FINANCE FINANCE EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT Pension Systems + Climate Risk : Measurement + Mitigation © 2020 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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The risk of claims resulting from such infringement rests solely with you. If you wish to reuse a component of the work, it is your responsibility to determine whether permission is needed for that reuse and to obtain permission from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. Cover design and layout: Diego Catto / www.diegocatto.com The Columbia SIPA Capstone team would like to extend our gratitude to the advisors, mentors, clients, interviewees, and participants who made our research possible. Authored by Pauline Deschryver, Patrick Dougherty, Jumi Kim, Laura Kunstler-Brooks, Jiaru Qin, Jing Wu, Shan Wu, and Bingjie Zhou Cary Krosinky and Thomas Murtha, Lecturers of International and Public Affairs, whose invaluable advising and feedback guided us throughout this project. Suzanne Hollmann, Saleha Awal, and the rest of the Columbia SIPA Capstone Program for their coordination and logistical support. Our client, Fiona Stewart, Lead Financial Sector Specialist at the World Bank’s Finance, Competitiveness, and Innovation Group, for her guidance and engagement with the project. The Secretariat of the International Organisation of Pension Supervisors (IOPS) for their collaboration on the survey and kindly allowing us to contract their members. We are very grateful to the representatives from Angola, Australia, Austria, Bulgaria, Chile, Colombia, Guernsey, Iceland, Ireland, Kenya, Malawi, Mexico, Namibia, North Macedonia, Romania, Slovakia, South Africa, and Uganda who kindly took the time to provide responses during what we appreciate was a very difficult and busy time for all supervisors due to their having to respond to the COVID-19 pandemic. We hope that our study can contribute to further work by the Organisation on this important topic. JP Leous and Neal Parry, and the SIPA administration, for awarding us the Leous/Parry Award for Progressive Sustainability. The award supports interdisciplinary approaches to protecting the environment and promotes collaboration from across the University to address the world’s environmental issues. We will use this platform to promote and publicize our work. The report is informed by several interviews with experts in the field. We would like to thank them for taking the time to discuss their perspective and experience, in particular: Will Martindale (PRI), Samantha Atherton (World Bank), Eri Yamaguchi (NYSCRF), Tetsuya Oishi (GPIF), Chad Cecere (GPIF), Yoko Monoe (GPIF), and Mina Yagi (GPIF). Your willingness to participate in our research has furthered our understanding of how climate risk will impact the financial system and we are hopeful that it will advance future climate finance solutions. >>> Contents Executive Summary 7 1. Pension Climate Action to Date 11 2. Climate Risk Exposure Landscape 15 3. Regulatory Landscape 23 3.1 Regulatory Mapping 24 3.2 Survey 30 4. Conclusions and Recommendations 35 Appendixes 37 References 43 >>> Executive Summary Pension funds can potentially play a critical role in combating climate change by providing much needed financing and investment. Intervention is necessary to bridge the financing gap of between $1.6 trillion to $3.8 trillion in mitigation costs and $180 billion in adaptation costs to limit global temperature rise and ecosystem collapse.1 Institutional investors such as pension funds have two motivations to providing such financing. On one hand, if the investor community does not act, they face a potential portfolio value loss of $10.7 trillion triggered by the materialization of transition, physical and regulatory risks. On the other hand, the transition to a 2°C scenario is expected to yield $2.1 trillion in global “green” investment opportunities for investors.2 This report focuses on pension system greening and aims to provide data-driven recommendations to orient climate-aligned investment practices. In order to undertake a holistic analysis, this report consists of the following sections: a literature review outlining the need to green the global pension system (Section 1); a review of relevant national and international actions taken (Section 2); a climate risk exposure landscape based on quantitative analysis deriving country pension fund climate risk scores (Section 3); a complementary regulatory mapping and score that uses a combined quantitative and qualitative approach (Section 4.1); and a survey of pension regulators to identify how each supervisory authority is interpreting practices and standards on ESG integration in the pension industry (Section 4.2). The final section of the report summarizes the conclusions and key policy recommendations. In addition, this report relies on insights from a series of case studies conducted, which profile several leading pension funds and their climate investment strategies (appendix 1). While all pension systems will face material risks resulting from climate change, some pension systems will be more vulnerable than others. To identify such risks and challenges of climate change, an in-depth data review and quantitative analysis was undertaken to create the Pension Climate Risk Heatmap for 71 countries. The derived pension climate risk measure was a composite measure based on data from the Notre Dame Global Adaptation Index, pension asset-to-GDP ratio, and percentage of pension assets held domestically. This approach allowed for an estimation of potential pension fund exposure to climate change risk, accounting for the relative fund size of pension fund assets in each country and the level of portfolio diversification internationally. Overall, the analysis indicates that pension funds are vulnerable to climate risk in varying degrees and forms. 1. Barbara Buchner et al., “Global Landscape of Climate Finance 2019” (Climate Policy Initiative, November 2019), https://climatepolicyinitiative.org/wp-content/uploads/2019/11/2019-Global-Landscape-of-Climate-Finance.pdf. 2. Beate Antonich, “Institutional Finance Update: Investors’ Decisions Impact Climate Change, and Climate Risks Impact Their Portfolios,” May 30, 2019, http://sdg.iisd.org/news/institutional-finance-update-investors-decisions-impact-cli- mate-change-and-climate-risks-impact-their-portfolios/. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 7 > > > F I G U R E 1 - Country Pension Climate Risk Heatmap 1.25 4.5 Source: authors An important counterpart to the Pension Climate Risk These Regulatory scores were combined with the Heatmap is the regulatory environment in which pension pension climate risk scores to sort countries into four funds operate. A follow up question was therefore posed as main groups. These comprise pension systems with low to whether the necessary regulatory measures are being put climate vulnerability and low regulatory risk, those with low in place by countries which could help mitigate this climate climate vulnerability but medium to high regulatory risk, risk. Using an in-depth quantitative and qualitative approach, countries with high climate vulnerability and low regulatory ESG pension regulations of 50 countries were mapped and risk, and finally those with high climate vulnerability and scored with the aim of outlining potential regulatory enablers medium to high regulatory risk. of sustainable investment. This review was complemented by a survey administered to members of the International Organisation of Pension Supervisors (IOPS), which provided further details on their ESG regulatory approach. 8 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT > > > F I G U R E 2 - Comparing climate risk and regulatory risk scores Comparing Climate Risk and Regulatory Risk 5.00 4.50 South Africa 4.00 Singapore Israel Brazil Malaysia Colombia 3.50 Nigeria Pen Australia Mexico United States Canada Switzerland Chile United Kingdon 3.00 Netherlands Japan Pakistan Climate Risk Score Spain Thailand India Denmark Egypt Finland Turkey 2.50 Poland Indonesia Germany Belgium Norway 2.00 Romania Portugal Italy Czech Republic 1.50 Sweden 1.00 0.50 0.00 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Regulatory Risk Score The final section of the report concludes that pension funds play a critical role in the transition to a low-carbon climate resilient economy. In the context of rising risks and opportunities posed by climate change, pension funds have to reinvent themselves to comply with their global presence and a definition of fiduciary duty aligned with today’s challenges. Based on the analysis undertaken, recommendations for regulators and pension funds alike are to: • Review investment guidelines to allow for appropriate • Build ESG literacy and awareness. Regulators should levels of international diversification. Regulators develop their own knowledge and measurement of climate should review pension fund investment guidelines to and other ESG risks and offer and promote educational check that they do not inadvertently expose pension funds tools and incentives to allow pension funds to develop to high levels of domestic climate risk. a robust internal expertise on climate and other ESG- • Adopt a holistic definition of fiduciary duty, fully related considerations. aligned with today’s challenges. Policy-makers • Share and adopt best practices. Pension supervisory should revisit pension funds’ definition of fiduciary duty, authorities could take a common stance on sustainable in line with financial, environmental, social and good finance practices, including ESG disclosure and reporting, governance imperatives to ensure that climate risks can including through the regulatory framework led by the be taken into account. IOPS. Further support is also required to help regulators adopt international standards and good practices in a proportionate and appropriate manner, reflecting the nature of their local market and pension systems and – as this study has shown – the potential level of climate risk faced. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 9 1. >>> Pension Climate Action to Date Institutional investors are an important potential source of financing for the investment which will be needed to meet global climate goals. The World Economic Forum estimates that approximately $44 trillion of economic value generation is moderately or highly dependent on nature and its services.3 To prevent complete ecosystem collapse, the world must limit global temperature rise to 1.5°C. Reaching this scenario is estimated to require between $1.6 trillion to $3.8 trillion in mitigation costs and $180 billion in adaptation costs. In 2018, climate finance flows fell far below that number at $542 billion, 93 percent of which went to mitigation activities and five percent to adaptation activities.4 Institutional investors, with total assets under management amounting to approximately $84 trillion, could play an important role as sources of global capital.5 Institutional investors such as pension funds have two motivations to providing such financing. On oner hand, if the investor community does not act to finance mitigation, it could face a potential portfolio value loss of $10.7 trillion triggered by the materialization of transition, physical and regulatory risks. On the other hand, a 2°C scenario is expected to yield $2.1 trillion in global “green” investment opportunities for investors. In practice, institutional investors have limited exposure to green investments. Less than one percent of global institutional investors’ holdings are in low-carbon assets, and they accounted for just 0.2 percent of total climate finance flows in 2016.6 Approximately seven percent of their equity portfolio remains exposed to the fossil fuel industry, and broader exposure to climate-policy-relevant sectors reaches roughly 45 percent.7 As such, the academic and institutional literature often calls the investor community to action. Among institutional investors, none are better positioned than the pension fund industry to lead the transition to green finance. Global pension assets amounted to an estimated $44.1 trillion in 2018 – representing the second-largest source of institutional capital globally after mutual funds. Over the last decade, they have seen significant growth with almost all countries reporting positive nominal growth in assets and absolute enrolment numbers. The average ratio of pension assets to GDP in OECD countries has steadily increased from 49.7 percent in 2008 to 126 percent in 2018. Pension assets even exceeded GDP in 8 out 36 OECD countries in 2018.8 Given their long-term perspective and their unique positioning of “universal investors”, they are well suited to invest in illiquid assets and foster the green transition. 