Response to LGPS Governance and reporting of climate change risk consultation | November 2022

1. It would be helpful to see and comment on the detailed guidance mentioned in the text and the draft regulations necessary to bring these intentions into force.  Without sight of this content, it is difficult to comment in detail on a number of the questions beyond welcoming the general direction of travel.
2. The consultation looks to assume that the LGPS is by its own actions able to influence the industry to produce the breadth and detail of data required to meet the requirements contained in the consultation. The LGPS is indeed a sizable asset owner on the UK and the global stage, however its fragmented nature together with its relatively small commitment to alternative investments would place some doubt on its ability alone to bring about real change in this area of the market. A more realistic approach would be one where the government encourages the LGPS to integrate its efforts in this area into those of the wider UK pensions industry. 
3. We are concerned about the timing of this consultation. If LGPS funds are required to report measures in respect of 2023-24 as proposed, then regulations, which are not yet available in draft form, will have to be at least finalised if not in statute in good time for 1 April 2023. Without regulation, any requests for data would be both uncertain and non-statutory in nature. LGPS funds have significant existing demands on their resources and need regulatory certainty as well as time to implement new requirements.
4. We consider there is a significant danger of the regulations becoming obsolete without regular and timely action to maintain them.  The ‘link’ to the recommendations of the international Taskforce on Climate-related Financial Disclosures (TCFD) is welcome, however apart from a couple of exceptions where LGPS funds may choose to use TCFD recommendations in addition to the requirements set out in this consultation, these regulations will stand as requirements in their own right. This is a rapidly changing area of the investment industry, one which TCFD may have to swiftly adapt to follow. Without equally fleet footed adaptation (realistically difficult in the area of regulatory change) LGPS funds could be faced with having to meet regulatory requirements which are no longer either industry standard or considered fit for purpose.
5. There is cost associated with the increased governance requirement. The consultation appears to assume that LGPS pools will be able to provide much of the data required over time as more assets are pooled. We have seen from the experience of private sector Defined Benefit (DB) schemes that data collection, additional advice and scenario modelling can be a significantly costly exercise. For example, some of the work undertaken by some of the larger sector DB schemes on TCFD will have cost hundreds of thousands of pounds. 
6. Economies of scale may achieve cost reductions where a significant proportion of assets are invested via the pool, however the danger of both regulatory divergence and differences in the investment requirements of individual funds should not be underestimated. Without an increase in the level of standardisation of demands on pools both in terms of preferred investment structures and required outcomes, there will continue to be friction between the needs of individual funds and therefore the ability of and the costs to the pool to provide the necessary data. LGPS investment pools, whatever their format (either fund owned, or fund appointed) are asset managers and fall under a separate regulatory framework from LGPS funds. Should those frameworks diverge in the future, either deliberately or as a result of legislative delay the ability of and therefore the cost to pools in providing the data needed by funds would be significantly impacted. At the same time, we also recognise the issues with regulatory standardisation pushing funds to ‘herd’ around the same investment strategy can have significant implications for financial stability (e.g. the 2022 UK liability driven investment (LDI) crisis and resulting regulatory intervention from the Bank of England). The DLUHC should work closely with other government departments and the financial regulators to ensure an effective implementation of the government’s TCFD and net zero ambitions.
7. While we are generally strongly supportive of transparent disclosure in all areas of investment, including costs and risk, we are concerned that the availability of the data set out in this consultation could, without effective narrative context, result in LGPS funds being placed in badly constructed and inconsistent league tables by activist groups or other organisations that may be an unintended consequence of bringing in requirements on asset owners where companies and asset managers are yet to have climate disclosure requirements implemented that would provide the data the LGPS funds needs to make decisions today. We therefore welcome the proposal for the SAB to produce a scheme report in this space and would urge both it and the government to use such a report to provide the valuable context needed to ensure the data provided is both transparent and robust while protected, so far as is realistic, from misuse.
8. We see issues with the modelling currently used for climate scenario analysis. Scenario analysis is designed to aid decision-making in uncertain environments. Limitations of current official scenarios and methodologies are becoming increasingly apparent. We cover more detail in our answer to question 3. The scenario models are failing to capture key aspects of the real world, including acute physical risk, politics and policy, unemployment, finance, asset prices, volatility, tipping points, path dependency and complex feedback loops. These omissions lead to implausible and partial narratives, which limit user engagement and divert modelers’ attention for critical variables. In the process, they limit their practical usefulness for both policy making and business decisions. These omissions mean that the resulting scenarios inadvertently understate the potential range of outcomes. We urge DLUHC to work with other government departments, financial regulators, the finance and investment industry to develop scenarios that better capture critical features of the real world and assess the factors that will drive action against climate change. The Real World Climate Scenarios roundtable is an initiative working on this issue – it would be good for DLUHC to engage with this work.

