6 June 2019
Following their recent declaration of a climate emergency, MPs last month gathered to debate Pension Funds: Financial and Ethical Investments. Many of the speakers supported the idea that pension funds should divest from (ie sell) their fossil fuel assets. It seems unlikely that the Government could compel trustees to act in this way – as it would run counter to fundamental principles of trust law and would undoubtedly face a backlash from the energy sector – but they may seek to encourage it.
I strongly agree that climate change poses significant financial risks for pension schemes and that trustees should take steps to understand and mitigate these risks. But is fossil fuel divestment an appropriate action for trustees?
Proponents of divestment often seem to miss the point that buying shares or debt of fossil fuel companies is not (except for new issues) giving the companies more money so they can expand their fossil fuel operations. It is simply changing the owner of existing securities.
Some people argue that divestment is still effective since it signals disapproval, starts to stigmatise the companies and potentially makes it harder for them to raise new finance in future. However, this argument seems to have a moral dimension that may be hard to square with trustees’ fiduciary duties to act in members’ best financial interests.
An important question is: who will buy the fossil fuel shares or debt if trustees sell them? Perhaps an investor who is indifferent to climate change risks or in denial of them.
I argue that it is far better for fossil fuel shares and debt to be owned by enlightened investors who use their ownership rights to encourage companies to anticipate and support the inevitable transition to a low carbon economy. That is expected to benefit long-term investment returns and so, in my view, sits comfortably with pension trustees’ fiduciary duties.
Shareholders have considerable influence. Numerous shareholder resolutions have called for fossil fuel companies to be more transparent about their business plans and set targets consistent with international climate commitments. Increasingly, these resolutions are succeeding. In addition, shareholders and bondholders can engage in dialogue with companies to encourage stronger action on climate change. In response to investor concerns, Shell recently announced new climate targets that would be linked to executive remuneration.
Engagement is sometimes criticised as a weak tool, perceived as little more than an occasional cosy chat. That may be a valid criticism sometimes, but there is the potential for engagement to be so much more. Investors can take a stronger stance and use forceful stewardship to demand meaningful action. Companies that are not preparing for the low carbon transition, or are even actively working against it, are risking a significant loss of value. Moreover, there is strong evidence that limiting temperature rises by cutting carbon emissions will be better for economic performance in the long-run, so they may be undermining the long-term health of the financial system. This is definitely something that trustees should be worried about.
Engagement can be more effective if it is accompanied by the threat of divestment. If investors are willing to sell their holdings if the company does not respond to engagement, that gives the investors greater leverage. For example, Legal & General is demonstrating this through its Climate Impact Pledge.
What should pension scheme trustees do?
Trustees often leave decisions about whether to hold fossil fuel assets to their investment managers, but they retain responsibility for the decisions made on their behalf. They should talk to their investment managers about climate risk and ask:
- What fossil fuel assets do they hold?
- How are they voting on climate resolutions?
- Are they engaging with companies on climate risk?
- What are they aiming to achieve through their engagement and are they being effective?
- Would they divest from companies that do not respond to engagement?
Trustees wanting to go further could consider the other course of action that MPs supported in their debate – allocating capital to green technologies that are supporting the low carbon transition.
To learn more about climate change and the implications for pension schemes, read our Guide to climate-related risks or speak to your usual LCP contact.