Is your pension fund ready for TCFD?

As momentum builds behind UK pension funds being required to comprehensively report the climate change risks and opportunities to which they’re exposed, this article in our recent series examines what’s involved in what is becoming the accepted framework for doing so – the Task Force for Climate-related Financial Disclosures (TCFD).

What is TCFD?

Formed in 2015 under the wing of the Financial Stability Board, with the high-profile advocacy of former Bank of England Governor, Mark Carney, and U.S. entrepreneur and former New York City Mayor, Michael Bloomberg, the underlying aim of TCFD was to drive home the message that climate risks should be an integral part of mainstream financial decision-making across the public and private sectors. Specifically, it set out a framework for organisations to quantify and report the risks in order to demonstrate to all stakeholders how they are taking their part in a just and orderly transition to a low carbon, climate resilient economy.

Five years on and well over 1000 companies around the world with a market capitalisation of many trillions of dollars have signed up voluntarily to the initiative. In the process, it has become the de facto standard for climate reporting, with the Financial Conduct Authority and The Green Finance Institute among the UK organisations joining others from around the world pushing for it to be mandatory in a number of sectors.

Indeed, current legislation passing through Parliament could mean that TCFD becomes mandatory for at least larger pension funds in the very near future. So, TCFD will need to become an increasingly familiar acronym to UK pension fund trustees.

A whole new ball game

Of course, pensions regulations already require a minimum level of ESG (environmental, social and governance) and stewardship disclosure. But TCFD goes way beyond this sort of reporting and makes climate risks and resilience integral to financial reporting and projections. In short, it recognises climate as a major financial risk that should be assessed, quantified and managed.

The reporting framework covers four core areas for organisations to demonstrate how they are responding to the financial risks and opportunities that climate change presents:

Reporting framework

1. 01

   Governance

   Governance around climate risks and opportunities.

2. 02

   Strategy

   The actual and potential impacts of climate-related risks and opportunities on strategy and financial planning.

3. 03

   Risk management

   How the organisation identifies, assesses and manages climate-related risks.

4. 04

   Metrics and targets

   The metrics and targets used to assess and manage climate-related risks and opportunities

What TCFD certainly is not is just a compliance exercise. TCFD will add financial and regulatory teeth to the urgency for wider action on climate risks and resilience – its essential requirements of risk identification, management and mitigation being significant and impactful to investor portfolios and activities.

Since the risks associated with climate risk and resilience vary from physical risks and the related economic impacts to liability risks and financial risks arising from the pace of transition to a low carbon economy, it will be important to address all of these. Broadly, they comprise:

• Physical – related to the physical risks to premises and disruption of infrastructure and supply chains that arise from extreme and adverse weather and the economic losses that result.
• Liability – legal costs and damages that result from organisations failing to meet responsibilities for climate risks.
• Transition – the legal, technology, market and reputation costs linked to how organisations adapt to, and the speed at which they adapt to, lower carbon and climate resilient economies.

While these are not new risks per se for pensions funds and their asset managers, equally the TCFD framework will present new challenges. Among these are the need for more extensive modelling of the natural world and the need to develop a much more granular understanding of an organisation’s role in and contribution to transition to a ‘net zero’ future.

No time like the present

By being proactive on TCFD and the challenges it presents, pensions fund can be far better prepared not only from a future compliance perspective, but also to meet the growing expectations of members, other stakeholders and society in general for demonstrable action from asset owners on climate issues. Put simply, the TCFD can be a powerful tool in delivering better pension outcomes.

Our suggested approach for bringing about this proactivity harnesses the TCFD elements in a five-step framework:

1. Establish your position – build the foundations of governance, importantly including well-settled and socialised climate investment beliefs connected to the core mission of the pension fund.
2. Assess your exposure – understand where you are, including the integrated risk management approach and use of climate scenarios described in the first article of this series.
3. Evaluate your response – work on your climate strategy and develop a carbon journey plan (see the second article of this series). Some investors have found the “4 Es” helpful to shape their possible actions and define their metrics and targets: Embed, Engage, Effect and Exclude.
4. Communicate your position and actions to stakeholders – the TCFD is an excellent mechanism for this, and being proactive, transparent and clear is often the way to success with communications.
5. Monitor and review – this isn’t a ‘one and done’ process. Measuring your progress on climate and incorporating feedback and lessons learnt will be central to the best investor approaches.

Progress in some or all of these areas should put pension funds in good standing for when TCFD becomes mandatory. And almost certainly, it is a matter of when, not if. Already, TCFD implementation is fast assuming the status of a reassuring statement of intent on managing climate risk and resilience across the financial and corporate world, and a powerful mechanism to spur meaningful action.

So, why not get ahead of the game?

Read our other article in this series on climate change.