The consultation proposes that LGPS funds will be expected to establish and maintain, on an ongoing basis, oversight of climate related risks and opportunities. They must also maintain a process or processes by which they can satisfy themselves that officers and advisors are assessing and managing climate-related risks and opportunities

BW Comment: As set out in the preamble we welcome this focus on climate related risks in the context of LGPS fund investment. Indeed, many LGPS funds are already well on the way to including robust governance structures to manage these risks. 

However, without sight of draft regulations or guidance in this area it is very difficult to comment further other than to state that we would recommend that the expectations referred to in the consultation should take into account the existing and future demands on LGPS funds by being sufficiently robust but also appropriately flexible in nature to ensure that those funds can effectively reflect their own investment approaches, objectives and targets. We would encourage government to seek out existing examples of appropriate best practice (including an awareness of the differing levels of resource available to LGPS funds across England and Wales) for inclusion in guidance and to ensure that any regulatory requirements are principle based rather than overly prescriptive in nature.

The consultation proposes that LGPS funds will be expected to identify climate-related risks and opportunities on an ongoing basis and assess their impact on their funding and investment strategies.

BW Comment: Many LGPS funds already identify climate risks and opportunities within their strategies, so regulation in this area should be principles based, alongside guidance making use of existing examples of best practice.
 

The consultation proposes that LGPS funds will be required to carry out two sets of scenario analysis. This must involve an assessment of their investment and funding strategies. One scenario must be Paris-aligned (meaning it assumes a 1.5-to-2-degree temperature rise above pre-industrial levels) and one scenario will be at the choice of the LGPS fund. 

Scenario analysis must be conducted at least once in each valuation period.

BW Comment: At this point in time, we share the Bank of England’s concerns over the reliability of current Paris alignment measurement.  We are aware there can be significant differences between the measured alignment of the same portfolio when different providers are compared.  Furthermore, it is worth noting that there are a number of variations of scenarios that assume a 1.5-to-2-degree temperature rise above pre-industrial levels. Take the Bank of England’s 2021 Climate Biennial Exploratory Scenario, as an example. Here, there are two scenarios that assume a 1.5-to-2-degree temperature rise above pre-industrial levels, the ‘early action’ scenario and the ‘late action’ scenario. However, given their underlying characteristics and assumptions, these two scenarios yield very different outputs for asset owners that use them to analyse impacts on their assets and liabilities. The former assumes a more gradual transition to net zero, resulting in limited transition risk, whilst the latter assumes a delayed transition, resulting in a higher degree of transition climate risk. However, we recognise the focus on the transition to a low carbon economy and the improvement in accessibility that these measures bring, compared to other climate related metrics.

Given these shared concerns we would like to see any move to require such scenarios to be set at a time in future when there is greater consistency in measurement and climate impacts are incorporated into climate financial scenarios so that the credibility of actions being undertaken by LGPS funds is not undermined.  This would also avoid the potential for the results to appear inconsistent simply due to a change of provider.

We believe this is also important when considering the use of pooled funds and is further compounded by the fact that few investment managers at present disclose the necessary statistics. For those using pooled funds for their investments there is a need for greater asset manager disclosure and clear, consistent methodology for accounting for pooled fund investments in a portfolio. 