3. World Economic Forum (2019) 4. Buchner et al. (2019) 5. Röttgers et al. (2018) 6. Buchner et al. (2017) 7. Battiston et al. (2017) 8. OECD Pension Markets in Focus 2019 PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 11 Though pension assets globally are fairly concentrated • FIDUCIARY DUTY: in 2005, the United Nations in absolute terms, they can also represent a significant Environment Programme Finance Initiative (UNEP FI) portion of developing economies’ GDP. 22 countries hold commissioned Freshfields Bruckhaus Deringer to publish $40 trillion of the total pension assets and seven of those a report on the legal framework needed to integrate ESG hold $36 trillion. They are Australia, Canada, Japan, the issues into the practices of institutional investors. The Netherlands, Switzerland, the United Kingdom and the United report argued that “integrating ESG considerations into States.9 Many of them are facing their own climate challenges: an investment analysis so as to more reliably predict Australia’s wildfires, Canada’s melting Arctic, the Netherlands’ financial performance is clearly permissible and is sea-level rise. While the pension systems in middle income arguably required in all jurisdictions”. ‘Fiduciary Duty in countries are smaller in absolute size, their relative size is the 21st Century’, a joint initiative of the PRI, Generation comparable to that of high-income countries. For example, the Foundation, and the UN Environment Program, published ratio of pension assets to GDP is 95.1 percent in South Africa, in 2015, is the follow-on report, which aims to outline how 91.3 percent in Namibia, and 40.9 percent in El Salvador, traditional concepts of loyalty and prudence translate into and similar in many other countries.10 In fact, it is doubly modern fiduciary duty.16 important for low and middle income countries to safeguard Their seminal publication argues that modern fiduciary their pension system as it serves as an important source of duties of investors include: domestic investment and shock-absorption.11 » accounting for financially material ESG factors; » incorporating stakeholder preferences into decisions; The debate on responsible investment by pension funds » supporting the stability and resilience of the financial has focused around four main themes: risk, reporting, system; fiduciary duty, and engagement. This report adopts the » disclosing investment practices; and, United Nations Principles for Responsible Investment (UN » practicing active ownership.17 PRI) definition of responsible investment as “a strategy and • ENGAGEMENT: shareholder engagement in particular is practice to incorporate environmental, social, and governance seen as the cornerstone of sustainable investing. Where (ESG) factors in investment decision and active ownership”.12 literature previously focused on the more traditional hedge Academic literature focuses on four main themes: fund activism which sought to advance shareholder • RISK: recent work on climate risk suggests that it is a interests, scholars are now focusing on ESG activism. long-run source of financial risk. This body of literature Researchers are discussing whether shareholder highlights institutional investors’ current perceptions of activism is effective, and if so, how it impacts shareholder climate risks and identifies several types of risk: physical and stakeholder values. There is significant evidence risk, transition risk, and liability risk.13 that successful engagements are followed by positive • DISCLOSURE: the debate on climate-related disclosure financial returns.18 centers on the effectiveness of mandatory versus voluntary disclosures, the content of the disclosures, and In recognition of the debate along these themes, the their ultimate effect on the climate crisis.14 Specifically, regulatory environment for pension funds has started to some scholars question whether disclosure is bound incentivize ESG considerations, and pension funds have to remove a variety of barriers, notably agency issues been increasingly focusing on sustainable investments. and short-termism, currently impeding the spread of Among high income countries, the EU is leading regulatory green finance.15 action requiring institutional investors to disclose and consider climate risk.19 9. Willis Tower Watson Global Pension Assets Study 2019 10. OECD Funded Pensions Indicators 2019 11. Amaglobeli et al. (2019) 12. “What Is Responsible Investment?,” PRI, 2019 13. Krueger et al (2019) 14. Hahn et al (2015) 15. Ameli et al. (2019) 16. To date, the two most comprehensive reports on pension system greening are: Kirjanas et al. (2018), and Della Croce, Kaminker and Stewart (2011) 17. Rory Sullivan et al., “Fiduciary Duty in the 21st Century” (PRI, October 2019) 18. Kim et al. (2011), Dimson, Karakaş, and Li (2015) 19. Guarascio (2019) 12 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT Climate change and the role of private finance has long disclosure of climate related financial information, the been a focus on the international stage. The United Nations 2019 TCFD progress report found that progress was not Framework Convention on Climate Change (UNFCCC) was sufficient and greater clarity is needed on the potential ratified in 1994. Since then, there have been numerous financial impact of climate related risks or issues.23 commitments to increase climate finance including the • IIGC: on the industry side, the Institutional Investors Cancun Agreement and most recently the Paris Agreement Group on Climate Change (IIGC) was established in in 2015.20 Initiatives to incorporate climate risks into financial 2001 as a forum between European pension funds and sector analysis, and to raise private sector financing to meet asset managers. Currently, the organization has 200 climate goals have also been building. Some of the major members and works towards mobilizing capital for low milestones include: carbon investments and increasing resilience to the • GFSG: the G20 under the presidency of Mexico established impacts of climate change. In 2019, the IIGC launched the Climate Finance Study Group with the aim of mobilizing the Paris Aligned Investment Initiative which aims to resources taking into account the objectives of the provide guidance and methodologies for investors to UNFCCC.21 Subsequently, the G20 Green Finance Study align portfolios with the Paris Agreement. The group is co- Group (GFSG) was established under the leadership of chaired by representatives from APB and the Church of China in 2015. The GFSG has the mandate to “identify England Pensions Board.24 institutional and market barriers to green finance, and • NGFS: the Network for Greening the Financial System (NGFS) based on country experiences, develop options on how was created in 2017. The group shares best practices and to enhance the ability of the financial system to mobilize works to contribute amongst policymakers, with the aim of private capital for green investment.”22 Under Argentina’s promoting climate risk management in the financial sector.25 presidency the scope of the group has expanded. NGFS members acknowledged that “climate-related risks • TCFD: the Financial Stability Board created the Task-force are a source of financial risk. It is therefore within the on Climate-related Financial Disclosure (TCFD) in 2015. mandates of central banks and supervisors to ensure the The remit of the TCFD was to develop voluntary and financial system is resilient to these risks.” consistent climate-related financial risk disclosures that would aid institutional investors in improving understanding In summary, pension funds have been recognized as a of material risks. Members of the Task Force include potentially significant source of financing to meet climate banks, insurance companies, credit rating agencies and goals, with numerous initiatives launched to help them fulfil pension funds. The TCFD published its final report and this role – but more needs to be done. There is a significant recommendations based on four areas in 2017 and the financial gap to address climate change, while less than report made the following recommendations: one percent of global institutional investors invest in the low- » Governance: Disclose the organization’s governance carbon climate resilient pathway. So far, the global institutional around climate related risks and opportunities. investment community has supported regulatory efforts led by » Strategy: Disclose the actual and potential impacts the PRI and the TCFD on identifying and disclosing climate- of climate-related risks and opportunities on the related financial risks. European pension funds lead regulatory organization’s businesses, strategy, and financial action on ESG disclosure and climate risk consideration. In planning where such information is material. low-and middle-income countries, where pension funds have a » Risk Management: Disclose how the organization critical weight in the economy, several regulators and pension identifies, assesses, and manages climate-related managers have started acting proactively in favor of the green risks. transition. Several international platforms since 1994 have » Metrics and Target: Disclose the metrics and targets raised awareness on the role of the investment community used to assess and manage relevant climate-related to address climate change and the need to align investment risks and opportunities where such information practices with ESG considerations. In order to meet ambitious is material.” and urgent climate goals, these initiatives need to be built on Currently, the TCFD represents 930 organizations, 87 to move from awareness pledge to capital commitments and of which are pension funds. Despite an increase in the effective changes in investment behaviour. 20. Lattanzio (2019) 21. Climate Finance Study Group, “Promoting Efficient and Transparent Provision and Mobilization of Climate Finance to Enhance Ambition of Mitigation and Adaptation Actions,” June 2016 22. G20 Green Finance Synthesis Report” (2016) 23. TCFD, “Task Force on Climate-Related Financial Disclosures: 2019 Status Report” 25. IIGCC, “2019 Year in Review” 26. NGFS Secretariat, “A Call for Action: Climate Change as a Source of Financial Risk” (Network for Greening the Financial System, April 2019), https://www.banque-france. fr/sites/default/files/media/2019/04/17/ngfs_first_comprehensive_report_-_17042019_0.pdf. