Investments in fossil fuels have risen up the public and political agenda of late.
The strength of public feelings coming to the fore during the Extinction Rebellion protests is providing increased pressure for meaningful action to replace perceived lip service.
Pension funds are a big piece of this puzzle, by virtue of the size of investments held. However, misconceptions abound.
In particular, there have been calls from a number of quarters for pension funds to divest from all their fossil fuel assets, as a point of principle.
Ministerial and campaign group pressure will continue, but – in the face of rhetoric as well as conflicting views flying around – pension trustees need to take steps to understand climate risks before looking to mitigate them.
As the former chairman of a climate change charity, I fully support strong action to address climate change.
Divestment from laggard companies – or at least the threat of it – is an important tool in trustees’ armoury, but it should not be the only tool.
Managing misconceptions
First, let us cut through some of the complexities and misconceptions in the fossil fuel divestment debate.
Many of those calling for divestment overlook the fact that investing in (that is, buying shares or debt of) fossil fuel companies is not akin to giving those companies more money to expand fossil fuel activities or operations.
Key Points
- Investments in fossil fuels have moved up investors' agenda.
- But divestment is not always the best option.
- Trustees need to be sure that divestment is the wish of all scheme members.
Instead, what is going on is usually a change in ownership of existing securities. If trustees sell their assets, someone else will buy them and fossil fuel production will continue unchanged.
Furthermore, while recent political debate has advocated wholesale divestment from fossil fuel assets, this will not be appropriate for most pension schemes.
This is because it is hard to reconcile such an action with trustees’ fiduciary duty to act in members’ financial interests.
There are also advantages to retaining ownership of those securities – something that is often overlooked.
Schemes that remain invested in fossil fuel companies have the powerful tool of ownership rights that they can use to encourage those companies to participate in the transition to a low-carbon economy.
Divestment can send a strong signal about an ethical stance, but it will remove the ability to drive change from within.
A related consideration is that the oil majors taking an active role in the transition to a low-carbon economy are big investors in the renewable energy sector.
By divesting from these companies, do trustees risk missing out on a significant future growth opportunity?
So the idea of ‘voting with your feet’ and ‘boycotting’ fossil fuel companies is not as clear-cut as it is often made out to be.
Divestment must be balanced against the power of exercising the ability to influence the transition to a less fossil fuel-reliant economy.
Empowering investor engagement
Another misconception I frequently see is around engagement – that is, investor-led dialogue that seeks to enhance the long-term value of companies.
First, there is a misconception that engagement applies only to equities. In fact, it is a tool that can be applied to any asset class.
Many fall into the trap of dismissing engagement as impossible or irrelevant if investments are not in equities.
The most common misconception around engagement, however, is that it can only ever be a weak tool.
Engagement is frequently criticised in this regard, and the perception is often of ‘cosy chats’ between investors and companies.
Sometimes that criticism may be valid, but engagement has the potential to be a far more powerful mechanism.
So-called ‘forceful stewardship’ is one mechanism for giving engagement additional impact, for example.
Engagement can also be made more effective when accompanied by the threat of divestment.
The threat of divestment signals disapproval, while it also provides investors leverage if they make it known they are willing to sell their holdings in the event that the company does not respond to engagement.
What members want
A key question is around what members want. And how does this fit alongside trustees’ primary duty to act in members’ financial interests?
It is often assumed that getting member views is a good thing. However, this may not always be the case.
There is public pressure to act on climate change, while there is a legal requirement to fulfil fiduciary duties.
So where do member views fit in?
Important questions arise, such as: How representative is members’ feedback? Will it be acted upon?
If trustees do seek member views, trustees may feel obliged to act on those views, whereas the reality is that trustees must look squarely at the financial arguments (at least as current law stands).
Some members may call for wholesale divestment from fossil fuels, but trustees would first need to be satisfied that this is the shared wish of the membership, not just of a vocal minority, as well as ensuring divestment does not risk significant financial detriment.
However, while these challenges may deter trustees from actively seeking member views, that does not preclude trustees from communicating their climate policies to members and demonstrating the trustees’ active engagement in the debate.
Members who want to make their voice heard can play an important role in holding trustees to account by seeking this information if trustees do not provide it proactively.
Transparency, accountability and legal pressure
This ties in with the broader push for transparency in this area. Since October, defined contribution schemes have had to publish their Statement of Investment Principles, while similar reporting requirements will be imposed on defined benefit schemes from October 2020. These steps will mean that members have greater sight of what schemes are doing.
As transparency rises, members will become more informed and this will empower them to apply pressure to drive change if trustees are not taking climate change seriously.
As well as members applying pressure, activists will keep the spotlight trained on these issues.
Outfits like Client Earth use information in the public domain to highlight where organisations are not fulfilling their duties to manage the financial risks from climate change.
The risk of legal action is another strong force, in that it would only take one legal case to put everybody else on notice.
The potential impact on reputation should also not be overlooked.
Future landscape
Where does the debate go from here? Having declared a state of ‘climate emergency’, ministerial pressure is sure to continue.
The UK’s Green Finance Strategy, published in July, set the expectation that large pension schemes will report on their climate-related practices by 2022. It also announced that The Pensions Regulator will consult on climate guidance. These steps will encourage greater focus on climate change by pension schemes, yet without imposing any additional legal requirements.
I expect soft encouragement will be the order of the day, as compulsion would conflict with the current legal framework for trustees.
For the time being, the focus is much more likely to be on enforcement, rather than reform – that is, ensuring that schemes are adequately fulfilling their duties as they now stand.
Claire Jones is head of responsible investment at LCP
