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June 14, 2021updated 21 Feb 2022 10:34am

Why top UK pensions plan to measure government debt climate risk

Assessing the climate risk of government debt is tricky for investors. A new initiative backed by the retirement schemes of telecoms firm BT and the Church of England is working on a solution. They give Capital Monitor the lowdown.

By stephanie baxter

Victoria Barron of BT Pension Scheme says the new framework is designed to help investors measure progress and engage with issuers. (Photo courtesy of BTPS)

    • Two influential UK pension schemes are backing an initiative to measure and monitor the climate risk of sovereign debt assets.
    • A central aim of the planned framework is to help with investment decision-making and, ultimately, drive environmental improvement.
    • The UK’s railway industry retirement fund and Brunel Pension Partnership are also showing an interest in using the tool.

As companies and governments increasingly pledge to reduce carbon emissions to net zero by 2050, institutional investors are starting to scrutinise how their sovereign bond holdings are exposed to climate change risks.

With this goal in mind, two influential UK retirement schemes – those of telecoms provider BT and the Church of England (CoE) – have partnered with international bodies, such as the UN-convened Net-Zero Asset Owner Alliance on a new initiative. The framework – Assessing Sovereign Climate-related Opportunities and Risk, or Ascor – will help asset managers and owners measure, monitor and compare climate change governance and performance related to government debt.

A key aim is to elicit greater transparency from government issuers on climate policies and risk in order to help with investment decision-making and, ultimately, drive environmental improvement.

BT Pension Scheme (BTPS) has been assessing climate change for “many, many years”, says Victoria Barron, head of sustainable investment. “We have grown increasingly aware that it is one of the biggest risks for our scheme.”

BTPS cannot measure the climate risks associated with sovereign debt as there are no comparable metrics available.

The £53.1bn ($74.9bn) defined benefit plan had £15.6bn invested in government bonds as of the end of March. And that is only set to increase. By 2034, all of the members will have retired, meaning the fund will have increased its allocation to assets such as sovereign bonds that can generate income while also matching scheme liabilities.

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BTPS and CoE Pensions Board were among the 457 investors – covering asset managers and owners with a total of $41trn under management – that issued a joint statement this month urging governments to get climate policy right and thereby drive massive investment.

Lack of existing metrics

Moreover, in October BTPS – which uses both external managers and and in-house investment teams – pledged to reach net zero by 2035, including scope 1, 2 and 3 emissions across its entire portfolio. However, it cannot measure the climate risks associated with this part of its portfolio as there are no comparable metrics available.

While investors who buy sovereign climate data can calculate a sovereign’s carbon emissions, BTPS says it is not aware of a service provider that can give an assessment of the climate change governance and performance of sovereigns.

“There has been a lot of work on equities and corporate credit, but not much on sovereign debt,” explains Barron. “We wanted to create a really innovative project by investors for investors, where we can create an output that will be able to assess climate change governance and the performance of sovereigns.”

The Ascor project is at the scoping stage and the assessment framework is expected to be piloted by the end of this year.

It is too early to say how the framework’s findings will impact pension scheme asset allocations, Barron says. Nor does the fund know whether Ascor will seek detail on what the proceeds from the bonds assessed will be used for.

But “it is likely that investors will ask more and more of these sorts of questions”, she says, and the project “will seek to be as useful to investors as possible”.

Paving the way to net zero

The development of Ascor has its roots in the Net Zero Investment Framework, launched in March by the Institutional Investors Group on Climate Change (IIGCC).

The CoE Pensions Board had also supported the IIGCC framework, which was designed to help pension funds assess their investments across multiple asset classes with a view to achieving net-zero carbon emissions.

Adam Matthews of the Church of England Pensions Board: Other asset classes need treatment similar to that being given by Ascor to sovereign bonds. (Photo courtesy of CoE Pensions Board)

Adam Matthews, chief responsible investment officer at the CoE Pensions Board, says: “Sovereign bonds was one of the asset classes for which [the IIGCC framework] provided a framework methodology – but it needed a practical tool to really implement it.