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 13 2. >>> Climate Risk Exposure Landscape INTRODUCTION Climate risk has increasingly emerged as one of the main risks to the current financial system. Financial institutions are, and will increasingly be, exposed to climate risks, which cover physical, transition and liability risks. An allocation of capital consistent with the transition is based on and is reinforced by adequate management of the risks and opportunities posed by climate change to the financial sector. These risks are multifaceted and can affect the financial sector through three channels (See Table 1): • “physical risks” that can arise from weather and climate events; • “transition risks” that result from the adjustment process towards a low-carbon economy; • “liability risks”, which is a particular form of the two categories above.27 For the purpose of this report, to identify the risks and challenges of climate change that pension funds across the world face, an in-depth data review and quantitative analysis was conducted to create a heatmap of pension fund climate risk for 71 countries.28 In order to derive a measure for pension fund climate risk, three key variables were used: i. country climate change risk; ii. pension assets-to-GDP ratio; iii. percentage of pension assets held domestically. This approach allows us to estimate pension fund exposure to climate change risk, account for relative pension fund size and the level of pension asset diversification. While all countries will face the material effects of climate change, some pension systems will be more vulnerable than others. The purpose of this analysis is to map pension risk and identify pension funds most exposed to the negative effects of climate change both in low, middle, and high-income countries. This will allow key trends and policy recommendations to be identified in order to help countries mitigate climate exposure and pension asset risk. The following sections outline the data sources, methodology, and findings. Throughout the comprehensive research and data analysis process, many data sources and indexes were considered. While there is no one comprehensive source of climate risk data, the final output used datasets that were available for the largest group of countries and had the most comprehensive country climate data. Where possible, three-year averages of data from 2015-2017 were used due to data limitations and to ensure coverage for the largest number of countries. For 19 observations three-year averages were not available using pension data— latest available data was used instead. 27. NGFS Secretariat, “A Call for Action: Climate Change as a Source of Financial Risk.” 28. This report defines a pension system as any plan, fund, or scheme which provides retirement income. Pension funds are pooled monetary contributions from pension plans set up by employers, unions, or other organizations to provide for their employees’ or members’ retirement benefits. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 15 CLIMATE RISK DATA: NOTRE DAME GLOBAL ADAPTATION INDEX The base country climate change score used Notre Dame governance - a composite measure taking into account rule Global Adaptation Initiative Index (ND-GAIN), which scores of law, regulatory quality, corruption and political stability, and 181 countries across 45 indicators on their vulnerability c) social readiness a composite measure taking into account to climate change and ability or readiness to adapt.29 inequality, ICT infrastructure, education, and innovation.30 This Vulnerability is defined as “the propensity or predisposition of data set is comprehensive in that it accounts for water scarcity, human societies to be negatively impacted by climate hazards” sea level rise, risk of climate change-induced diseases, and and is measured across six key areas: food, water, health, more. However, it is limited in that it does not account for ecosystem services, human habitat, and infrastructure. The extreme weather events or natural disasters, e.g. hurricanes. six sectors in turn are given a composite measure based on A potential extension of this mapping would be to incorporate six indicators which measure exposure to climate change data from indexes such as Germanwatch, which explicitly map hazards, sensitivity within the sector to impacts of climate the risks of extreme weather events.31 Climate change can have change and the adaptive capacity of sectors to cope with the compounding effects and increase the likelihood of extreme impact of climate change. Readiness is defined as the ability of weather events, which will increase in frequency if we reach a country to use effective investments to undertake adaptation tipping points. Figure 3 gives an overview of how the ND-GAIN actions. Readiness is measured on three areas by the index: score is derived. A comprehensive technical note with detail on a) economic - measured as the ease of doing business, b) each indicator is publicly available.32 > > > F I G U R E 3 - ND-GAIN measure summary 33 Health Food Escosystem Habitat Water Infrastructure Social Esconomic Governance (6) (6) (6) (6) (6) (6) (4) (1) (4) 12 Adaptive Capacity Indicators. Two for each sector. 12 Sensitivity Indicators. Two for each sector. 12 Exposure Indicators. Two for each sector. VULNERABILITY READINESS ND - GAIN PENSION ASSET DATA The country data on pension assets-to-GDP ratio and the Pension Funds 2019.35 Countries that have legislation or laws percentage of pension fund assets invested domestically banning foreign investment by pension funds were assumed came from several sources. The primary source of pension to have 100 percent of pension fund assets held domestically. data was the OECD Global Pension Statistics, which offers the In addition, countries that had pension fund foreign investment most comprehensive global coverage.34 This data details the limits, and where other data was unavailable, were assumed size of countries’ pension assets as a percentage of GDP and to invest up to that limit i.e. if a country had a 15 percent the percentage of assets held domestically for 49 countries. limit on foreign investments pension funds were assumed to Further data on pension fund domestic assets was derived diversify their assets and invest 15 percent in foreign assets from the OECD Annual Survey of Investment Regulation of with the other 85 percent held domestically. 29. In this analysis we use the ND-GAIN score unadjusted by GDP. 30. Chen et al (2015) 31. “Germanwatch,” 2020, https://germanwatch.org/en. 32. Chen et al. (2015) 33. Chen et al. (2015) 34. “Global Pension Statistics,” OECD, 2019 35. “Annual Survey of Investment Regulation of Pension Funds” (OECD, 2019) 16 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT Other supplementary sources of data were used to fill data gaps on percentage of domestic assets. This was important in order for a more comprehensive understanding of climate risks faced by SIDS and high-income economies that had data missing. The team used the World Bank and Pacific Island Investment Forum pension funds data to provide a detailed breakdown of the size of and assets of pension funds across the Pacific Islands including Fiji, Papua New Guinea, and Vanuatu. Pension asset data for Germany, Canada, and Australia was used from the PwC Beyond their Borders 2020 publication.36 In order to include the US in our analysis, data from CEM Benchmarking on US pension funds was used as a proxy for the percentage of US pension funds held domestically and in foreign assets.37 METHODOLOGY To derive the overall country pension score, countries • Second, a country with pension fund assets held in several were split into quintile groups based on their values geographical areas in the event of a domestic climate shock across ND-GAIN score, pension assets-to-GDP ratio, and will have more diversified exposure compared to a country percentage of pension assets held domestically. Quintile whose assets are solely held domestically. Therefore, the thresholds were identified, and each country was assigned a percentage of domestic pension assets offers a useful corresponding quintile group based on their relative score. A proxy for the level of climate risk diversification. quintile group of “1” indicates the best score and “5” indicates the worst score. For this purpose, the ND-GAIN index was inverted Table 1 details the cut-off score for each quintile group. so that a higher score indicates higher vulnerability and lower A country’s raw scores on each variable determine the quintile readiness to implement climate change adaptation measures. group allocation. Any country with pension asset-to-GDP Two other important assumptions were made in this process. ratios above 50.8 percent, with 95 percent of those assets • First, countries which have a high exposure to climate held domestically would be assigned the worst quintile score change and also have larger pensions asset-to-GDP of 5 for both variables. Thus, if a country has 100 percent of ratios potentially face greater negative shocks to their pension assets held domestically, they will be assigned to portfolios and investments from these risks. In the event quintile group 5 for this measure, and if these assets represent of severe climate impacts, pension investment returns under 1 percent of GDP, the country will be assigned a quintile could be severely reduced with increased risk of stranded score of 1 for this measure. An ND-GAIN score of 5 would be assets. While every pension fund is vulnerable from the assigned to quintile group 1, a score of 9 to quintile group 2 material effects of climate change, larger pension funds and so on. that fail to adapt will have larger economic ramifications. > > > T A B L E 1 - Quintile groupings Inverted Pension assets as Percent of pensions ND-GAIN score a percent of GDP assets held domestically Q1: 0-20% 33.51492188 5.663666667 59.86666667 Q2: 20-40% 41.32910328 8.990666667 75.64 Q3: 40-60% 48.60772015 16.3 86.43333333 Q4: 60-80% 54.98604968 50.84966667 95 Q5: 80-100% <54.9860496799179 <50.8496666666667 <95 36. “Beyond Their Borders: Evolution of Foreign Investments by Pension Funds” (PwC, 2020), https://www.alfi.lu/getattach- ment/bbd902ee-feb9-4534-b68c-aee8c6706f4e/alfi-evolution-of-foreign-investments-by-pension-funds.pdf. 37. “CEM Benchmarking,” 2020, https://www.cembenchmarking.com/. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 17 The final step to derive the overall pension climate risk Moreover, the double-weighting also accounts for the fact score involved weighting the quintile groups across the that many countries pension systems are non-existent or three variables. Pension asset-to-GDP ratio was double- represent a small percentage of GDP. The ND-GAIN index weighted to reflect the higher economic exposure countries and percentage of assets held domestically were weighted with much larger pension assets face from climate risks. equally. Therefore, the pension risk score for each country is: (0.25*ND-GAIN quintile) + (0.5*percent GDP pension assets quintile) + (0.25* percent domestic assets quintile) For example, if a country was in quintile group 5 for ND-GAIN, 4 for percentage of pension assets of GDP and 2 for domestic pension assets the overall pension fund climate risk would be: (0.25*5) + (0.5*3) + (0.25*4) = 3.75 18 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT FINDINGS Figure 5 is a heatmap of the pension fund climate risk scores as described above. On this heatmap, yellow indicates a country with a lower pension fund climate risk; orange, a medium pension fund climate risk; and red, high pension fund climate risk. The mapping indicates countries’ risk relative to each other and a low pension risk score does not preclude mitigative action. Indeed, no country scored in the top quintile for each variable and climate risks of country pension funds are often different in nature. > > > F I G U R E 5 - Country Pension Climate Risk Heatmap 1.25 4.5 European countries such as Italy, Latvia, Lithuania, Perhaps unsurprisingly, small island economies such Sweden, and Slovenia have the lowest pension fund as Papua New Guinea, Fiji, and Vanuatu have the highest climate risk. This is in part because all have a much lower levels of pension fund climate risk scoring relatively percentage pension assets relative to GDP compared to poorly on every measure. In addition to facing high country other high-income countries and, indeed, many low-income climate risk as small island developing states (SIDS), their countries. The asset-to-GDP ratio for Latvia is only 1.5 percent pension funds hold most assets domestically - 100 percent and 5.6 percent in Sweden. Likewise, these countries have in the case of Vanuatu, 93 percent in Fiji, and 87.2 percent higher levels of diversification of assets (i.e. small percentages in Papua New Guinea. Moreover, compared to other smaller of assets held domestically) and score relatively well on the economies, these countries have relatively high pension ND-GAIN index. Despite facing high climate risk, Armenia assets as a percentage of GDP. Small island countries in faces comparatively low pension risk due to small asset-to- particular are vulnerable to effects of climate change such as GDP ratio and with pension funds holding approximately 30 sea level rise. In addition, their pension funds face substantial percent of assets abroad. risk because of limited geographical portfolio diversification. