The Long Game

Pensions are the key to sustainable finance and getting us to Net Zero, argues Guy Opperman

By Guy Opperman MP

October 31, 2021

The UK needs a win-win to get to Net Zero and to create real growth around a green industrial revolution. I believe we can do this. UK workplace pensions, which sit under my portfolio as Pensions Minister, will play a massive part. In the pensions space, a combination of green gilts, public-private partnerships, a change to pension spending and our new approach can crack the defining problem of the 21st century. 

The UK already leads the world in combatting climate change. We are the first G7 country to legislate for Net Zero by 2050, the first to put climate reporting into law, and have delivered the biggest reduction in emissions in the G7. But we need to change the wider dynamic. Change the perception amongst the public as to the challenge of climate change. This is not a burden we have to carry, but an opportunity to be grasped. And this particularly applies as we are first in the market and therefore have a competitive advantage. How we act now will determine both the climate outcome but also our own returns. And it will shape the political mood of this great country. 

As the UK Pensions Minister these last four years I have placed climate change at the heart of reforms. I am certain we can both drive forward the change but also get us the new growth we are all seeking. There is no doubt that sustainable finance and our pensions industry are uniquely placed to help provide the necessary investment required. 

Everyone is now in agreement that if we are to reach our ambitious climate targets, we need to invest in clean energy solutions like wind, solar, nuclear, and hydrogen. The question is how to mobilise that investment. 

Major energy projects tend only to be paid for using government revenue, levies on bills, borrowing or by the investment of the vast financial muscle of the UK pensions market. Or a combination of all four. The state paid for the first generation of nuclear power. Subsequently, renewables were developed using widespread government subsidies. But in a post-Covid world financing projects is going to be harder. The British State – like most other countries – is struggling with the £400 billion added costs to the Exchequer because of the pandemic. As a Conservative, I would argue that taxes are already high with the richest 1% already paying more than 25% of the UK’s total tax take, and general taxes having recently gone up to accommodate social care and increased NHS costs. So, finding new tax revenue for Net Zero measures will be difficult. It’s not impossible as I outline below when we discuss green gilts, but, as a government, we must accept that we are working in a constrained fiscal space. Extra borrowing by the government is simply not sustainable long term, until balance sheets get repaired. And the private sector has taken a hit from the pandemic too. The capacity of individual companies to spend or even borrow more is limited and likely to become more constrained as rates rise in response to inflation. I accept that some companies have the capital to spend, but the market is a very different place to two years ago. However, there is a way ahead. As a champion of sustainable finance for several years, I have been driving new legislation and advocating for a different type of investment strategy. This work is now producing real change. 

In 2018, the Department for Work and Pensions (DWP) started the process of legislating to ensure pension schemes started taking their climate and sustainability obligations seriously. This came in the form of Environmental, Social and Governance regulations (ESG), which I brought into law as Minister. These regulations mean that occupational pension schemes, with more than 100 members, must take due account of climate risk in their investment practices. These must now be included as “financially material considerations” in each scheme’s Statement of Investment Principles (SIP). These reforms are transforming investing. At the same time, there has been a psychological and practical change in the minds of pension scheme trustees and their asset managers. They now fully accept the risks of climate change to UK pension funds.

It is in the pension schemes’ members’ interests that we transition quickly: the reasons are multiple but just focus for now on pension scheme member returns. The evidence suggests that financial returns will suffer in higher climate warming scenarios. This can be seen in several ways. We are already experiencing severe weather events at increasing frequency. These damage physical assets and supply chains, increase migration and conflict, and – in turn – result in losses to pension scheme assets.

Clearly, very soon, the international community is coming together to expand upon the promises made at the Paris Conference, with the UK hosting COP26 in Glasgow. We will all need to play our part going forward, from the biggest business to the individual consumer with our choices and daily decisions. And there is something that tens of millions of us as British citizens have that can play its role in cutting carbon emissions too: a pension. 

This Conservative government has made tangible progress in shaping sustainable finance both to tackle climate change and to ensure a good return for pension scheme members. But these pensions still need investment opportunities. So that is why I and others have been pressing for an alternative investment vehicle. And it is happening; let me give two major examples.

