Climate change – a significant financial risk

Climate change is a significant financial risk – one that’s increasingly reshaping the way we look at our investments and their long-term returns. Put simply, climate change could negatively impact the investment returns we need to pay pensions for decades to come.

For example, a building we own could get damaged by flooding. A company we invest in that fails to transition to a low carbon world could be less profitable in the future. An industry we invest in could face rising costs if they don’t adjust and comply to changing regulations.

And because we’re a Universal Owner – with a highly diversified and long-term portfolio that broadly represents global capital markets – we’re inherently exposed to systemic risks like climate change. A hot world is likely to be bad for many investments. And we can’t avoid this outcome by divesting from high-emitting companies. Instead, we need to address systemic risks if we are to minimise the financial impact they could have on our investments.

That’s why climate is one of the four focus areas of our responsible investment strategy and why we’ve set an ambition for our investments to be net zero by 2050, if not before.

I’m pleased with the progress we’re making towards this ambition – the emissions intensity of our portfolio has declined by 51% between 2019 and 2024, putting us ahead of our interim target¹. We’ve just published our latest TCFD report² where you can read more about this.

But despite this progress, we remain deeply concerned.

Real-world emissions continue to rise while those of our own portfolio are falling. There’s a disconnect and it’s a real worry not just for me personally, but for our investment teams, our executive and our board.

Reducing our portfolio emissions is not enough on its own. If the real world doesn’t transition alongside this then the systemic risks from climate change will only grow, which could impact the long term returns we need to pay pensions.

Much more needs to be done, and quickly, to slow down or reverse the rise in global temperatures and we all have a part to play – pension funds, investors, policymakers and governments alike. For us, we’re committed to taking meaningful action in the areas where we can have an impact by:

• Engaging with governments and regulators to advocate for policies that are conducive to real-world decarbonisation. We need to make it as easy as possible for consumers and companies to change behaviour, removing barriers (both financial and non-financial barriers) to change as far as is possible.
• Engaging with the highest emitting companies in our portfolio to encourage them to reduce their carbon emissions. This kind of stewardship can contribute to meaningful real-world impact - read more in our latest blog. 
• Collaborating with asset owners and like-minded investors globally as we each seek to influence where we are most able so to do. We hope our new approach to climate scenario analysis will support this, which I talk more about below.
• Integrating climate risk into our investment decision-making process, which our approach to climate scenario analysis also addresses.

From government, we need a steady pipeline of investible opportunities that support the transition to a low carbon economy. We also need consistent and joined up regulation, and a stable policy environment. This will require the UK and other governments to have the right financial and non-financial incentives that encourage companies to move towards a low-carbon future.

I’ve talked a lot about risks, but climate change presents investment opportunities too. The transition to a lower carbon world needs to be financed and it will require further investment into renewable energy and infrastructure, which policymakers can facilitate. We already have around £2bn invested in renewable energy and clean technology, such as onshore and offshore windfarms, solar farms, and energy-from-waste projects. These types of investments can offer long-term, stable returns while also supporting the climate transition. We’re always looking for opportunities to increase our investments in climate solutions that provide the right financial returns, but the steady pipeline I mentioned above is still too limited.

Enhancing our climate scenario analysis

I wanted to share some of the work we’ve been doing this year to enhance our climate scenario analysis – a vital tool that helps us assess the financial risks we face as investors under various future climate outcomes.

Last year we worked with the University of Exeter to develop four new climate scenarios that better reflect real-world risks and opportunities and which inform investment decision making. This year, we’ve built on that collaboration by updating the scenarios to strengthen our assessment of transition risks and we’ve incorporated physical risks in our scenario analysis for the first time.

The updated scenarios are now more aligned with what’s happening in the real world. They consider interactions between the climate transition and broader macroeconomic factors such as geopolitical developments and economic cycles, enhancing realism and relevance. We’ve also improved the usefulness of the scenarios by focusing them on shorter time horizons to reflect the urgency of climate change.

The scenarios are being actively used by our asset allocation and investment teams to inform our investments. Moving forward, we’ll continue to use the scenarios both to inform top-down asset allocation and bottom-up security selection. We’ll also use them to inform our policy advocacy and engagement with governments and regulators.

Our new physical risk modelling focused on assessing the potential impacts of extreme weather events to estimate their potential economic impact. We divided the entire planet into a 1km by 1km grid and overlaid this with both location specific GDP data and projected simulations of where extreme weather events might occur. Our modelling focused on five acute hazards: river flooding, wildfires, heatwaves, tropical cyclones, and droughts – as well as one chronic hazard – the impact of heat stress on labour productivity.

This modelling provides us with a greater understanding of which regions and asset classes could be most at risk from the impacts of climate change and will help inform our asset allocation now and in the future.

This enhanced scenario analysis provides a more dynamic and realistic view of potential climate impacts than traditional models, and we hope it encourages our peers to take a similar approach. By more accurately reflecting real-world risks and opportunities, we can strengthen our ability to navigate a wide range of possible futures in an increasingly volatile and uncertain world.

We’ve a dedicated section in our TCFD report where you can read more about our updated scenarios and our approach to climate scenario analysis.

What is our TCFD report?

Each year, we report on how we’re managing climate related risks and opportunities in our Taskforce for Climate-related Financial Disclosures (TCFD) Report. TCFD is a framework to help companies understand and disclose their financial exposure to climate risk.

Our report looks at how we’re tackling the financial risks of climate change and includes some examples of the actions we’re taking. One is our engagement with motorway services company Moto regarding its energy transition strategy. Another is our support of the growth of BRUC Energy, a Spanish renewables platform, as it looks to be a leader in solar and wind renewable energy.

You can read more about our progress and approach in our latest report. You can also read about our approach to stewardship and some of our key activities in our latest Stewardship report.

¹ Our interim net zero target is to reduce our non-sovereign emissions in the DB part by 25% by 2025, and by 50% by 2030 (relative to a 2019 baseline).

² Taskforce for Climate-related Financial Disclosures (TCFD) is an industry-led framework to help companies understand and disclose their financial exposure to climate risk.