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 19 Similarly, South Africa has one of the highest levels while facing higher country climate risk than Uruguay and of pension risk overall and compared to other African Costa Rica, have a lower level of pension climate risk. Mexican countries. While pension funds in South Africa invest 23 pension fund foreign assets are slightly higher and the asset- percent in foreign - a medium risk score - the country performs to-GDP ratio is lower than both Uruguay and Costa Rica. poorly on the ND-GAIN index and has a relatively large asset- Conversely, Colombian pension funds invest approximately to-GDP ratio. Many countries in the region face high levels 32 percent in foreign assets, which is comparatively high of pension risk with high climate risk and the majority of for the region. The majority of the countries in this region assets invested domestically. That said, countries such as performs poorly on all measures with the exception of Chile Egypt, Mozambique, and Zambia perform well compared to and Peru. Chile scores well on the ND-GAIN index and has their peers. However, this is driven for the most part by their comparatively higher diversification of pension fund portfolios small pension fund size compared to GDP as these countries with slightly over 59 percent of its assets held domestically. perform poorly otherwise. Peru, while facing high domestic climate risk, similarly has geographically diversified pension assets. While performing relatively well on country level climate measures, high income countries such as the Asian countries, broadly defined, fare relatively United States, Canada, Australia and the United Kingdom better compared to other regions, with the exception are classified as medium to high level risk because of of Singapore. Singapore has one of the highest pension the large relative size of their pension fund assets. All of climate risks due to a high asset-to-GDP ratio and the fact these countries have average pension assets-to-GDP ratios that the entirety of its pension assets are held domestically. over 80 percent for the 2015-2017, with Australia’s ratio In contrast, South Korea has the lowest pension climate risk above 120 percent. These economies are better equipped to of the region, scoring well on the ND-GAIN index and with adapt to climate challenges, but the potential material risk on an asset-to-GDP ratio of 8.9 percent. However, the South pension fund assets is large. Many of these countries should Korean pension assets are 90 percent domestic scoring it in take advantage of the opportunities that greening the pension the second lowest quantile grouping. India and Pakistan face system can bring, with green finance markets increasing in higher levels of pension risk, in particular because they either prominence and offering long-term returns. have bans on pension funds investing in foreign assets or no effective rules to do so. As a result, all pension assets are held The majority of South American countries score medium domestically in these two countries. Indonesia’s pension risk to high risk. Brazil, Costa Rica, and Uruguay score high to is comparatively low overall and for the region, however, this medium on pension climate risk indicators. For the most part, is driven by a very low asset-to-GDP ratio of 1.8 percent, with the pension assets of these countries are held domestically high country climate risk and low pension asset diversification (above 90 percent for all three) and the countries score otherwise. Table 2 further details the top and bottom scoring relatively poorly on the ND-GAIN index. Mexico and Colombia, countries on the pension fund climate index. > > > T A B L E 2 - Highest and lowest pension risk scores by country TOP 3 LOWEST TOP 3 HIGHEST Pension Climate Risk Scores and Countries Pension Climate Risk Scores and Countries 1.25 Latvia 4.5 Fiji, Vanuatu 1.5 Sweden 4.25 Papua New Guinea, South Africa 1.75 Armenia, Italy, Lithuania, Slovenia 4 Malawi, Singapore, Trinidad and Tobago 20 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT CONCLUSION Overall the analysis indicates that pension funds face An important assumption made in this analysis is that climate risk and different countries are vulnerable in different geographical diversification of assets reduces climate risk ways. While many high-income countries may have the capacity unanimously. While this is often plausible in many scenarios, to adapt to the challenges of climate change, large asset-to-GDP future research could account for foreign asset risk by deriving ratios mean the material effects of climate change could be large. a measure of average world climate risk. This, however, would In addition, the limited capital invested in green assets even by have to take into account feasible assumptions about world pension funds leading in the green finance space should be a pension asset allocations by geography. A potential proxy for cause for concern. Nine low income countries in our analysis the risk of pension foreign asset allocations could be world have 100 percent of pension assets invested domestically. equity indices such as the MSCI All Country World Index Indeed, the general trend is that low income countries have much (MSCI AWCI), which could be weighted by the ND country lower geographical diversification of assets despite facing high climate risk methodology. These could be used to derive a levels of pension risk in most cases. These risks are particularly weighted value for the climate risk of foreign assets based on prominent for SIDS. Greater geographical diversification of the percentage of assets invested in each country. In addition, assets, and in some cases changes of regulation to allow this, a more ‘bottom up approach’ could be taken, analyzing the are recommendations that follow from this analysis. sectoral exposure of different countries stock market indices to see which are particularly exposure to high emission While every effort was made to use the most sectors such as energy.38 This information could further refine comprehensive data and coverage, there are some the analysis of how much climate risk pension funds’ domestic limitations that future research should seek to address. investments represent. First, missing data on several pension funds means that the analysis is restricted to 71 countries. Following works could In summary, this climate risk map should serve as a seek to analyze the pension fund risk of a wider number of starting point to identify country level pension fund risk countries. Second, this analysis assumes the same level of and for pension systems and pension funds to begin pension fund climate risk and allocation of pension fund assets addressing them. The methodology uses three variables and across entire countries. For large countries such as the US a system of quintiles to assess the exposure to climate-change and Australia, where regional pension funds are more or less of pension funds in 71 countries, and the findings emphasize active in the green finance space, this might not necessarily that pension systems are vulnerable in different ways. Many be true. A more granular regional analysis could provide European countries have the lowest pension climate risk, further interesting insights. Third, the analysis could benefit notably because of a much lower pension asset to GDP ratio from incorporating other important measures of climate risk compared to other countries. Small island economies have such as the impact of extreme weather events and measures the highest levels of pension climate risk and their pension indirectly related to climate change - e.g. air pollution, waste systems face substantial risk because of limited geographical management - should be considered. Factoring in risks portfolio diversification. Most African countries, with some from extreme weather events would highlight an increased notable exceptions, face high levels of pension risk with high vulnerability and risk for small island nations, which already climate risk and the majority of assets invested domestically. face the highest pension risk according to our measure, but Some high-income countries are classified as medium to high are likely underweighted in terms of e.g. hurricane risk. In level risk because of the large relative size of their pension addition, the robustness of these findings may be checked fund assets. The majority of South American countries perform against other climate risk indexes. poorly on all measures, except Chile and Peru. Asian countries fare relatively better compared to other regions. 38. For example, some domestic stock indexes (such as in Colombia or Latvia) are particularly heavily weighted towards the energy sector. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 21 3. >>> Regulatory Landscape INTRODUCTION An important counterpart to mapping country pension climate risk is the regulatory environment that pension funds operate in which can act as an important mitigant. Since 2008, there has been a strong momentum towards stricter regulatory measures across the world’s 50 largest economies in the area of sustainable investments applicable to asset owners with a 250 percent growth in the number of regulatory measures in this field, reaching 350 measures in 2016. By 2019, across some 500 policy instruments, more than 730 hard and soft law policy revisions existed to encourage or require investors to consider long-term value factors.39 Most of the regulations focus on long-term value drivers, including ESG factors. Regulatory initiatives that reinforce responsible investment practice for pension funds can catalyze ESG incorporation into investment decision making and help reduce the material risks climate change poses to pension funds. Regulatory norms, in particular in relation to fiduciary duty, put further impetus behind the agenda of responsible investment. Some national supervisory authorities have already made ESG integration and disclosures mandatory. For example, in November 2018, Sweden introduced new investment guidelines for AP funds 1-4. These include flexibility to invest more in illiquid asset classes and more in-house oversight. Most importantly, AP 1-4 must invest in a way that contributes to sustainable development.40 In March 2020, Mexico’s National Commission for the Retirement Savings Systems (CONSAR) published mandatory provisions for pension funds relating to ESG integration in debt and equity, ESG risk and investment policies, and ESG disclosure that will go into effect in 2022.41 For this paper, an extensive review of regulations on sustainable investment for pension funds was undertaken. This aimed at: providing an overall picture of the level of advancement on socially responsible investment (SRI) and responsible investment (RI) legal frameworks; identifying best practices and laggards; comparing this legal backdrop with the exposure of national pension funds to climate-related financial risks; and measuring the extent to which international regulatory standards and recommendations around ESG have been implemented. The goal is to outline potential regulatory enablers of sustainable investment that mitigate climate exposure and vulnerability and foster positive social and environmental impacts. This relationship was explored with two methodologies: a regulatory map and a survey. 