Furthermore, placing such a requirement within regulations risks it becoming obsolete without continual review and time sensitive updating of those regulations. For example, a future COP may develop an alignment model which supersedes Paris as a result of the continually changing ability of the industry to provide accurate data or a shift in the scientific understanding of temperature change.

We see a risk of regulatory standardisation of scenarios and set requirements for specific scenarios creating a ‘herding’ behaviour – with funds all following very similar investment strategies. This can have significant implications for financial stability, so the DLUHC should work closely with other government departments and the financial regulators to ensure an effective implementation of the government’s TCFD and net zero ambitions.

Proposing that LGPS funds select a second scenario of their own in addition to the Paris Aligned scenario provides for greater flexibility to ensure the scenario is appropriate to individual fund strategies, portfolios, use of investment vehicles and availability of suitable data. This flexibility could lead to the danger of a multiplicity of LGPS scenarios which could be confusing for scheme members and other stakeholders, however this could be mitigated by the provision of effective and detailed guidance on the construction of such scenarios, clearly setting out the principles to be followed and including examples of best practice from within the sector and across the industry.

For example, for private sector pension schemes, the Department for Work and Pensions have set out a range of scenarios that Trustees of such schemes may wish to consider. These are:

1. A measured, orderly transition – which is associated with lower transition risks and less severe physical risks.
2. A sudden, disorderly transition – transition risks are also more likely to materialise, alongside increased physical risks.
3. A “hot house world” – climate goals are missed and physical risks are high with accompanying severe social and economic disruption.

Furthermore, the Department for Work and Pensions have also referenced scenario providers as well as a list of reference scenarios. As a result of this guidance, results across private sector schemes have become more comparable. 

In this respect our preference would be for both scenarios to be principle based and informed by clear, comprehensive and up to date guidance. This would in our view enable each LGPS fund to model outcomes which are best suited to its investment strategy and avoid the danger of regulatory obsolescence.
 

The consultation proposes that LGPS funds will be expected to establish and maintain a process to identify and manage climate-related risks and opportunities related to their assets. They will have to integrate this process into their overall risk management process.

BW Comment: Many LGPS funds already identify climate risks and opportunities within their risk management processes and so regulation in this area should be principles based with guidance making use of existing examples of appropriate best practice.
 

The consultation proposes that LGPS funds will be expected to report on metrics as defined in supporting guidance. The proposed metrics are set out below:

• Metric 1 will be an absolute emissions metric. Under this metric, LGPS funds must, as far as able, report Scope 1, 2 and 3 greenhouse gas (GHG) emissions.
• Metric 2 will be an emissions intensity metric. We propose that all LGPS funds should report the Carbon Footprint of their assets as far as they are able to. Selecting an alternative emissions intensity metric such as Weighted Average Carbon Intensity (WACI) will be permitted, but LGPS funds will be asked to explain their reasoning for doing so in their Climate Risk Report.
• Metric 3 will be the Data Quality metric. Under the Data Quality metric, LGPS funds will report the proportion the value of its assets for which its total reported emissions were Verified, Reported, Estimated or Unavailable.
• Metric 4 will be the Paris Alignment Metric. Under the Paris Alignment Metric, LGPS funds will report the percentage of the value of their assets for which there is a public net zero commitment by 2050 or sooner.

Metrics must be measured and disclosed annually.

However, the consultation does not intend to limit the range of additional and more ambitious metrics LGPS funds may select. The consultation encourages LGPS funds to calculate other metrics which are endorsed by the TCFD, such as Climate Value at Risk (VAR)

BW Comment: With regard to metrics 1 and 2 (absolute emissions and emission intensity) it is helpful that these carbon metrics are not the only metrics proposed. For schemes taking an engagement approach and looking to influence companies to change their practices it may be more helpful to look at measures other than carbon footprint that are better aligned to the reporting on the strategy of the scheme. We note there is a greater challenge with regard to Scope 3 (including the potential for double counting that means that Scope 3 emissions cannot be meaningfully aggregated at portfolio level) but we support the proposal to include Scope 1, 2 and 3 data in these metrics. We believe that a proportionate approach in the short term would be to focus LGPS funds’ efforts on the asset classes that can be adjusted to improve their climate metrics, for example by moving from a standard equity index to an ESG equity index. 

