Pension funds must weigh up risk of fracking company investments

Out-Law News | 06 Sep 2018 | 5:27 pm | 2 min. read

Local government pension funds must weigh up the financial risks of investing in energy companies engaged in fracking before deciding whether or not to divest, an expert has said.

Nick Stones of Pinsent Masons, the law firm behind, was commenting on new research on the extent of local government pension funds' exposures to fracking companies (20-page / 1.7MB PDF), conducted by environmental groups. Platform London, 350 and Friends of the Earth found a combined investment of £9 billion in these companies by UK local authorities, and are calling for a national divestment campaign.

In their report, the campaigners tracked investment by local authority pension funds in energy companies involved in fracking activity anywhere in the world in March 2017. The UK government recently granted the first permit for shale gas fracking under a new regulatory regime to a site in Lancashire.

Stones said that pension scheme trustees were required to consider environmental, social and governance (ESG) issues as part of their investment decisions where they pose financially material risks. Otherwise, trustees can only consider ethical considerations, such as moral disapproval of certain industries, if they have good reason to think that scheme members would share their concerns, and the decision does not involve a risk of significant financial detriment to the scheme assets.

"The main reason why funds have been reluctant to do anything is a misapprehension that this is all to do with ethics," he said. "But ESG risk isn't about ethics: it is about identifying risks that may lead to investment underperformance."

"Take climate change as an example. There is a scientific consensus that climate change is happening, and that the emission of greenhouse gases will need to be significantly reduced. Climate change can adversely affect investment performance: in the longer term, because of actual weather changes, and in the shorter term because of political and technological changes resulting from growing concerns about our climate. This is not an ethical matter. It is about managing the risk that certain assets may underperform in the future," he said.

"Funds must therefore assess whether climate change and other ESG risks could have a material impact on their scheme's investment performance – otherwise, they risk being in breach of their duties," he said.

The House of Commons Environmental Audit Committee has suggested that some trustees misunderstood the nature of these so-called fiduciary duties as a need to "maximise short-term returns", an approach which could result in them underestimating longer-term risks. Earlier this year, the committee wrote to the UK's top 25 private sector pension funds to ask them how they manage the risks that climate change poses to pension savings.

In April, Pinsent Masons and the University of Leeds published a report in which they sought to clarify how trustees should consider climate change as part of their investment strategy in an appropriate and proportionate way, despite the lack of a coordinated approach on how these factors should be taken into account.

"There is a duty on trustees to take account of all relevant considerations when making their investment decisions," said Stones. "Not knowing whether or not something is relevant does not relieve the fund of that duty."

"Funds cannot simply ignore ESG risks. But if the fund has considered these matters, and believes that the investment is still sound, then the investment decision is a valid one," he said.