the trustees of the Electricity Supply Pension Scheme, which has assets of about £34bn and did not respond to requests for comment about the letter.
The effectiveness of ClientEarth’s campaign may come down to how widely its maximalist interpretation of fiduciary duty is shared.
For the moment, pension fund trustees in the UK are still not sure if they can prioritise the positive climate impacts of an investment at the expense of creating returns for beneficiaries, according to Laura Brown, head of client and sustainability solutions at Legal & General Investment Management, a major UK asset manager. “There is an interest in clarifying that . . . our clients need to know how they can exercise their fiduciary duty.”
Trustees of large pension funds in the UK are already required to set a climate-related investment target, and must also consider the potential impact of climate change on a scheme’s assets and liabilities.
“If you have a really chaotic transition, there’s a risk of wider failings within the financial system and economies generally, and therefore that will have a negative impact on all of us — including the savings of individuals in their pensions schemes,” said Faye Jarvis, pensions partner at the law firm Macfarlanes.
But suggesting trustees “have a duty to minimise climate risk to the financial system as a whole is stretching the concept of fiduciary duty too far,” she added. “In my view, managing this type of risk should be the responsibility of governments, not trustees of pension schemes.”
Climate Capital
Where climate change meets business, markets and politics. Explore the FT’s coverage here.
Are you curious about the FT’s environmental sustainability commitments? Find out more about our science-based targets here
A key challenge is that there are limited options for asset owners who want to continue investing in big energy companies while managing their fiduciaries’ exposure to climate risk.
Existing structures, such as green bonds, raise typically smaller amounts for specific environmentally themed projects, while sustainability-linked bonds raise general purpose debt with a variable repayment rate based on climate targets. Neither option forces the issuer to meet its climate goals.
Unless investors choose not to buy a company’s bond in the first place, punishing an issuer for failing to meet a climate target usually means waiting until the bond matures and refusing to refinance it. So meaningful engagement could take decades.
One solution proposed by ClientEarth is for investors to demand all new fossil fuel bond deals include a so-called “put” clause: a guarantee by the company to repay the debt early and in full if it fails to meet its climate targets. (Kenza Bryan)
Smart read
Our colleague Lukanyo Mnyanda has a striking story on climate campaigners’ legal challenge against the Rosebank oilfield, a 300mn barrel project which has become a key battleground in the UK’s climate debate.
