Annabel Tonry, Executive Director, Consultant Sales Team, J.P.Morgan Asset Management
Climate change is one of the largest systemic challenges we face – affecting the way we live, work and interact with our environment.
Governments across the globe have set ambitious targets to meet the objectives of the Paris Agreement, a legally binding treaty that has brought nations together in committing to limit global warming to well below 2°C, ideally 1.5°C above pre-industrial levels.
For defined contribution (DC) plans, the way that policymakers approach the path to net zero emissions will have a meaningful financial impact on the companies held in their portfolios, in terms of both cash flows and valuations. If, for example, governments implement higher carbon taxes, it will directly impact companies’ bottom lines. While new environmental regulations, or increased subsidies for greener forms of energy, could also benefit companies already moving in a more sustainable direction by investing in cleaner forms of energy.
While the Government has not yet imposed mandatory net zero targets for DC plans, new regulations set out by the Pensions Schemes Act 2021, does require occupational pension schemes to set climate-related targets and to have oversight of the risks and opportunities presented by climate change, as many of the forecasted impacts are likely to pose a material financial risk to members’ savings. Members are also becoming more engaged on the topic of climate change and placing greater emphasis on the importance of responsible investing.
Net zero considerations are therefore becoming increasingly prevalent for DC schemes, as the transition to a low-carbon economy will cause a fundamental shift in how businesses across all sectors held in their portfolios operate. The sectors most highly exposed to climate change issues are the same sectors that will need to make the biggest changes if we are to achieve a low-carbon world.
When aligning to a net zero pathway, rather than excluding high carbon sectors, we believe pension schemes should look to invest in those companies that are most transition ready, by identifying those which have, or are in the process of adapting their business models to move towards lower emissions in the future.
To help determine a company’s transition-readiness, we believe companies should be evaluated across three key pillars:
- Firstly, we need to evaluate how a company manages its greenhouse gas emissions throughout its supply chain. This helps identify those companies making a significant effort to reduce their emissions.
- Secondly, to truly transition to a lower carbon world, we need to evaluate how a company manage its resources, including energy, water and waste. This will help identify those companies using resources more sustainably.
- Finally, it is important to look at how a company manages climate-related risk, these are risks posed as a result of climate change, e.g., physical risks, for example, how a company would fare as a result of increased coastal flooding.
This analysis will help provide a better sense of a company’s level of focus on sustainability and can help identify those companies that are most likely to benefit from the transition to net zero, from those most at risk.
While achieving net zero emissions by 2050 is possible, it will require huge changes to the global economy and substantial investment. With global pension assets exceeding US $56 trillion in 2020*, pension schemes will play a critical role in helping reach net zero climate goals. Collectively, members can use the power of their investments to enact real change by driving capital to positive environmental outcomes, and by moving early can benefit from climate-related opportunities before they are priced in.
*Source: OECD, Pension Markets in Focus – November 2021.
For Professional Clients/ Qualified Investors only – not for Retail use or distribution.