With regard to metric 3 (data quality) we can see why this metric is included from the reasoning given particularly in terms of managing expectations of both data accuracy while the industry develops its abilities in this area as well as the appropriateness of using the data to compare LGPS funds.  However, we are concerned it could crowd out other more useful metrics for a long-term investor, such as successful stewardship engagement outcomes, which would measure the stewardship successes where the investor is seeking to engage with companies to get these to reduce emissions over time. For example, if an LGPS fund strategy is to engage with its managers / investments in pursuance of some sort of net zero / reduction in carbon emissions basis then reporting on the success or otherwise of this approach is going to be far more helpful for stakeholders than data quality. 

With regards to metric 4 (Paris Alignment Metric), we believe that the use of a forward-looking metric is important. Specifically, many of the backwards looking metrics (such as emissions data) provide an indication of how an investment is positioned today, but does not provide an insight into the future progression of the investment, in terms of the transition to net zero. 

However, we also recognise there are concerns with alignment metrics, including: 

1. Data availability – which tends to be low for this metric, even in public markets.  
2. Data quality / credibility – although there are good frameworks available to assess the credibility of targets which should be encouraged. 
3. Lack of insight for companies that have not yet set targets – a simple metric (such as the Paris Alignment Metric) may help to encourage companies to put in place third-party verified targets sooner.  
4. Differing methodology – although we would not encourage a single methodology across data providers as unintended negative consequences may arise if one methodology is widely applied. 
5. Aggregability – this is specific to a portfolios implied temperature.

We see the suggested Paris Alignment Metric (i.e. the percentage of the value of their assets for which there is a public net zero commitment by 2050 or sooner) as the preferred alignment metric over the short term given that, unlike other alignment metrics (such as portfolio implied temperature), it can be aggregated to a portfolio level, it is easy to understand and it is more objective.

We welcome the encouragement to LGPS funds to include additional and more ambitious metrics as endorsed by TCFD. We recognise that a multiplicity of LGPS measures could be confusing for scheme members and other stakeholders, however we believe that as well as focusing on the climate risk metrics, LGPS funds should be encouraged to report on upside risk measures also, for example proportion of green, sustainable or social impact investment assets. Indeed, we would prefer to see this approach adopted for all measures i.e., for regulation to be principles based rather than being prescriptive and to require LGPS funds to produce a set of industry standard measures supported by clear and comprehensive guidance including examples of best practice from within the sector and across the industry.

This approach would enable LGPS funds to report on measures which are relevant to their targets in this space, appropriate to their investment objectives and resources and enable them to ensure that suitable context is provided for scheme members and other stakeholders to comprehend the purpose, intention and impact of the LGPS fund’s approach rather than provide a set of backward looking numbers which may appear comparative in nature but which in reality may not be.

There is a danger of prescriptive measures creating incentives for investment behaviors which are designed to make the numbers look good regardless of the underlying impact on climate change. For example, reducing exposure to carbon emissions purely to make metric 1 look better when staying invested in some of the currently carbon intensive sectors may be part of the long-term solution. Climate change is a global issue and LGPS funds invest globally, so there is a need to recognise investments in emerging and developing markets may have greater difficulties in obtaining data. These investments can also potentially have higher carbon footprints than investments in developed nations that are already transitioning away from fossil fuels. Regulations should not disincentivize the essential financing needed to transition all of the world’s economies away from fossil fuels

A principles-based approach would also help to avoid the sort of regulatory obsolescence mentioned earlier in this response. Hard coding measures in regulations sets a clear expectation both for LGPS funds and scheme stakeholders however, unless there is both a commitment and ability to maintain regulatory requirements within the fast-moving area of climate measures there is a very real danger of outdated numbers having to be produced while the rest of the industry has moved on.

Should the prescriptive measures approach proposed by the consultation be reflected in regulations we would strongly suggest that either a statutory commitment to regularly review the measures and/or a sunset provision on those measures be included to ensure they remain relevant and up to date.
 