Green Gilts 

I, and others, have been pressing for a UK government green gilt to provide a venue for such sustainable investing. Green Gilts are raising billions for green government projects like zero-emissions buses, offshore wind, and schemes to decarbonise homes and buildings in this financial year. They are issued to institutional investors such as pension funds and provide a fixed rate of return until their expiry. The UK’s inaugural Green Gilt is a 12-year bond, maturing on 31st July 2033. Other countries such as France are already doing this. And in September 2021 it happened here in the UK. 

£10 billion was raised from the sale of the Gilt on the launch day: this was the largest inaugural green issuance by any sovereign, with the largest ever order book for a sovereign green transaction. A second issuance in October raised a further £6 billion with an order book that was 12 times oversubscribed, indicating the huge appetite for such investment vehicles.

By launching the Green Gilt in the run-up to COP26 next month, the UK is demonstrating its commitment to tackling environmental challenges and the vital role that green finance plays in this fight. This funding will be used to finance vital green government projects across the country, including things like clean transportation, renewable energy, climate change adaptation, and preserving our natural environment. In helping us to build back better and greener, it will also help to create jobs as we transition to net-zero.

As set out in the Government’s Green Financing Framework, published earlier in the summer, the money raised by the Green Gilts will be used to finance expenditure. But it also massively kickstarts private sector investing, mobilising the considerable reserves that built up during the unprecedented monetary policy conditions of the pandemic. The Green Gilt will be followed later in the year by the world’s first standalone retail Green Savings Bonds, issued by NS&I. These two products will allow UK investors and savers to join the collective fight against climate change while creating green jobs across the country. At present, the Green Gilt does not include new nuclear projects, but I hope that this could change as the partnership to create new nuclear will need considerable government support for the private sector, although the private sector will pay the lion’s share. 

Long Term Asset Fund

At the same time in September 2021, we launched the Long Term Asset Fund (LTAF) as a venue for UK auto-enrolled workplace pension funds to invest in. This is the product of a year’s worth of work by the Productive Finance Working Group. It is a partnership between government, regulators, and industry, upon which I was proud to participate. It was co-chaired by the Governor of the Bank, the Chief Executive of the FCA, and the Economic Secretary to HM Treasury.

Appropriately managed, investment in such assets has the potential to generate better returns for investors, including those saving for retirement in auto-enrolled Defined Contribution (DC) pension schemes, given their typically long-term investment horizons. These types of pension schemes are an increasingly important vehicle for saving for retirement, given their assets have increased from around £200 billion in 2012 to over £500 billion today, and are expected to double to £1 trillion by 2030.

Investment in productive finance assets can also benefit the wider economy by facilitating the transition to Net Zero technologies and infrastructure. Without a doubt, this can provide a boost to long-term growth and support an innovative, greener future for the UK. Don’t take my or the Chancellor’s word for it: this idea has the backing of the industry, from the Investment Association to Hargreaves Lansdown to the managers of large pension schemes like the Tesco Workplace Pension Scheme. 

The LTAF is also designed to bring other advantages. There is growing international demand for access to long-term assets such as infrastructure and building projects, so structures such as the LTAF will help the UK to keep its place as a leading global centre for asset management, linking to wider important opportunities such as the development of green finance as part of the wider focus on sustainable long-term growth. Investment in Net Zero is a part of this. In short, opportunities exist to market this and benefit from it in every way. And I am sure future long-term asset funds can be bigger and better. 

Putting the consumer in charge

Some might argue that what I have outlined is very ‘techy’, and not accessible to the consumer. In other words, the normal man or woman in the street. But whether they are on the Clapham Omnibus or down the pub they still care about what is happening to get us to Net Zero. To fix that we have introduced climate-based financial reporting. This was started with the Pension Schemes Act 2021, which was passed through Parliament in January. It makes pensions safer, better and greener. It also empowers the consumer. The background is as follows: To facilitate the world in helping to get to net zero, the Task Force on Climate-related Financial Disclosures (TCFD) was set up and its recommendations established a framework for declaring the potential impacts of climate change on the financial system. It is supported by many key figures and organisations, from the World Bank to the G20 Financial Stability Board, and the UK government’s climate change adviser, Mark Carney, the former Governor of the Bank of England. I met with Mark in January 2020 and we agreed to implement climate reporting into UK law. This would be a world first. 

