Threatening Managers Over Climate Risk?

Owen Clark of the Financial Times reports that a large UK pension scheme is threatening managers over climate risk:

One of Britain’s largest pension schemes has given its 130 asset managers a two-year deadline to reduce their exposure to climate change or risk being fired.

Brunel Pension Partnership, which manages £30bn on behalf of 700,000 members and 10 government bodies, also threatened to vote against directors at the companies it invests in and divest if they do not demonstrate significant progress on managing climate risk by 2022.

“Climate change is a rapidly escalating investment issue,” said Mark Mansley, chief investment officer at Brunel, which manages the retirement schemes for nine local authorities and the government’s Environment Agency.

“We found that the finance sector is part of the problem, when it could and should be part of the solution for addressing climate change. How the sector prices assets, manages risk and benchmarks performance all need to be challenged.”

Brunel’s move comes at a time of heightened pressure on fund managers and financial groups over their role in financing companies that contribute to climate change. Discussions about the environment dominated last week’s annual get-together of political and business leaders at the World Economic Forum in Davos.

Lauren Peacock, campaign manager at ShareAction, the lobby group, said she expected more pension funds to take a tougher stance with their investment managers.

“All asset owners should now be scrutinising their managers’ voting record on climate issues and giving mandates to smarter, more responsible asset managers,” she said. “We fully expect this to become the new normal.”

Last year Japan’s $1.5tn Global Pension Investment Fund withdrew a large mandate from BlackRock over its lack of action on environmental, social and governance issues. The New York manager has since refocused its attention on climate risk.

On Monday, Brunel unveiled a new climate policy, which includes a five-point plan aimed at building a financial system that is fit for a zero-carbon future.

Under the plan, the pension provider said it would stress-test its portfolios under a range of climate scenarios. It will also challenge its investment managers to demonstrate reduced exposure to climate risk and show they have engaged with the companies they invest in to meet goals set by the Paris Agreement.

“Now is the time for everyone in the finance sector to show leadership in response to the climate emergency,” said Emma Howard Boyd, chair of the Environment Agency. “As investors we have a responsibility to our beneficiaries to ensure the assets entrusted to us are resilient to climate risks.”

Brunel was created in 2017 and is one of eight national pooled pension funds. Its members include the local authority pension funds of Avon, Buckinghamshire, Cornwall, Devon, Dorset, Gloucestershire, Oxfordshire, Somerset and Wiltshire.

On Monday, Brunel Pension Partnership put out a press release calling the finance sector 'not fit for purpose' for addressing climate change:

Brunel Pension Partnership, one of eight pooled Local Government Pension Scheme funds across the UK, has set out a groundbreaking new approach to managing climate-related financial risk. Its new climate policy, published today, commits Brunel to using its influence to challenge the asset manager industry, which it describes as “not fit for purpose” for addressing climate change.

Brunel’s new policy – ‘A five-point plan to build a financial system which is fit for a carbon-zero future’ – builds on insights gained in the course of procuring new asset managers for its 10 LGPS clients. Brunel engaged 130 asset managers and reviewed 530 investment strategies from a climate perspective.

Chief Investment Officer Mark Mansley said,

“Climate change is a rapidly escalating investment issue. We found that the finance sector is part of the problem, when it could and should be part of the solution for addressing climate change. How the sector prices assets, manages risk, and benchmarks performance all need to be challenged.”

Some of the practical implications of the policy state that between now and 2022, Brunel will demand that their material holdings take steps to align their emissions with Paris benchmarks and improve their climate management quality.

Those that fail to do so will face the threat of votes against the re-appointment of Board members, or being removed from Brunel’s portfolios when the partnership carries out a stocktake of its policy’s effectiveness in 2022.

Equally, Brunel will challenge their investment managers to demonstrate reduced exposure to climate risk and effective corporate engagement that puts companies and portfolios on a trajectory to align with a 2°C economy. Managers that fail to do so face the threat of having their mandates removed.

Chief Executive Officer Laura Chappell said,

“Our clients have high ambitions on climate change, but the finance sector does not currently offer a sufficient range or quality of climate-aware products and expertise across all asset classes to meet their needs. We want to enable our clients to integrate climate change mitigation and adaptation across their investment strategies in a substantive way.”

Chief Responsible Investment Officer Faith Ward said,

“We have a climate emergency on our hands and it would be irresponsible of us to accept the status quo. We need to systematically change the investment industry in order to keep temperature rise to well below 2°C.”

Specific challenges within the finance sector identified by Brunel include:

• An emphasis on short-term rather than long-term performance, which drives short-term thinking by investors and companies
• An unwillingness by asset managers to invest in the low carbon economy, especially in areas which depend on public support or where technologies are perceived to be unproven
• Backward-looking investment risk models that are inherently flawed at taking future climate risk into account
• Instances of perverse incentives and conflicts of interest throughout the system – not least, the use of conventional market-weighted benchmarks to measure performance, when climate risk is not adequately priced by the market

A five-point plan to build a financial system which is fit for a carbon-zero future

Brunel already conducts carbon footprints of its listed equity portfolios and allocates 35% of client infrastructure portfolio investments to renewable energy funds. Building on these strong foundations, its new policy commits the partnership to taking action as follows.