The consultation proposes that LGPS funds will be expected to set a target in relation to one metric, chosen by the LGPS fund. The target will not be binding. Progress against the target must be assessed once a year, and the target revised if appropriate. The chosen metric may be one of the four mandatory metrics listed above, or any other climate related metric recommended by the TCFD.

BW Comment: Requiring the setting of a target which is non-binding, revised as appropriate and making use of regulatory/industry standard measures provides a necessary focus for both the LGPS fund and its pool/managers. Regular assessment and reporting on progress against the target will provide reassurance to scheme stakeholders. For those reasons we would welcome this proposal.

Allowing each LGPS to choose its target is also welcome in that it will enable the fund to focus on a target appropriate to its own particular situation and objectives. 

We would however point out the dichotomy between the flexibility shown in this target setting proposal and the prescriptive nature of the measures, the dangers of which we have set out in our response to question 5. Should LGPS funds choose to base their targets on one of those prescriptive measures then the risks of the targets being similarly inappropriate to the fund’s objectives, creating perverse incentives or becoming obsolete are carried forward.
 

The consultation proposes that LGPS funds will be expected to publish an annual Climate Risk Report. This may be a standalone report, or a section in the LGPS fund’s annual report The deadline for publishing the Climate Risk Report will be 1 December, as for the
The first Climate Risk Report is proposed to be due in December 2024 and that scheme members must be informed that the Climate Risk Report is available in an appropriate way.

BW Comment: The timing of the requirement to report is a concern given that we have not yet had sight of draft regulations which would need to be finalised if not on the statute book prior to 1 April 2023. Without this confirmation of requirement, it will be difficult for LGPS funds to put in place the necessary manger/pool requirements for data and the resources needed to analyse and report on that data.

Aligning the Climate Report with the timetable of the Annual Report, if not requiring its inclusion within the Annual Report, does present some risk of the Climate Report being subject to the delays experienced in this area over the last couple of years. 
 

The consultation proposes that the Scheme Advisory Board (SAB) should prepare an annual Scheme Climate Report including a link to each individual LGPS fund’s Climate Risk Report (or a note that none has been published) and aggregate figures for the four mandatory metrics. We also propose that a list of the targets which have been adopted by LGPS funds.

The consultation states that government are open to views as to whether any other information should be included in the Scheme Climate Report.

BW Comment: Our only comment on this proposal is that the SAB be provided with the resources and expertise it will need to ensure that a scheme report is clear, comprehensive, accurate and includes the level of contextual information necessary to mitigate the risk of inappropriate ‘league tables’ and other inaccurate comparative comment.
 

For pooled assets, the consultation states that government expect that LGPS pools will be able to provide data, calculate metrics and carry out scenario analysis on these assets where that data is available. Some pools will already be able to provide advice on non- pooled assets or will wish to develop or jointly commission such advice.

There is potential for a multiplicity of different analyses and reports to be required on the same LGPS assets and if LGPS funds’ strategies significantly differ it will be resource intensive for their pool to produce analysis for them. We expect to see this issue reduce in importance over time as more assets transition into the pools.

BW Comment: In principle we would fully support the use of pools to avoid duplication of effort and cost in this area. The LGPS pools will have a clearer view than ourselves of their abilities to provide the services envisaged but we would just like to make the following comments on this section of the consultation.

• At least in the medium term a significant level of LGPS assets will not be pooled and therefore the LGPS pool in will not be able to provide LGPS funds with the necessary data and/or scenario analysis
• Multiple reporting on assets does not reduce as more assets are pooled as both LGPS funds and LGPS pools are separate entities subject to separate regulatory frameworks and requirements. A similar danger was recognised and dealt with in respect of OPS firms by excluding them from FCA reporting requirements so that both the scheme and its asset manager is subject to just one reporting framework. Only by adopting a similar approach could duplicate reporting be completely avoided in the LGPS
• LGPS pools will, apart from those assets managed in house, be reliant on sourcing data from third parties in the same way an LGPS fund will be reliant on third parties for non-pooled externally managed assets.
• LGPS pools can provide a centralised service in this area but will have to develop the expertise and resource to do so. LGPS funds may wish for reasons other than cost to make use of existing advisory firms in this space.
• In order for LGPS pools to operate effectively in this space there would need to be significant conformity amongst funds in the setting of targets (both in nature and timescale). Even if this could be achieved (which in a highly political scheme is doubtful) the question would need to be asked as to how appropriate it would be for local elected members, accountable to local taxpayers to effectively delegate decisions with such importance and public interest.
   