The Pension Schemes Act now includes the new provisions that will allow the government to mandate pension schemes to adopt and report against the TCFD recommendations. We are asking trustees to consider the financial risks posed by climate change to their members’ investments. Trustees should then disclose how they have done so to their members and the public. Again, with this transparency comes accountability, change and empowerment.

The Act gives the Government the power to require schemes to take account of the UK’s Net Zero targets, as well as the Paris Agreement goals of limiting the rise of average global temperatures, with a view to ensuring that there is effective governance of the scheme with respect to the effects of climate change.

More people than ever before are thinking about how their pension is invested. Many people are now taking a personal interest in how their savings can play their part in getting Britain to Net Zero. The next stage is pension scheme portfolio alignment with the Paris Agreement. 

Measuring Paris Alignment will allow schemes to assess their exposure to transition risks using forward-looking metrics. Taken together with existing disclosure requirements, this metric will inform trustees’ decisions around stewardship, voting and investments. Paris Alignment reporting also has the potential to be a powerful tool for communicating to members a scheme’s progress in transitioning to Net Zero. 

Stewardship and its consequences

At the same time, we are tackling stewardship and the role that pension funds have in driving where and how their money is invested sustainably. Stewardship of high-carbon companies, when done effectively, can drive down real-world emissions, and reduce the climate risk to which the scheme is exposed, and more importantly shape that company’s evolution. Trustees need to hold their asset managers to account to ensure scheme members’ best interests are protected. 

Currently, schemes must produce and publish a Statement of Investment Principles (SIP) which details the policies controlling how they invest, including their stewardship activities. However, a review my officials undertook earlier this year found that SIPs were generally high level and unilluminating, especially concerning voting and engagement.

It is clear to me that there is currently a misconception among trustees that stewardship is not a key part of their work, or that they are unable to carry out any stewardship activity due to the way they invest. This kind of attitude must change if we are to create sustainable outcomes for members. We have already taken steps to accelerate progress to address this governance oversight. In July, the DWP launched the Occupational Pensions Stewardship Council. The Council is already building trustee stewardship capability and strengthening the asset owner voice in engagement with service providers. The Council has 32 members, including occupational and local government pension schemes, representing over £570 billion in assets under management. 

Furthermore, the Taskforce on Pension Scheme Voting Implementation (TPSVI), which I established in December 2020, published a set of recommendations last month intended to help industry improve voting systems and increase the number of asset managers who are prepared to engage with their clients’ voting preferences. The Stewardship Council is working closely with members of the TPSVI and together they will be able to use their collective power and expertise to improve stewardship across industry. 

And later this month I will be consulting on guidance that seeks to help trustees fully understand their requirements on stewardship and voting, and how they should report these activities in their annual Implementation Statement. 

Divestment and sustainable finance

I am a passionate advocate of everyone understanding where their money is invested. Anything that aims to engage savers with their pensions and encourage sustainable investments is a good thing. But widespread divestment would be a disaster and we must constantly push back against those who argue that this is the way ahead. Clearly, some of those advocates are far left like Extinction Rebellion but even the Labour Party has dabbled with ideas of divestment. 

Some climate campaigners – with good intentions – have argued that divesting pension funds away from high carbon assets will help us achieve our Net Zero climate goals. I disagree. Simply selling these assets to others without the same environmental concerns or governance oversight is counterproductive and will do nothing to get Britain to Net Zero. And it is going to be business, backed by sustainable finance, that will create largescale hydrogen, carbon capture, scalable battery technology, new nuclear and so much more. That needs capital. 

Partnership with business is the way to achieve the innovative change required. By investing in sustainable assets, trustees can nudge, cajole, and vote firms towards lower-carbon business practices. COP26 will be key to securing the investment in UK pension schemes which are genuinely world-leading in this space.

My glass is very much half full. I believe we can get to Net Zero by 2050 and create the new jobs, new tech and so much more that the UK needs.