• Policy – Brunel will encourage policymakers to adopt policies such as a meaningful price on carbon and removal of fossil fuel subsidies.
• Products – Brunel will identify product areas where there is client demand for more innovative products, and invest in their development.
• Portfolios – Brunel will stress-test its portfolios under a range of climate scenarios. It will challenge its investment managers to demonstrate reduced exposure to climate risk and effective corporate engagement that puts companies on a trajectory to align with a 2°C future. Managers that fail to do so will be replaced.
• Positive Impact – Brunel will report on the proportion of its portfolios invested in the low-carbon transition and on how its portfolios align with the goals of the Paris Agreement.
• Persuasion – Brunel will engage with its material holdings to persuade them to improve their climate management quality, using the Transition Pathway Initiative assessment framework. It will ask its material holdings to advance at least one level on the TPI management quality staircase each year, with the aspiration of all material holdings being on TPI Level 4 by 2022. In cases where companies fail to show progress, Brunel will vote against the reappointment of the Chair and other board members.

In the course of developing this policy, Brunel undertook an exhaustive consultation process with its clients and other stakeholders in the local government finance sector. Those clients are now showing their support, with Wiltshire Pension Fund today announcing that it has allocated approximately 20% of their assets into Brunel’s Low Carbon Passive Equity portfolio.

Emma Howard Boyd, Chair of the Environment Agency – whose pension fund is a Brunel client – said,

“Now is the time for everyone in the finance sector to show leadership in response to the climate emergency. The Environment Agency Pension Fund was one of the first pension funds to recognise the financial risks from climate change. As investors we have a responsibility to our beneficiaries to ensure the assets entrusted to us are resilient to climate risks. I’m delighted to join with partners across the Brunel Partnership in calling for an investment industry fit for a net zero future.”

Tony Bartlett, Head of Business Finance & Pensions at Avon Pension Fund, another of Brunel’s 10 clients, also voiced support for the policy, saying,

“This groundbreaking policy sets out ambitious expectations for our investment managers and assets, which will enable us to protect our beneficiaries’ pensions well into the future. And it demonstrates the power of partnership – within the Brunel pool and beyond – that will be required to respond effectively to the financial risks posed by climate change.”

Note: The criteria for decisions to vote against board members, exclude companies or remove mandates from investment managers will be established in partnership with Brunel’s clients over the next 12 months.

About Brunel Pension Partnership Limited

Brunel Pension Partnership Limited (Brunel) brings together circa £30 billion investments of 10 likeminded Local Government Pension Scheme funds. We believe in making long-term sustainable investments supported by robust and transparent process. We are here to protect the interests of our clients and their members. In collaboration with all our stakeholders we are forging better futures by investing for a world worth living in.

Brunel is one of eight national pooled funds and manages the investment of the pension assets for the funds of Avon, Buckinghamshire, Cornwall, Devon, Dorset, Environment Agency, Gloucestershire, Oxfordshire, Somerset and Wiltshire. Find out more at www.brunelpensionpartnership.org

So, Brunel is taking a big step forward in calling out the finance sector for not doing enough to address climate change, and threatening action if managers and companies don't meet its demands.

I can't say they're wrong about the finance sector, it is notoriously shortsighted and typically doesn't implement changes unless regulators or policymakers force it to.

Let's look closely at Brunel's five-point plan:

1. Policy – Brunel will encourage policymakers to adopt policies such as a meaningful price on carbon and removal of fossil fuel subsidies.
2. Products – Brunel will identify product areas where there is client demand for more innovative products, and invest in their development.
3. Portfolios – Brunel will stress-test its portfolios under a range of climate scenarios. It will challenge its investment managers to demonstrate reduced exposure to climate risk and effective corporate engagement that puts companies on a trajectory to align with a 2°C future. Managers that fail to do so will be replaced.
4. Positive Impact – Brunel will report on the proportion of its portfolios invested in the low-carbon transition and on how its portfolios align with the goals of the Paris Agreement.
5. Persuasion – Brunel will engage with its material holdings to persuade them to improve their climate management quality, using the Transition Pathway Initiative assessment framework. It will ask its material holdings to advance at least one level on the TPI management quality staircase each year, with the aspiration of all material holdings being on TPI Level 4 by 2022. In cases where companies fail to show progress, Brunel will vote against the reappointment of the Chair and other board members.

From these, points 3, 4 and 5 are worth noting, especially number 3 since it's explicitly warning managers to change their attitudes on climate risk or face dire repercussions.

Last year, Brunel selected Truvalue Labs to evaluate ESG risks:

Truvalue Labs, which analyzes AI-driven environmental, social and governance (ESG) data, has been appointed by the UK’s Brunel Pension Partnership to evaluate the ESG and reputational risks across all Brunel’s managers and their holdings for listed equities and bonds.