39. “Taking Stock: Sustainable Finance Policy Engagement and Policy Influence” (Principles for Responsible Investment, 2019) 40. Rachel Fixen, “Swedish Parliament Approves Buffer Fund Investment Freedoms Bill,” IPE, November 2018, https://www. ipe.com/swedish-parliament-approves-buffer-fund-investment-freedoms-bill/10028423.article. 41. “DISPOSICIONES de carácter general en materia financiera de los Sistemas de Ahorro para el Retiro” (2020), https://www. gob.mx/cms/uploads/attachment/file/542142/CUF_compilada_20200303.pdf. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 23 3.1 Regulatory mapping D ATA METHODOLOGY The main database is the United Nations Principles The regulatory map combined quantitative and for Responsible Investment’s regulation map. This map qualitative approaches. The qualitative approach, based on covers 500 responsible investment-related legislation and soft a granular review of the existing regulatory frameworks and law initiatives across the 50 largest economies in the world.42 norms of 23 countries aimed at identifying the requirements, Per the PRI’s methodology, the regulation map indicates the binding or non-binding, related to: year of implementation, the responsible authority, whether • The definition of asset owners’ fiduciary duties as regards the measure is voluntary or mandatory, the integration of ESG issues in their investment processes and capital environmental, social and/or governance issues, and whether allocations; it addresses these issues in isolation or in combination. Data • The nature and scope of the requirements to disclose pertaining to ESG regulation targeting pension funds was ESG issues; selected, which included requirements to incorporate ESG or • The nature and scope of the requirements to engage with disclose how ESG is considered, stewardship codes, and best companies and issuers on ESG issues; principles for engagement and voting. Almost half—23 of the • The nature and scope of the requirements to report on ESG 50 countries analyzed in the PRI database—possess or are issues, and the mention of specific reporting guidelines; working on rules regarding pension funds and ESG criteria. • The differentiated weight given to each pillar of ESG issues; Most regulatory frameworks do not refer to ESG issues with • The attention given in legal frameworks to the long- explicit directives on how to integrate them. However, there is term impact of climate change and the recognition of its an upside to such flexibility; these frameworks do not prevent materiality to investment outcomes; pension funds from making further effort on ESG integration.43 • The mention of exclusion requirements by negative screening (e.g. exclusion of investments in the tobacco industry); Additionally, the research was supplemented with the • The presence of control mechanisms or sanctions following reports and databases: attached to SRI regulation. • OECD 2019, “Annual Survey of Investment Regulation of Pension Funds” 44; This data was compared across regions to identify similarities • EUROSIF 2011, “Corporate Pension Funds and based on geography, type of pension funds (i.e. defined benefit or Sustainable Investment Study”45; defined contribution), size in terms of assets under management, • PRI 2016, Global Guide to Responsible Investment and type of law (e.g. Common Law or French law). Regulation46; • World Bank 2018, Incorporating Environmental, Social The quantitative analysis built on the findings of our and Governance (ESG) Factors into Fixed Income qualitative research. First, pension funds for 50 countries were Investment.47. mapped into the database by identifying the legal specificities applicable to pension funds pertaining to sustainable investment. Specifically, whether ESG regulation pertained to pension funds was examined, whether it was mandatory, voluntary, or comply- or-explain, whether it requires ESG integration and how each pillar is considered, whether there is an exclusion policy, and whether there is a requirement to report or disclose ESG issues. The mandatory regulation designation indicates that some type of stewardship law exists that does not directly address ESG, whereas the mandatory ESG regulation designation is given to countries where clear ESG guidance exists. 42. “Responsible Investment Regulation Map,” Principles for Responsible investment, September 9, 2019, 43. “Responsible Investment: 2017 Annual Study” 44. OECD “Annual Survey of Investment Regulation of Pension Funds” 45. “Corporate Pension Funds & Sustainable Investment Study” (Eurosif, 2011) 46. “Global Guide to Responsible Investment Regulation” (Principles for Responsible Investment, 2016), 47. Inderst and Stewart (2018) 24 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT For each above-mentioned criterion, a numerical score between one and ten was allocated. Lower scores indicate higher regulatory risk. The score came from both ESG regulations and national stewardship codes. Stewardship code guidelines were discounted by one-third, to reflect the focus on regulation. The below grid indicates our scoring matrix (See Table 3). > > > T A B L E 3 - Scoring Matrix for Regulatory Risk Mandatory ESG M*ESG 10 Mandatory Environmental M*E 9 Mandatory Social M*S 8 Mandatory Governance M*G 8 Comply-or-Explain ESG C*E*ESG 7 Mandatory M 7 Voluntary ESG V*ESG 5 No ESG N 1 FINDINGS The methodology yielded the below comparison of America they are almost exclusively voluntary. The following climate risk to regulation risk data (See Figures 6 and definition was adopted for “hard” or mandatory regulations: 7). Overall, the majority of countries have several regulatory sustainable investment norms applicable to pension funds frameworks that pertain to sustainable investing for pension set out legally binding and specific duties and obligations. For funds, weaving mandatory and voluntary elements together. The soft” or voluntary guidelines: sustainable investment guidelines interpretation and nature of sustainable investment regulation applicable to pension funds refer to a large spectrum of quasi- tend to vary across geographical regions. In Europe, regulations legal instruments that are not clearly defined, leaving the level tend to be relatively prescriptive, whereas in Asia and North of application to the pension funds.48 48. Neher (2017) PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 25 > > > F I G U R E 6 - Comparing pension climate risk and regulatory risk United Kingdom Czech Republic United States South Africa Netherlands Switzerland Singapore Indonesia Colombia Denmark Germany Australia Malaysia Romania Pakistan Thailand Portugal Belgium Sweden Norway Canada Finland Nigeria Mexico Poland Turkey Japan Egypt Spain Brazil Israel India Chile Peru Italy Pension Climate Risk Regulation Risk Overall climate & regulation Risk Low High SCALE Risk Risk > > > T A B L E 7 - Disaggregated scores for pension climate risk and regulatory risk United Kingdom Czech Republic United States South Africa Netherlands Switzerland Singapore Indonesia Colombia Denmark Germany Australia Malaysia Romania Pakistan Thailand Portugal Belgium Sweden Norway Canada Finland Nigeria Mexico Poland Turkey Japan Egypt Spain Brazil Israel India Chile Peru Italy ND Quintile % GDP Quintile % Domestic Quintile Pension Climate Risk Pension Fund Regulation Score Stewardship Code Score Regulation Risk Overal Climate & Regulation Risk Low High SCALE Risk Risk Additionally, 21 out of 50 national jurisdictions have Examining each jurisdictions climate risk score against implemented regulations regarding ESG reporting and its regulatory risk score, as indicated in the tables below for disclosure requirements. Some jurisdictions implemented select jurisdictions. This allowed four important categories of “comply-or-explain” policies in their disclosure process, e.g. combined risk to be identified (See Figures 8): highly regulated South African, Norway. Most others require disclosure without low climate risk countries, highly regulated high climate risk issuing specific guidelines on how such disclosure should occur. countries, lightly regulated low risk countries, and countries with Self-regulation plays an important role in many countries, with high climate risk and improving regulation. many pension funds recognizing the materiality of ESG factors and adjusting investment strategies accordingly. 26 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT > > > F I G U R E 8 - Four-quadrant matrix of combined climate and regulatory risk in 35 jurisdictions Comparing Climate Risk and Regulatory Risk 5.00 4.50 South Africa 4.00 Singapore Israel Brazil Malaysia Colombia 3.50 Nigeria Pen Australia Mexico United States Canada Switzerland Chile United Kingdon 3.00 Netherlands Japan Pakistan Climate Risk Score Spain Thailand India Denmark Egypt Finland Turkey 2.50 Poland Indonesia Germany Belgium Norway 2.00 Romania Portugal Italy Czech Republic 1.50 Sweden 1.00 0.50 0.00 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Regulatory Risk Score 1. COUNTRIES WITH LOW PENSION VULNERABILITY TO C L I M AT E C H A N G E A N D LO W R E G U L ATO RY R I S K : This category consists of exclusively European countries, all of which displayed a high level of ESG-related regulatory measures and frameworks (See Focus Box 2). France is particularly ahead with far-reaching requirements in terms of ESG reporting by pension funds. The French Article 173-VI of the Energy Transition Act requires pension funds to provide information on how they integrate ESG factors in their investment, voting decisions, exposure to climate risks, and contribution to the transition to a low carbon economy in their portfolio construction. Amongst European countries, Scandinavian countries have pioneered the introduction of standards and frameworks promoting ESG activities in financial management. For example, the Norwegian Government Pension Act of 2005 led the government to introduce a set of ethical guidelines. Given the influence and size of the Norwegian pension fund, these guidelines have become a benchmark for responsible investment across Europe and beyond. