Canadian pension trustees and climate risk: if they only had a strategy?

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In January, Nordea, the Nordic countries’ largest pension manager, announced that it would exit about 40 coal producers. These fund managers are taking a range of approaches to “divestment” ranging from a full sell-off of fossil fuel shares to more considered strategies of dropping the riskiest companies, including coal and oil sands. 

Canadian pension fund administrators and their investment managers should take note of all these developments.

Engagement

While the debate rages on as to whether full or even partial divestment from risky fossil fuel companies makes financial sense, it is clear that pensions must actively engage with the fossil fuel companies in their portfolio to ensure that they are prepared for a low-carbon economy that will include sustained low oil prices, carbon re-pricing, and increased competition from renewable energy.

The goal of engagement is to demonstrate to concerned pension members that shareholder value can still be created via holdings in fossil fuel companies – but not through “business as usual.” New climate policy scenarios require either the winding up of the weakest, most subsidy-dependent, and carbon-intensive companies - US coal or pure play Canadian oil sands operators come to mind - or demanding that they implement business plans that can ensure strong returns for investors even in a low-carbon world economy.

What does engagement through forceful stewardship look like? Canadian pension trustees could demand high-carbon energy companies produce business plans that would work under a 2 degree maximum warming policy scenario – the global carbon budget that is required to keep warming to no more than 2 degrees and to maintain a prosperous economy.

Profitably winding up some of the most polluting fossil fuel companies, by increasing dividends to shareholders as production slows and exploration budgets are reduced.  Companies like Exxon and Chevron are already facing demands for reduced capital expenditure on exploration and development of new resources and increased dividends for shareholders. Requesting that carbon-intensive companies produce 2 degree business plans that would enable them to continue operating in a more efficient manner under a carbon re-pricing policy scenario.

Hedging climate risk

Pension funds can also consider hedging against the risks associated with high-cost carbon intensive assets by re-weighting investment portfolios away from fossil fuels and towards sectors that will thrive in a low-carbon energy system, including renewable energy, technology, and property. Shifting just 5 per cent of assets into carbon secure investments would grow member savings in a responsible way, while reducing the likelihood of a disruptive market adjustment to new climate policy scenarios.

These three options - divestment, engagement, and hedging risk - can be considered as complementary tools for pension fund leaders aiming to better manage climate risk and create value for millions of Canadian pension members. Whatever blend of approaches is adopted, it is also essential that trustees exercise the voting rights on company shares that belong to their members. If trustees are properly assessing and managing climate risk on behalf of their members, they must hold the management of company’s they are invested in to account on climate change issues by raising resolutions and voting at annual meetings, and communicating this information to members.

What makes a king out of a slave? Courage!

Similar to the Cowardly Lion’s  own journey, Canadian pension fund trustees need to find the courage to respond to market signals relating to carbon pricing in Canada and abroad, take action to protect their member savings, and communicate a climate risk management strategy - it’s their legal duty.  This is not the place to go into details of Canadian pension trustees’ legal duties - these are defined in provincial and federal laws and regulations, as well as under common law fiduciary principles.

Trustees should be proactively assessing and managing risk and opportunity in the best interest of their members. As global investors respond to the transition to a lower-carbon energy system, Canadian pension trustees will come under increasing pressure to communicate to their members on one of the defining investment risks of our time.

Nobody likes being told what to do. This is especially true of pension trustees and their investment managers. But the magnitude of members’ pension savings that is at risk is gigantic, as are the investment opportunities in a low carbon economy. Leadership on climate risk management and disclosure is already being shown by asset owners around the world, and there is growing consensus in the investment community about the material financial risks associated with climate change.

All of this suggests that Canadian pension trustees have a professional, legal, and ethical duty to explain to their pension members how this risk is being managed.

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