Brunel was the first of the Local Government Pension Scheme, or LGPS, funds to become a signatory to the UN-supported Principles for Responsible Investing (PRI) and has, in partnership with its client funds, “embedded ESG considerations into all of its decision-making processes,” says Faith Ward, chief responsible investment officer, Brunel Pension Partnership. “Responsible investment is central to how Brunel fulfils its fiduciary duty."

“We appoint managers that share the view that concentrating on the fundamental long-term performance of businesses, which includes the integration of risks, is most likely to deliver a successful long-term performance outcome,” says Ward.

Of Truvalue Labs, Ward comments, “We like the objectivity of Truvalue Labs’ data that isn’t dependent upon what companies publish about themselves. Their timely material ESG data helps us to continually monitor the managers in our client partners funds and to evaluate and select new managers.”

Truvalue Labs leverages its powerful Truvalue AI engine to process vast amounts of data in seconds and score companies on key measures. For example, the Insight score ranks ESG behaviour at a given point in time, and the momentum score shows the company’s trajectory of ESG performance – whether it is improving or declining.

“It can be difficult to find data that captures the ups as well as the downsides, but Truvalue Labs covers both positive and negative aspects of companies’ ESG track records,” says Helen Price, assistant investment officer at Brunel.

“We think that this combination of the long-term and momentum is a strength over other tools that may just be using a single rating,” Ward says. “We evaluated a number of providers on the market and concluded that Truvalue Labs had the tool we wanted as a primary source, both for communicating with managers and for evaluating the risks in our portfolios,” she concludes.

Now, it's important to note Brunel isn't the only pension to take climate risk seriously. All of Canada's large pensions take climate risk seriously which is why most of them are part of the world's most responsible investors.

In terms of targets and goals, I'd place the Caisse in the top spot as its CEO has already sounded the alarm on climate change and the giant pension even upped its low-carbon asset target after attaining goals ahead of time, but others are also doing important work in tackling climate change. For example, OPTrust has implemented a climate-savvy project as part of its Climate Change Action Plan to ensure the portfolio remains resilient and agile in meeting the challenges of climate change.

The big difference with Canada's large pensions and Brunel is not one Canadian pension is openly threatening to replace any external manager if they don't take climate change seriously.

Don't get me wrong, I'm sure there are serious discussions taking place in the background on climate risk with all external managers at Canada's large pensions and I know they are using their proxy voting power to further ESG principles in public companies they're investing in, but Brunel is openly putting companies and external managers on guard: "you have two years to shape up or we will replace you and/or vote against reelecting board members."

In terms of voting to replace boards, unless others follow suit, that initiative won't go anywhere but Brunel can fire external managers it feels are not taking climate risk seriously.

Here, it needs to openly communicate how it measures climate risk and stress-tests its portfolio "under a range of climate scenarios". Transparency and consistency are critically important.

And this is where I foresee some issues arising as there is no standard way of measuring climate risk. Moreover, while divesting from fossil fuel companies is met with applause from young millennials and their socialist/ environmentalist university professors, I openly wonder if these measures are in the best interests of pensioners over the long run.

I've said it before, I am all for ESG investing, it makes great sense and it's here to stay, but I'm also very careful because we are only at the beginning stages of the so-called ESG revolution and a lot of things have yet to be ironed out and my biggest concern is that common sense typically is disregarded especially when dealing with pensions which have a fiduciary duty to invest in the best interest of their stakeholders.

When I recently read an article about a tenured McGill professor who resigned over the university's refusal to divest from fossil fuels, I cringed and wrote this on LinkedIn: "He's wrong on so many levels and obviously doesn't understand the meaning of fiduciary duty."

What makes me nervous is when I see climate change ideology being elevated to a theological level and all common sense is thrown out in order to place some radical environmental agenda first.

Can pensions do more to address climate risk? Yes, no doubt about it, and many of the largest asset managers are already doing something to address climate risks and opportunities very seriously, but threatening external managers without a coherent framework is a recipe for disaster in my humble opinion.

And elevating climate change over fiduciary duty is simply wrong no matter how you sell it. Climate risk is part of a fiduciary's long-term risks but it's not the only risk and you cannot lose sight of this because the biggest risk of all at all pensions is that assets will not match liabilities over the long run.

Anyway, I'm glad the folks over at Brunel are addressing climate risk head on but I'm not convinced about their approach and while this latest initiative has garnered a lot of media attention, my hunch is there are lot of kinks that need to be worked out.

If I was Mark Mansley, CIO of Brunel, I'd invite Gordon Power, CIO and cofounder of Earth Capital, over to my office to discuss how to best address climate risk in a coherent way.

Below, PLSA talks to Mark Mansley, CIO, Brunel Pension Partnership about pooling. You can also register here to  watch a recent panel discussion on ESG featuring Faith Ward, Chief of Responsible Investing at Brunel.

I embedded a great panel discussion from last year on sustainable investing featuring Hiro Mizuno, CIO of Japan's GPIF and Hugh O'Reilly, the former president and CEO of OPTrust.