Fiduciary duty and climate change – where we stand

It’s been almost two years since the previous government published its Green Finance Strategy, which states it “will engage with interested stakeholders on how we can continue to clarify fiduciary duty”.

It’s also nearly a year since the Financial Markets and Law Committee (FMLC) published its paper, ‘Pension Fund Trustees and Fiduciary Duties: Decision-making in the context of Sustainability and the subject of Climate Change’.

And it’s nine months since Sir Stephen Timms, then the chair of the Work and Pensions Committee, wrote to the then-pensions minister about its evidence session on this subject.

So, what did we learn in that process, and how has the pension industry’s thinking developed since then?

The FMLC’s conclusions

Since the very beginning of pension scheme trusteeship – and emphasised by the widely quoted Cowan v Scargill case in 1985 – trustees have had to balance maximising financial returns for beneficiaries with managing risks and wider considerations including environmental and social issues.

In 2014, the Law Commission provided some clarification on fiduciary duties when setting an investment strategy, and stated that “non-financial factors” could be taken into account if they met two tests relating to beneficiary views and risk of significant financial detriment.

The FMLC, in its paper, points out that whether a factor is financial depends on the motive underlying its consideration, and not its nature. Factors that could be considered financial are becoming broader over time.

Specifically, sustainability and climate change should be considered as financial factors, given their potential significance to the scheme’s return and risk across different investments and the scheme’s various time horizons.

Although there are clear regulatory requirements on what needs to be disclosed by pension schemes regarding environmental, social and governance factors, what needs to be done is less clear. The law as it stands is still open to different interpretations.

Trustees are likely to welcome clarification as promised in the Green Finance Strategy, for example through endorsement of the principles set out in the FMLC paper, both to aid their decision making and to provide confidence over potential legal challenges.

Climate risk versus climate impact

While it is clear that climate risks could significantly affect financial returns and therefore should be considered by trustees in their investment decision making, what about climate impact?

Trustees’ investment decisions have an impact on climate change and hence the risks faced by the scheme – for example, through the choice of whether to invest in high emitters or companies providing climate solutions, and how they use their influence with investee companies.

Some climate-related risks are systemic and, in the coming decades, unlikely to be avoidable by diversification alone. A scheme’s investments now could have a real-world climate impact, reducing the systemic risks and shaping the investment landscape, ultimately affecting beneficiaries’ financial outcomes in the future.

Even if trustees do not consider their investments’ climate impact to be a financial factor now, they will need to revisit this issue regularly as the financial impact becomes clearer.

“Drill, baby, drill”

When Donald Trump was elected president of the US in November, oil and gas stocks surged, while the value of some clean energy and renewable stocks fell.

During Trump’s 2024 campaign he spent much time pledging to bolster oil and gas production, exit the Paris Climate Agreement (again), and undo the Inflation Reduction Act. According to the International Monetary Fund, this act would have invested some $400bn over the coming decade to reduce carbon emissions.

These policies would very likely change the outlook for climate risks and opportunities across the whole portfolio over the next few years, especially investments in the energy sector.

They could also change the longer-term outlook by increasing the systemic financial risks to include higher warming scenarios. Trustees of pension schemes will therefore have even more to consider when allowing for climate change in their investment decisions.

Trustees and their advisers may continue to debate whether and how to incorporate climate change in their investment decisions as part of their fiduciary duties.

However, as UN secretary-general António Guterres recently said in his opening remarks to the World Leaders Climate Action Summit during COP29: “Climate finance is not charity, it’s an investment.”

Donna Matteucci is a member of the Society of Pension Professionals’ council.