Pension Fiduciaries and Climate Change: A Canadian Perspective.

• Author: Peihani, Maziar

Climate change has emerged as a major issue of financial risk for Canadian pension funds when determining where to place investments. The author argues that while such pension funds recognize climate change as an issue that holds the potential for significant financial risk, the funds' current approach to climate-related risks faces critical limitations. The author identifies the current practices of the five largest pension funds in Canada when faced with climate-related financial risks, then discusses the key shortcomings in current practices among the pension funds in three main areas.

First, the author examines organizational governance, which seeks to understand investment policies and guidelines related to climate risk, as well as the involvement of senior management and the pensions' boards of directors in guiding their funds in the face of these risks. Second, the author considers the funds' strategy and risk management, which encompasses any specific climate strategies adopted by the pension funds, as well as any tools or metrics used to manage and mitigate climate-related financial risk. Third, the author canvasses pension funds' engagement and advocacy, which includes any stewardship practices that monitor or seek to improve the climate practices of investee companies.

The author concludes by discussing the remaining challenges to pension funds and defining a path forward. The remaining challenges are approached by comparing Canadian funds to their international peers' approaches to climate-related financial risk, and by examining the position of Canadian pension funds within Canada's wider climate policy implementing the Paris Agreement. The author defines the path forward for pension funds as requiring a strong policy signal from government that could accelerate their transition to investments promoting the low-carbon economy.

Introduction I. Organizational Governance A. Pathways to Improve Boards' Oversight of Climate Change II. Strategy and Risk Management A. A Primer on Climate Risk Management B. Integrating Climate Considerations into Investment Decisions C. Investments in Renewable Energy D. Climate Metrics and Targets III. Engagement and Advocacy A. Revisiting Engagement's Potential in Addressing Climate Risks IV. Remaining Challenges and the Path Forward Conclusion Introduction

In December 2015, 195 countries reached the landmark Paris Agreement to limit global warming to no more than 2[degrees]C above pre-industrial levels and even aspired to bring the global temperature increase below 1.5[degrees]C. (1) This historic commitment was made in recognition of the catastrophic consequences of climate change, such as rising sea levels, forest fires, droughts, and forced migration. Indeed, the number of climate-related disasters has already doubled in the past twenty years, with the economic losses increasing from USD 895 billion in the 1978-1997 period to USD 2.3 trillion in the 1998-2017 period. (2) The practical implication of the Paris Agreement is that greenhouse gas (GHG) emissions must be brought down to net zero before the end of the century, and likely before 2070 so that global warming is limited to 2[degrees]C. (3) The latest scientific research also suggests that the worst effects of climate change cannot be avoided unless the temperature increase is limited to 1.5[degrees]C. To achieve this target, carbon dioxide (CO2) emissions must be cut by forty-five per cent by 2030, which would require "rapid and far-reaching transitions" in energy, land, transport, and infrastructure. (4)

However, the deep decarbonization needed to combat global warming can only take place if the financial system is aligned with the Paris Agreement goals. This point is especially important in the Canadian context, where the government has pledged under the Paris Agreement to reduce its annual emissions to thirty per cent below 2005 levels by 2030, (5) but the capital markets are heavily dependent on the resources which produce the GHG emissions in the first place. Canada can, therefore, achieve its Paris targets only if its financial flows also become consistent with "a pathway towards low greenhouse gas emissions". (6)

At the forefront of the structural transition to a low-carbon economy are pension funds, institutional investors entrusted with providing retirement income for millions of people. In Canada, pension funds manage over CAD 3.8 trillion in gross assets, acting as major investors across the domestic and global economy. (7) As such, there is the potential for these pension funds to mobilize considerable capital for climate-friendly investments and to exert significant pressure for decarbonization in line with the Paris Agreement goals. (8) Furthermore, as long-term, highly diversified financial institutions, Canadian pension funds are increasingly exposed to climate-related financial risks. This point is becoming increasingly evident in light of a growing body of evidence that climate change will significantly impact the financial system in the coming decades. (9) Extreme weather events, such as wildfires and hurricanes, can disrupt the operations of financial institutions, impair their assets, and exponentially increase their insurable losses ("physical risks"). (10) In Canada, the annual insurable losses from extreme weather events have risen from CAD 400 million a few decades ago to an astonishing CAD 1.9 billion in 2018. (11) Financial institutions are also vulnerable to risks that arise in the structural transition to a lower-carbon economy, such as vast reserves of fossil fuels becoming stranded, thereby placing significant market valuations at risk ("transition risks"). (12)

It is imperative to understand the governance of climate-related financial risks in the Canadian pension sector because these institutions manage a large amount of capital, frequently adopt long-term investment strategies, and bear a significant mandate to provide a retirement income to plan beneficiaries. There will be particularly profound consequences for young Canadians who reach the age of retirement in forty to fifty years as the worst effects of global warming unfold, and the full extent of climate-related financial risks materialize. Furthermore, Canadian law requires pension trustees and administrators to act in the best interests of their beneficiaries. If the Canadian pension sector disregards climate-related financial risks or does not sufficiently protect the investments of its plan beneficiaries, this may amount to a breach of fiduciary duty. (13)

. is article provides an in-depth analysis of the current practices of the five largest pension funds in Canada regarding climate-related financial risks. The Canada Pension Plan Investment Board (CPPIB), Caisse de depot et placement du Quebec (CDPQ), Ontario Teachers' Pension Plan (OTPP), Public Sector Pension Investment Board (PSPIB), and British Columbia Investment Management Corporation (BCIMC) were selected for analysis due to their extensive and diverse portfolios. These institutions collectively control about CAD 1.2 trillion net assets. (14)

There are a variety of avenues that pension funds may pursue to address climate-related financial risks, ranging from strategic oversight by the board of directors to direct engagement with investee companies on their approach to climate change. These activities may be conceptualized as falling into three core areas: (1) organizational governance, (2) strategy and risk management, and (3) engagement and advocacy. The category of organizational governance encompasses investment policies and guidelines, as well as the involvement of senior management and board of directors with respect to the organizational approach of the institution on climate-related financial risk. Strategy and risk management refers to any specific climate strategies that are adopted by pension funds, and any tools and metrics that are employed to manage and mitigate climate-related financial risks. Finally, the category of engagement and advocacy pertains to any stewardship practices that monitor or seek to improve the approach of investee companies toward climate change. This article explores current progress on each of these three core areas of activity concerning the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). (15) The TCFD recommendations promote consistent and meaningful disclosure of climate-related financial risks and opportunities, and are regarded as a crucial soft law instrument that has received significant support amongst the G20 countries and the broader business and finance communities. (16)

The article argues that although the five Canadian pension funds discussed have begun to understand the importance of climate change, their current governance of climate-related financial risks faces critical limitations. The most pressing challenge to date has been the absence of a strong policy signal to sway markets in the direction of a transition to a lower-carbon economy. The lack of cohesion in Canada's climate policy, driven by enormous subsidies to the fossil fuel industry and a willingness to bail out high emitters, has distorted market incentives for climate change adaptation and mitigation. This is significant because profits and losses drive market activity. Although it may be unethical for investors to bet against the government implementing environmental policies that penalize companies, the lack of a policy signal encourages investors to disregard environmental, social, and governance (ESG) risks and maximize their profits in a very competitive market environment. Without an unequivocal cue from Canadian policymakers, the pension sector will not have enough support to make the bold changes that are necessary in order to respond to climate risks in a timely fashion.

The forthcoming analysis will identify and discuss the key shortcomings in current practices of pension funds...