In October 2021, new regulations from the Department for Work and Pensions will compel many large pension schemes to report in line with recommendations from the Taskforce for Climate Related Disclosure (TCFD). This means schemes will have to publish significantly more detailed climate data covering holdings, risk management, governance and other metrics.
“Climate change is rarely out of the news, and in these last few weeks alone we have seen extreme weather catastropically affecting human life, alongside business operations in China, central Europe and North America,” says Bruno Bamberger, Solutions Strategist at AXA IM. “Regulators are acting as quickly as they can with more rules requiring key actors, including pension schemes, to publish more data, enabling markets, investors and consumers to make more informed choices to ensure progress towards a sustainable world.”
There is a window of opportunity for schemes to act, with the divergence in credit spreads between lower-and higher-rated issuers at its lowest point in the post-Global Financial Crisis era (just 39bps spread differential between BBB- and A-rated global credit). The same lack of dispersion holds between climate leaders and climate laggards – with no premiunm to pay for investing in lower emitting or more climate-aligned bonds. This means that now is potentially one of the cheapest times for pension schemes to integrate climate factors into their investment processes. Realigning portfolios to be more climate resilient also allows the opportunity to support wider world climate change mitigation.
Bamberger believes more investment opportunities could emerge if regulation and investor sentiment create more market dispersal – namely a wider range of returns between the bonds issued by progressive company management teams that are benefiting from the net zero transition and the low returns from climate laggards. The latter may well see their cost of borrowing rise, reflecting their lack of preparedness in the run up to net zero in 2050, and they could ultimately experience downgrades and defaults, creating losses for their lenders.
“We are calling on pension schemes of all sizes to act now,” says Bamberger. “The current window of opportunity allows a chance to lock more climate resilience into portfolios, with increased allocations to bond issuers that are prepared for a changing world, and lower allocations to those that are not.
“It’s reasonable to expect any asset owners taking this path to experience more predictable income streams, from companies facing less disruption in future – and reduced risk of downgrades and defaults from climate related exposures.”
The growing issuance of green, social and sustainability bonds presents a significant opportunity, he points out, with the cumulative issuance of these bonds potentially reaching USD2 trillion in 2021. “This new issuance is from a much wider range of sectors than before, and the new issuance market gives long-term asset owners a good opportunity to green their portfolios without incurring trading costs.
“Larger pension schemes will also likely be able, through their investment managers, to influence the terms and conditions of these green bonds before they are even issued, creating further opportunity for decarbonisation.