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 27 > > > B O X 1 - European Sustainable Finance Regulatory Framework At the EU level, the Institutions for Occupational • The Act of 19 February 2001 (Loi Fabius) introduced Retirement Provision (IORP) Directive provided a an incentive for pension funds to take environmental common set of basic requirements across member and social criteria into account in their asset states until recently. Its second iteration, IORPII defined management policy, and enabled the creation of the importance attached to ESG factors both in terms of solidarity-based employee savings funds. the potential impact of ESG factors on portfolio risks and • The Act of 17 July 2001 stipulates that investors’ returns, and pension funds’ role as long-term investors. management board, which implements the However, it allowed pension funds the discretion to orientations of the institution’s investment policy, integrate ESG factors in their investment policy on a reports to the supervisory board on “the manner in voluntary basis, as follows: “Member States should which the general orientations of the fund’s investment require IORPs to explicitly disclose where these factors policy have taken into account social, environmental are considered in investment decisions and how they are or ethical considerations”. part of their risk management system”. • The law of 12 July 2010 on national commitment to the environment requires “société d’investissement With the 2018 EU Action Plan on Sustainable Finance, the à capital variable” (SICAVs) and management level of requirement regarding ESG integration will increase. companies to disclose how they consider ESG issues The Taxonomy Report has been published (March 2020), in their investment policy and how they exercise the and disclosure requirements will apply to pension funds as voting rights attached to the financial instruments they are financial market participants. For each relevant resulting from these choices. product, pension funds will be required to state: • The law of 17 August 2015 on the energy transition for • how and to what extent they have used the Taxonomy green growth extends these obligations to institutional in determining the sustainability of the underlying investors and requires them to fully disclose their investments; investment guidelines, the carbon footprint of their • to what environmental objective(s) the investments portfolios and their orientation to climate targets, as contribute; well as reporting their climate risks. This is the first • the proportion of underlying investments that are law of its type worldwide. Taxonomy-aligned, expressed as a percentage of the investment, fund or portfolio. UNITED KINGDOM Similarly to France, the UK is particularly ahead on The revision of the EU Pension Fund Directive “Guideline sustainable investment guidelines for investors and asset on the activities and the supervision of occupational owners. Notably, several laws promote transparency of pension schemes” (2016) is another milestone for pension funds and investment strategies in charities, and sustainable investments. Among other things, it compels include tax breaks for investments for solidarity purposes. pension funds to disclose the extent to which ESG factors • The Occupational Pension Schemes (Investment) are considered both in their investment decisions and in Regulation (1995-2001) compels local government their risk management systems. This regulatory measure pension funds’ Statement of Investment Principles is likely to have a “multiplier effect” by influencing the to report (in their Statement of investment principles reporting practices of multinational companies. or Declaration of Investment Principles) the extent to which social, environmental and social criteria are FRANCE taken into account; and when they select, retain or Since 2001, France has enacted a large number of carry out their investments. laws governing sustainable investments targeted at • The “Code of practice for defined-contribution pension funds, state pension schemes, and investment schemes” (2016) requires pension funds to take into companies. The 2015 revision of the law on the energy consideration all financially relevant factors, including transition for green growth signaled a very ambitious ESG criteria, in their investments. policy on ESG integration by asset owners and investors. 49. “European SRI Study” (Eurosif, 2018), http://www.eurosif.org/wp-content/uploads/2018/11/European-SRI-2018-Study.pdf; “L’investissement socialement responsable,” Ministère de la Transition écologique et solidaire, February 7, 2019, https://www.ecologique-solidaire.gouv.fr/linvestissement-socialement-responsable. 28 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT 2. COUNTRIES WITH LOW 3. COUNTRIES WITH A HIGH PENSION VULNERABILITY TO PENSION FUND VULNERABILITY C L I M AT E C H A N G E A N D M E D I U M TO C L I M AT E C H A N G E A N D LO W TO H I G H R E G U L ATO RY R I S K : R E G U L ATO RY R I S K S : Some EU countries have regulatory frameworks and These countries have a high level of ESG-related standards that are not aligned with best-in-class member regulatory measures and frameworks. This category states, notably those in Eastern Europe. Romania and the includes Brazil, the Netherlands, South Africa. The high level Czech Republic have a low level of ESG-related regulatory of ESG integration is often related to regulatory tradition and measures and frameworks. The Czech Republic in particular historical development. The more profoundly the ESG concept does not have any pension fund regulation regarding ESG, is rooted in the public’s awareness and the earlier codes have nor a stewardship code. In terms of disclosure requirements, come out, the more advanced later regulation is. For example, none of the regulatory frameworks in Slovakia, Hungary, socially responsible investing (SRI) is deeply rooted in the and Poland require pension funds to disclose their approach South African market. In fact, some of the earliest records regarding ESG investing. Albania, which is set to accede to of such investments date back to the Apartheid boycott of the EU, also lacks disclosure regulation. South African companies. Initiatives such as the King Code on Corporate Governance (revised repeatedly from 1994 to 2017) have also played a role. As awareness of the importance of ESG issues has grown, so has investor demand for greater transparency. > > > B O X 2 - South African Sustainable Finance Regulatory Framework • Circular 130 (2007), created by the financial • CRISA – the Code for Responsible Investing in regulatory agency, provides guidance on how to South Africa (2011) encourages the entire investor include responsible investment policies and suggests community to implement ESG components of the that risk management should not be limited solely to regulation 28 as long as other aspects belonging to financial aspects. international voluntary codes (e.g. UN-PRI). It also • The revised Regulation 28 of the Pension requires investors to consider the King Report on Fund Act (effective in 2011) states that pension Corporate Governance South Africa (King III) with funds should address all factors (including ESG) regard to the principles for governance structures and that may affect an investment on the long term. sustainable operations. • 4th iteration of the King Code (2016) underlines that institutional investors are compelled to implement an active engagement strategy. 4. COUNTRIES WITH MEDIUM TO HIGH PENSION VULNERABILITY TO C L I M AT E C H A N G E A N D A N I M P R O V I N G , B U T M E D I U M TO H I G H , L E V E L O F R E G U L ATO RY R I S K These countries have been steadily improving their explicit regulations or guidelines related to climate change or level of ESG-related regulatory measures and frameworks. ESG factors. However, since hosting COP25 last year, Chile They are not geographically concentrated. This category has started the regulation design process. Led by the Ministry includes some Asian countries like Japan, Malaysia, some of Finance, pension fund administrators and other financial Latin American countries like Chile. In Japan, the strong sector representatives signed a green agreement to establish central government impetus will mean that any regulation a working plan beginning in 2020. The agreement defines a will be government driven. According to the Chilean pension series of specific commitments to incorporate ESG guidelines regulatory agency, Chile has just started to implement ESG and considerations and to manage the risks and opportunities integration at the national level. As of yet, they do not have any associated with climate change. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 29 > > > B O X 3 - Sustainable Finance Regulatory Framework Japan The Japanese State pension fund, the GPIF, is leading In 2017, the Japanese Ministry of the Environment the sustainable investment agenda for pension funds, released green bond guidelines, which boosted green along with significant changes in the regulation. In 2014, issuances from four to eleven in one year. Continuing Japan became one of the first markets in Asia to adopt on this path, the High-Level Meeting by the Government a Stewardship Code. The seven-principle code aimed on ESG Finance in 2018 led to the report entitled to encourage investors to promote sustainable returns “Toward becoming a big power in ESG finance”. This and growth through the use of shareholder voting and ambitious publication included a set of non-binding engagement. In 2017, the amended Code explicitly recommendations on climate disclosure, engagement, asked signatories to consider medium- to long-term regional ESG finance, ESG literacy, and development of sustainability criteria in their engagements, including ESG products across asset classes. ESG factors, and required institutional investors to disclose the rationale of their vote to combat conflicts of interest in voting decisions. 3.2 Survey To supplement the regulatory map, a survey of pension The survey reflected the IOPS guidelines and their struc- supervisory authorities was undertaken, which aimed to ture. In order to effectively capture the current ESG trends at identify how each supervisory authority is interpreting both the policy and practice level, the survey was divided into global best practices and standards on ESG integration two sections: Section I Regulatory Framework and Section II in the pension industry. The survey aimed to supplement Market Practice. Section I examined whether, and if so how, the regulatory map by identifying how each supervisory each supervisory agency incorporates ESG factors into its authority is interpreting global best practices and standards regulatory framework on areas including investment method- on ESG integration in the pension industry. The IOPS50 ologies, risk assessment, stress-testing, and disclosure of infor- recently released ESG guidelines to provide voluntary mation. Several questions focused on details of the regulatory guidance to regulators, supervisors, and other entities who agency’s efforts on ESG factors such as providing guidance on supervise the consideration of ESG factors in the investment ESG disclosure and ESG reporting standards to pension funds and risk management processes of pension funds51. In terms under its jurisdiction. Section II focused on the pension funds of environmental risk, the guidelines consider physical, under each regulatory agency’s jurisdiction, specifically on their transition, and liability risks to be material. This is in addition practices towards ESG factors, green investing, climate-related to social risk, e.g. child labor and slavery, health and safety, risks and investment as well as the main barriers to incorporat- discrimination, and governance risk, e.g. executive pay ing ESG factors. The survey is beneficial in two ways: on one issues, bribery and corruption. The guidelines are divided into hand the written portion of the survey, in which many supervi- four sections: overall consideration of ESG factors, integration sors highlighted relevant laws and regulations in their jurisdic- of ESG factors, disclosure of ESG factors, and scenario of tions, allowed for the identification of clear trends in pension investment strategies. A summary of the guidelines is included regulation as it pertains to ESG factors; on the other hand as in the appendix (see appendix 3). the survey closely follows the IOPS guidelines, the survey can serve as a tool for further research and/or monitoring the imple- mentation of the guidelines. 50. The IOPS is an independent international body that cooperates closely with the OECD, the World Bank, International Social Security Association (ISSA), Internation- al Association of Insurance Supervisors (IAIS), and the IMF. Its overarching goal is to support effective supervision of private pension systems worldwide. Its main objectives are to: serve as a pension supervisory standard-setting body; facilitate international cooperation; promote the implementation of international standards; and assist countries with less developed private pension arrangements. The IOPS currently has 90 Members and Observers, representing members from 79 jurisdictions and territories. For further information see www.iopsweb.org 51. http://www.iopsweb.org/iops-supervisory-guidelines-esg-factors.htm 30 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT FINDINGS The survey received 18 responses:52 Angola, Australia, Austria, Bulgaria, Chile, Colombia, Guernsey, Iceland, Ireland, Kenya, Malawi, Mexico, Namibia, North Macedonia, Romania, Slovakia, South Africa, and Uganda. The respondents’ income classification is shown in the figure below. > > > F I G U R E 9 - Income Classification by World Bank Income Groups 11% 11% 39% 39% Low Lower Middle Upper Middle High S E C T I O N I . R E G U L AT O RY F R A M E W O R K The survey allowed for the mapping of various regulatory frameworks which, lay out how to consider and incorporate ESG factors into investment-processes. The following implementation patterns were identified (See Figure 10). > > > F I G U R E 1 0 - Types of ESG Regulations Implemented Does the pension regulation framework require consideration of ESG factors? 