The consultation states that the government intends to provide high level statutory guidance to accompany changes to regulations. This will include guidance relating to the governance activities required of LGPS funds and the Climate Risk Report. The government has also asked the SAB to produce more detailed operational guidance. The SAB will also be asked to produce a standard template which LGPS funds will be required to follow in producing their Climate Risk Report.

BW Comment: Guidance will be significant in effectively supporting LGPS funds in this area. Our preference would be for a less prescriptive and more guidance-based approach. This is not an area in which the Government or the SAB can claim to be experts (nor, it could be argued, should they be) and so there is a need to draw on other expertise. The SAB’s Responsible Investment Advisory Group provides an excellent forum for an effective debate around the scope, content and approach of guidance but in itself does not have the capacity to develop the guidance while the SAB secretariat is already stretched in meeting current workloads and again does not contain a significant level of expertise in this area.

Therefore, we would encourage the active and early involvement of a wide range of sector and industry expertise in the development of the necessary guidance. This should include:

• Significant representation from LGPS funds as only they will know what will be helpful and useful and how far templates and examples can go to meet the requirements.
• A wide range of managers covering different asset types
• Industry leading research and data providers
• Consultants with a track record in this space
• Evidence from academics, climate scientists and policymakers, through organisations like the UK Centre for Greening Finance & Investment (CGFI), Committee for Climate Change (CCC) and Green Finance institute (GFI), and the supranational Intergovernmental Panel on Climate Change (IPCC).
• Other government departments and financial regulators also acting to deliver the government’s net zero and TCFD ambitions.
• Collaborative initiatives like the UN-convened Net Zero Asset Owner Alliance (NZAOA), the Institutional Investors Group on Climate Change (IIGCC), Paris Aligned Investment Initiative (PAII)
• Professional bodies setting the standards and qualifications for advisers like the Institute and Faculty of Actuaries (IFoA) and CFA Institute.

This process should be supported by the provision of sufficient resource, both in terms of expertise and scale, to the SAB secretariat to ensure guidance can be drafted, published reviewed and revised swiftly, accurately and responsively.
 

The consultation states that while government will not be imposing any legal requirement on an individual’s knowledge and skills, they wish to promote best practice in approach. The consultation proposes a requirement that each LGPS fund take proper advice when making decisions relating to climate-related risks and opportunities and when receiving metrics and scenario analysis.

The consultation asks for views on how LGPS funds will be able to satisfy themselves that the advice is high quality and provided by appropriately qualified people. 

BW Comment: Whilst welcoming a requirement for LGPS funds to take proper advice in this area we recognise that defining ‘proper’ either too widely or too prescriptively could provide challenges for LGPS funds. Too widely and LGPS funds could face a barrage of approaches from inappropriate suppliers seeking to make a fast buck, too prescriptively and LGPS funds may find themselves unable to use existing trusted advisors. 

However, given the nature and significance of the risks associated with climate change we would encourage government to err on the side of caution and look to provide some level of prescription in relation to climate risk advice. For example, the development of a specification for these services with the LGPS framework which would include a minimum level of industry recognised expertise together with an evidenced track record in this space could be a way forward.
 

BW Comment: We would support the response made by the Scheme Advisory Board that it is important that LGPS funds’ transition plans recognise the need to support a just transition and that this should be reflected in the best practice examples referred to earlier in this response. While having regard to protected characteristics, which in law would only apply within the UK, the Board feels that it is important that LGPS investment policies support development goals related to equality and human rights considerations globally, as well as domestically.