Why pension funds are still pushing for climate action

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As much of the financial sector has gone quiet on climate issues over the past year or two, one crucial segment of it has bucked the trend: pension funds, and other long-term investors known in the trade as “asset owners”. Can they make a difference?

SUSTAINABLE INVESTMENT

The odd one out

The insurers’ net zero alliance was the first to go, disbanded in April last year. This January, the equivalent body for asset management companies suspended normal operations pending a (still ongoing) strategic review. Then, last Friday, the Net-Zero Banking Alliance shut down.

It’s been only four years since the announcement that $130tn of financial assets had been mobilised in various sectoral coalitions under the Glasgow Financial Alliance for Net Zero. Those who slammed that claim as vastly overblown have been vindicated with remarkable speed.

Yet the oldest of those sectoral alliances — the Net-Zero Asset Owners Alliance — has been ticking along rather smoothly. Founded in 2019, the NZAOA includes 86 pension funds, insurance companies, endowments and other long-term investors, with a total of $9.2tn under management.

True, this is two members fewer than it had a year ago. But compared with the rush of exits suffered by the other net zero alliances, the NZAOA looks like a beacon of stability. The contrasting fates of this body and its sister entities offer some important lessons about the state of financial sector climate action, and where it goes from here.

Different times

When most of the biggest US and European banks signed up to the NZBA in 2021, hopes were running high for aggressive government action to slash emissions.

That action has proved slower than anticipated, with fossil fuel production continuing to grow. Sticking to their pledge to align lending with a 2050 net zero pathway would have required major banks to give up a lot of profitable financing work. A study of 65 major global banks by Reclaim Finance found that they provided $3.28tn of financing for fossil fuels in the past three years.

Legal risk, too, has played a major role, with US Republican politicians questioning whether banks and insurers broke antitrust rules through their green collaboration. They’ve also argued that these net zero targets may conflict with banks’ fiduciary obligations to their shareholders, and asset managers’ to their clients.

The asset owner coalition is far better placed to stay the course. Its members do not face the same competition law constraints as banks and insurance providers (the NZAOA includes several insurance companies, but their involvement is connected only with their investment operations).

Most importantly, the NZAOA faces far less of the tensions around fiduciary duty that have dogged the other net zero alliances. The youngest pension contributors won’t retire for another 40 or 50 years. Pension fund managers and other long-term asset owners have a fiduciary responsibility to protect the interests of beneficiaries decades into the future — not least by acting against long-term climate risks.

Upping the pace

The question now is whether asset owners are making good on that duty. Last week, the NZAOA held its annual general meeting, in which members discussed future priorities including more work on climate adaptation, and efforts to include members from under-represented regions. The body is also preparing to publish a fifth iteration of its “target setting protocol”, a framework that members can use to manage financial climate risk.

But what if, as well as reducing climate risks to their portfolios, asset owners started seriously using their clout to reduce climate risks for the world as a whole? That’s the argument made by Cambridge university’s Ellen Quigley, in a recently updated paper on “universal owners” — investors with large, diversified portfolios that reflect the whole global economy.

These investors “cannot diversify away from systemic risks such as climate change,” Quigley argues, “and can only counter whole-system threats by effecting change in the real economy”.

This argument has been catching on among some of the biggest long-term investors. Those now explicitly linking their climate policies with universal ownership principles range from the US’s Calpers to the UK’s Universities Superannuation Scheme, as well as Norway’s huge sovereign wealth fund.

This year, Japan’s $1.7tn Government Pension Investment Fund announced that it would consider impact investing strategies in an effort to reduce environmental threats to global markets. “Reducing the negative impacts of sustainability-related issues on capital markets is essential for a universal owner like GPIF to pursue long-term investment returns,” it said.

Meanwhile, asset owners have been piling pressure on the asset management companies to which they outsource much of their investment work. In February, 26 asset owners with $1.5tn in assets warned their asset managers to step up on climate action or risk being dropped.

Soon after that, the UK’s People’s Pension pulled £28bn from State Street, citing sustainability concerns. Last month, Dutch fund PFZW moved a mandate worth about €14bn from BlackRock for similar reasons.

A more co-ordinated approach from asset owners, through the NZAOA or another grouping, could have still greater impact. That would complement the work of the existing Climate Action 100+ initiative, which includes both asset owners and asset managers (who, as noted above, face greater constraints in setting climate policies).

Quigley’s paper argues that through a more rigorous approach to their bond investments, asset owners could shift the economic incentives for high-emitting companies and the banks that finance them. Other high-impact approaches, she asserts, include votes against company directors, and concerted engagement on public policy.

Whether this is the right approach, and how much impact it can have, is debatable. (Tom Gosling, of the London School of Economics, for example, argues for a more modest view of what asset owners can achieve.) But this is precisely the debate that climate-concerned asset owners need to be having.

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