78% 78% 72% 72% 17% 17% 11% 11% 17% 11% 17% 11% Incorporation of ESG into Incorporation of ESG into Stress testing of Disclosure of ESG risks investment methodologies risk management processes climate or other risks and opportunities Mandatory Voluntary Not allowed 52. The IOPS Secretariat, in coordination with the client, administered the circulation and participation of the survey. The full survey questionnaire is available under the appendix of this report (appendix 2). In total, the survey contained 15 questions with estimated time-to-complete of under 20 minutes. Due to the COVID-19 pandemic, the survey received fewer responses than expected. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 31 • ESG integration: Pension supervisors overwhelmingly 72 percent reported that they did not provide guidance on reported that ESG integration is voluntary in their ESG disclosure. Among those that provided investment jurisdiction. Only 22 percent of the respondents had at guidance, guidance on risk management and stress- least one mandatory requirement on ESG consideration testing was most prevalent. All who provided disclosure in either investment methodology, risk management, or guidance required disclosing ESG investment policy to disclosure. One country reported mandatory consideration the supervisory authority itself, while some also required of all three categories. Seventy-two percent reported that reporting to members and stakeholders. Most glaringly, all current ESG regulations are voluntary, though many EU however, no jurisdiction had implemented any type of countries indicated that they had either already or will soon reporting or labeling of green investment including green transpose the IORP II directive into mandatory national taxonomies, label bonds, green loans, or other investment law. Among those who adopted a mandatory or voluntary labeling. However, this is bound to change with the ESG framework, it was common to consider ESG factors recently published EU taxonomy recommendations. in investment decisions and reporting. Some of them Finally, 84 percent of the respondents indicated that also assess ESG factors in risk management. Only two they had no requirements on ESG considerations when respondents, one in Africa and the other in Latin America, awarding mandates or monitoring external managers, specifically defined ESG integration as inconsistent with though half of those indicated they had plans to implement fiduciary duty. Finally, there was no significant difference such guidelines. in uptake of ESG regulations between low- and high- • ESG-related networks: Most supervisory authorities income countries. reported that pension funds in their jurisdiction had • ESG guidance: The majority of supervisory agencies not joined any international ESG-related networks, provided no guidance on ESG integration into or that they did not collect information about these investment management and disclosures. None had partnerships. The United Nations Principles for reporting standards for green investments. Overall, Responsible Investment (UN PRI) was most cited for 77 percent of the jurisdictions reported that they did not those that belong to a network. provide guidance on ESG investment management and SECTION II. MARKET PRACTICE The survey then went on to examine how ESG factors are being incorporate by pension markets in practice. The following outline the main findings (see Figure 11): > > > F I G U R E 1 0 - Main barriers to ESG incorporation What is the Financial barriers 17% 17% main barrier to Lack of climate-related incorporating disclosure and ratings ESG factors Unclear policy into investment 5% environment decisions for the pension Transition costs funds in your 17% Fiduciary duty jurisdiction? Lack of knowledge Other 22% 5% 17% 32 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT • Main drivers to green investment: Performance is the CONCLUSION main driver for pension funds to pursue green invest- The regulatory map and survey results, considered ments, followed closely by diversification and sustain- together, indicate several trends. ability. Some respondents indicated that the importance of • First, the responses indicated that the current level of ESG factors should be balanced against the adequacy of ESG integration remains limited and divergence exists pensions and insulation of pension savings from inflation. from regulatory guidance. More often than not, ESG • Main barriers to green investment: The four most impor- consideration was voluntary. All EU countries indicated tant barriers to greening investment were fiduciary duty; that they were in the process of transposing IORP II. unclear policy environment; lack of climate-related dis- Consistent with the regulatory map, it was observed closure and unreliable ratings; and lack of ESG-specific that older EU members had pre-existing national ESG knowledge and data.53 The overall barriers reported by legislation, while newer members had not yet or only pension supervisors can be divided as follows: recently started regulating ESG issues. » Structural barriers: unclear policy environment (e.g. • Second, the responses in the market practice section inconsistency in policy) and the lack of standards indicated that pension funds in many jurisdictions did and certification. not consider nor engage with companies on climate » Financial barriers: fossil fuel subsidies, unpriced car- risks separately from overall ESG risks. The pension bon externality, and transaction costs due to the size supervisors attributed the lack of green investment to of green bonds. barriers including a lack of environmental policy support, » Technical barriers: the lack of common taxonomy, regulatory disincentives, lack of appropriate investment analysis and methodology as well as knowledge and data for ESG investments. vehicles and market liquidity, transaction cost issues, and » Legal barriers: some respondents also indicated a lack of knowledge, track record, and expertise among fiduciary duty as the main barrier. The findings of pension funds regarding ESG investments and their the survey and literature review reveal that regula- associated risks. tors and managers have a very extensive definition • Third, among countries with medium to high pension of intentionality. The assumption that fiduciary duty climate risk, levels of regulatory improvement differed is only about maximizing financial returns ignores dramatically. Some countries in this category had other important considerations that affect this same immediate plans to implement guidance on ESG financial efficiency. Fiduciary duty on one hand, and investment management and disclosure, whereas others intentionality about environmental and social consid- still legally prohibited ESG incorporation for pension erations on the other hand are not mutually exclusive. funds. South Africa is notable as the country with the Research increasingly shows that accounting for en- highest climate vulnerability score, but also a highly vironmental factors positively impacts financial perfor- robust and established mandatory ESG framework. This mance, notably by minimizing downside risk.54 is consistent with our observation that countries that do • Climate-risk considerations: Most respondents re- not have an urgent climate threat have been slow to act, ported that pension funds in their jurisdiction did not while those who do have been quick to act on regulation. consider climate change risks separately from overall ESG considerations. Among six respondents whose pen- Overall, there is significant interest in and a trend towards sion funds consider climate issues separately, most do so developing new regulations to assist and encourage pension in their reporting or investment decision-making. Only two funds to integrate ESG considerations. To tap into this respondents indicated that pension funds in their jurisdiction source of capital, pension supervisors have a role to play conducted climate-specific scenario analysis. The written re- in enhancing the availability of attractive opportunities and sponses indicated a clear trend among pension supervisors; instruments to pension funds. The solutions may include many recognize that climate risk identification and manage- regulatory support to develop new investment vehicles for ment frameworks must evolve in the future. desired risk-return profiles, improved knowledge and training, • Engagement with companies: Those pension funds and the consolidation of pension funds. Additionally, many that engage with companies regarding ESG are likely of the countries that had both high climate risk and high to promote company disclosure and encourage com- regulatory risk did not respond to the survey, including Israel, panies to reduce externalities. However, a majority of the Nigeria, Pakistan, India, Singapore, and Malaysia. We would respondents reported that pension funds in their jurisdiction recommend that the IOPS administer the survey to these did not engage with companies on climate change at all. jurisdictions to track their progress on global ESG guidelines. Of those that did, three requested improved climate disclo- 53. sures, and only For this section, actively onemanually the team engaged matched in responses proxy voting. write-in with the closest possible multiple choice option. 54. Clark et al (2015) PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 33 4. >>> Conclusions and recommendations As institutional investors, pension funds play a critical role in the low-carbon climate resilient pathway. Endorsing this role means aligning their definition of fiduciary duty with contemporary expectations: promoting ESG considerations and achieving financial returns. In the context of rising risks and opportunities posed by climate change, pension funds have to reinvent themselves to account for their global presence. The analysis from this report recommends several actions to accelerate this change. 1. Review investment guidelines to allow for appropriate levels of international diversification. Regulators should review pension fund investment guidelines to check that they do not inadvertently expose pension funds to high levels of domestic climate risk. Investment guidelines should be set appropriately to recognize local capital market and pension systems conditions. 2 . Adopt a holistic definition of fiduciary duty, fully aligned with today’s challenges. Policy makers should revisit pension funds’ definition of fiduciary duty, in line with financial, environmental, social and good governance imperatives to allow climate change and other risks to be dealt with appropriately. 3 . Build ESG literacy and awareness. Regulators should develop their own knowledge and measurement of climate and other ESG risks and offer and promote educational tools and incentives to allow pension funds to develop a robust internal expertise on climate and other ESG-related considerations. Greening a pension system involves developing awareness and expertise within the pension funds regarding climate change (e.g. drivers of vulnerability and of exposure by sector, level of readiness; TCFD requirements) and ESG considerations (e.g. materiality by sector, key metrics, regulatory guidelines). The survey for this report found that many regulators and the pension funds they oversee still do not feel they have the enabling environment to make such moves and adopt such practices. 