“The logical next step was to create a way of translating broader macro guidance into a practical tool that is transparent and publicly accessible; that our pension fund can use but is also available for others to use, so that we are all operating off a similar kind of data set,” Matthews adds.

BTPS’s Barron says Ascor is not designed to rate sovereigns on their climate change credentials, but to help investors measure progress and engage with issuers.

Ascor will enable investors to engage with national debt offices, and policymakers to understand projects and targets. “Unless you have these conversations, progress cannot really happen,” Barron says. “But there’s no way to have those conversations coherently at the moment.

“We hope this project will deliver consistency in terms of assessment, that investors will be able to integrate it into how they analyse their investment decisions and portfolios, and that it will help with decision-making when assembling portfolios.”

The consultation and pilot will explore practical issues such as ensuring fair treatment for less-developed countries. Barron says it is important to reflect these nations’ commitments in context, such as by considering the roles of fossil fuel subsidies and state-owned enterprises.

Gathering schemes’ support

Ascor has already attracted attention from other major investors despite being at such a nascent stage. RPMI – which manages Railpen, the multi-employer pension scheme for the UK’s railway industry – has expressed interest in it.

However, the scheme is still open to new members, so, unlike BTPS, its investments are mostly in the growth-focused assets, such as equities and private markets, says RPMI head of sustainable ownership Michael Marshall. The fund held government bonds worth £1.3bn at the end of 2019, according to its most recent annual report, accounting for 4.3% of its £29.8bn investment portfolio.

RPMI integrates environmental factors into its portfolio by asset class, and monitors all its external fund managers, says Marshall. In its fixed income allocation the scheme excludes some issuers for climate-related concerns, and in April hired a full-time analyst to focus solely on climate change.

Elsewhere, Bristol-based Brunel Pension Partnership, which manages £30bn in assets on behalf of ten UK local authority retirement schemes, will use the Ascor framework to measure climate risk where it has exposure to sovereign debt, says chief responsible investment officer Faith Ward.

Alongside BTPS, CoE Pension Board and IIGCC, Ascor’s collaborators include the Coalition for Environmentally Responsible Economies (Ceres), the UN-backed Principles for Responsible Investment (PRI), and the Transition Pathway Initiative (TPI). Consultancy Chronos Sustainability is providing support.

Brunel Pension Partnership will use the Ascor framework to measure climate risk where [we have] exposure to sovereign debt.Faith Ward, Brunel Pension Partnership

Data from the TPI has been crucial to the environmental work of investors such as the CoE Pensions Board, which co-founded the initiative in 2017. TPI published guides this year specifically focusing on engagement and incorporating environmental, social and governance concerns into sovereign bond investment.

Some such schemes have had a demonstrable impact. Last year, following engagement efforts by the CoE national investing bodies – which includes the CoE Pension Board – 12 companies made changes to meet the bodies’ climate change requirements. These were set using TPI data and helped push carbon-intensive sectors to align with the goals of the 2015 Paris Agreement. The CoE bodies also restricted investment in nine companies for failing to meet the same standards.

While some sectors are making progress towards a low-carbon future, many companies are yet to engage with reporting requirements or carbon reduction work.

Seeking wider impact

“Increasingly, TPI is being viewed by investors as the key independent investor assessment of the transition, and we will be significantly strengthening the initiative so it can play an even greater global role,” Matthews says.

Institutional investors can have a big impact when they work together to drive real change, interviewees say. For example, the CoE Pensions Board jointly led an initiative to improve safety in the mining industry and has also played a key role in institutional shareholder engagements with energy major Royal Dutch Shell on energy transition issues.

Having a big impact is necessary, BTPS’s Barron says, as “we need to move the trillions in these areas” and “not simply just be standing there with a net-zero achieved alignment”.

Indeed, Ascor and the Net-Zero Investment Framework are just the first steps on what the institutions backing them are determined will be a game-changing journey for environmental investing.

Other asset classes need similar treatment, such as private equity, infrastructure and property, says Matthews. “There will be a degree of continually evolving these frameworks as our knowledge increases.”

Such comments underscore the increasingly collaborative and international nature of investing for the good of the planet and its inhabitants.

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