4 . Encourage sharing and adopting sustainable finance best practices. Pension supervisory authorities could take a stronger and common stance on sustainable finance practices, including ESG disclosure and reporting, including through the regulatory framework led by IOPS and supported by a global coalitions of pension funds. The research conducted for this report suggested that pension regulators and look to international standards and organizations such as the IOPS and the World Bank to provide them with a better understanding of ESG issues – including how to apply international good practices and standards in a proportionate and appropriate way in their own jurisdictions. The analysis conducted suggests that this support is needed as there is gap in some countries between the potential climate risks which pension funds in face and the regulatory and other mitigation factors which are being taken to address and mitigate these factors. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 35 >>> Appendixes Appendix 1: Case Studies To gain insight into how individual pension funds were crafting their sustainable investment strategies within existing climate risk and regulation frameworks, the team conducted extensive desk review and a series of interviews with pension fund administrators. The resulting case studies will be featured in a separate report. However, the conclusions we drew from these case studies were essential to the analysis in this report and are thus included below. The pension funds profiled were as follows: Country Pension Fund Canada Canada Pension Plan Investment Board (CPPIB) Japan Government Pension Investment Fund (GPIF) The Netherlands Stichting Pensioenfonds ABP (ABP) Norway Government Pension Fund of Norway (GPFG) United States New York State Common Retirement Fund (NYSCRF) Overall, these case studies were drawn from a pool of pension funds that were relatively similar in asset size and all came from high income economies. Notably, each pension did have a specifically articulated climate strategy that was separate from its overall ESG strategy, which indicates that pension funds are paying attention to greening. Implementation of pension fund greening varied widely on: • Regulatory environment ranged from those in heavy-touch (GPIF, ABP) to light touch regulatory environments (NYSCRF). Thus, the funds were likely able to execute their climate strategy regardless of the regulatory environment because of their prominence as large asset holders, and their strongly established internal investment processes. Smaller funds, however, will lag behind without the implementation of clear regulations. • Climate investment strategies ranged from emissions focused (GPIF), to more holistic environmental considerations that included natural capital (ABP, GPFG). Pension funds that are focused solely on energy efficiency and emission-reductions could be missing climate opportunities in the adaptation space. • Quantitative climate goals and disclosures were lacking for almost all funds. Though each fund had a well-articulated climate strategy that included specific objectives, many failed to define these objectives in numeric terms, such as CPPIB and NBIM. Often, they did not report how they were greening each asset class. PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 37 Appendix 2: Survey questionnaire S E C T I O N I . R E G U L AT O RY F R A M E W O R K 1 . Does the pension regulation framework require consideration of ESG factors? If so, in what form? Please check all that apply. * Check all that apply. Not allowed Voluntary Mandatory Incorporation of ESG into investment methodologies Incorporation of ESG into risk management processes Stress testing of climate or other risks Disclosure of ESG risks and opportunities Please describe the relevant regulatory framework: 2 . Does your supervisory agency provide guidance to pension funds on integrating ESG factors into the investment process? Please check all that apply. * Check all that apply. Yes, guidance on analyzing ESG factors Yes, guidance on inclusion and exclusion criteria Yes, guidance on incorporating ESG factors into risk management and stress-testing No guidance Please describe the guidance you are providing on ESG integration in detail, or the reason there is insufficient guidance: 3 . Does your supervisory agency provide guidance to pension funds on ESG disclosure? Please check all that apply. * Check all that apply. Yes, guidance on disclosure to pension supervisory authority Yes, guidance on disclosing substantial financial factors, including ESG, to members and stakeholders Yes, guidance on disclosing sustainability factors, including ESG factors, stewardship, and other non-financial factors to members and stakeholders No guidance Please describe the guidance you are providing on ESG disclosure in detail, or the reason there is insufficient guidance: 38 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT 4 . Are there reporting standards for ESG and green investments which are used by the pension funds in your jurisdiction as part of their investment process? Please check all that apply. * Check all that apply. Green taxonomy Label bond standards (green/sustainable bonds etc.) Green/sustainable loan standards Other investment product labeling Other: 5 . Does your supervisory agency have any guidelines or requirements in place for the pension funds to consider ESG factors when awarding mandates and monitoring their external asset managers? Please choose one answer. * Mark only one oval. There are strict requirements imposed on the activities of external managers There are guidelines for monitoring the activities of external managers but they are not mandatory There are no requirements at present but there are plans to implement requirements in the near future There are no requirements and no plans to implement requirements Please describe the guidance you are providing on ESG integration in detail, or the reason there is insufficient guidance: 6 . Have the pension funds under your supervision joined or planned to join SASB, TCFD, or the UN-convened Net-Zero Asset Owner Alliance? Please check all that apply. * Check all that apply. SASB (Sustainability Accounting Standards Board) TCFD (Task Force on Climate-related Financial Disclosure) United Nation-convened Net-Zero Asset Owner Alliance None of them Other: PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 39 SECTION II. MARKET PRACTICE 7 . What is the main driver for the pension funds in your jurisdiction to engage in greening investment? Please choose one answer. * Mark only one oval. Performance Sustainability Stability Diversification Public Independence Benefit Transparency Liquidity Other: 8 . What is the main barrier to incorporating ESG factors into investment decisions for the pension funds in your jurisdiction? Please choose one answer. * Mark only one oval. Financial barriers (e.g. fossil fuel subsidies, unpriced carbon externality) Fragmentation (e.g. smaller scale of low carbon technologies) Trust (e.g. lack of climate-related disclosure, unreliable ESG rating agencies) Unclear policy environment (e.g. inconsistency in policy) Transition costs Fiduciary duty Other: 9 . Which new asset classes do pension funds in your jurisdiction include in the portfolio that are sustainability-related? Please check all that apply. * Check all that apply. Labeled green bonds Green infrastructure (e.g. electricity demand-side management technology, smart grids, coastal protection, water infrastructure, etc.) Green real estate (e.g. building complying with green standards) Sovereign bonds (ESG rated) Other: Please describe the guidance you are providing on ESG integration in detail, or the reason there is insufficient guidance: 40 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT 1 0 . How do pension funds in your jurisdiction consider climate-related risks separately from ESG factors? Please check all that apply. * Check all that apply. Incorporate climate-related risks into risk management (e.g. conduct stress test or scenario analysis) Incorporate climate-related risks into investment decisions (e.g. incorporate climate- related risks into inclusion or divestment criteria) Incorporate climate-related risks into reporting Do not consider climate-related risks Please describe the guidance you are providing on ESG integration in detail, or the reason there is insufficient guidance: 1 1 . How do pension funds in your jurisdiction engage with the key companies in which they invest on the topic of climate change? Please check all that apply. * Check all that apply. Exercise shareholder voting rights based on climate issues Engage with companies on requesting improved disclosure Engage with companies on how their business can reduce negative environmental externalities No engagement Please describe the activities: PENSION SYSTEMS + CLIMATE RISK : MEASUREMENT + MITIGATION <<< 41 Appendix 3: IOPS Supervisory Guidelines on the Integration of ESG Factors The guidance note addresses ten guidelines, which can be summarized as follows: • Overall consideration of ESG factors • Disclosure of ESG factors » Guideline 1: supervisory authorities should require » Guideline 7: supervisory authorities should require consideration of ESG factors, alongside any other that pension funds report to them on how they financial factors, in their decision-making. integrate ESG factors into their risk and investment » Guideline 2: supervisory authorities should clarify management. to pension funds and asset managers, possibly » Guideline 8: supervisory authorities should advise through regulations or rules, that taking ESG factors pension funds on how to report ESG factors, into account is consistent with fiduciary duty. alongside other financially material factors, to their » Guideline 3: supervisory authorities should clarify members and stakeholders. that if accounting for non-financial factors in any » Guideline 9: supervisory authorities should require way sacrifices returns, pension funds must clearly that pension funds, in their investment policy, communicate this to members. disclose to members and stakeholders how they plan » Guideline 4: supervisory authorities should require to address ESG factors, stewardship, engagement, that pension funds consider ESG factors, while and any other non-financial factors. pursuing their established risk-return objectives. • Scenario testing of investment strategies • Integration of ESG factors • Guideline 10: supervisory authorities should encourage » Guideline 5: supervisory authorities should require pension funds to develop adequate scenario testing of pension funds to document and implement ESG their investment strategy for all significant financial factors, integration in their investment policy. 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Neher, Agnes. “Sustainable Investment Spotlight: Stricter European Regulations Favour Sustainable Investments.” J. Safra Sarasin, 2017. https://www.jsafrasarasin.ch/internet/ch/en/sustainable_investment_spotlight_stricter_ european_regulations_favour_sustainable_investments_en.pdf. “Responsible Investment: 2017 Annual Study.” Governart and VigeoEiris, 2017. http://www.vigeo-eiris.com/wp-content/uploads/2017/09/Estudio-2-Ingle%C2%B4s.pdf. Principles for Responsible investment. “Responsible Investment Regulation Map,” September 9, 2019. https://www.unpri.org/sustainable-markets/regulation-map. “Taking Stock: Sustainable Finance Policy Engagement and Policy Influence. ” Principles for Responsible Investment, 2019. https://www.unpri.org/Uploads/c/j/u/pripolicywhitepapertakingstockfinal_335442.pdf. 44 >>> EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT