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Do pensions hold the key to the UK’s net zero transition?

New research shows that pension funds could quadruple what they invest in climate solutions.

In a world grappling with the reality and dangers of climate change, the UK finds itself at a crossroads. People across the world are already dealing with the damaging impacts of rising temperatures and we are at serious risk of exceeding the 1.50C global warming threshold.

Later this month, world leaders will gather at the UN’s climate conference, Cop28, to take stock of how their nations are individually and collectively making progress towards commitments to reduce greenhouse gas emissions. Expectations are low.

In the UK, the climate emergency is no longer a fringe concern. The environment is often cited as one of the most important issues facing the country by voters, and it has become part of mainstream political discourse.

The government has set a legally binding target to achieve net zero by 2050 while pledging to spare British families the “unacceptable costs” of net zero. The Labour Party is promising to slash energy bills and create quality jobs by making Britain a clean energy superpower. So, while there is political consensus on the need to decarbonise the economy, the next question is: how do we pay for it?

For the UK to reach net zero by 2050, it’s accepted that we need to invest in climate solutions – essentially, any economic activity which contributes substantially to climate change mitigation, particularly those which avoid or remove carbon emissions such as renewable energy, electric vehicles and carbon capture technology. Latest estimates put the necessary investment at £2.4trn between now and 2035. Climate finance may be in the spotlight unexpectedly, but it’s clearly too important to be just a pawn in next year’s election battle.

As we ponder the challenge that lies ahead, could pensions hold the key to funding the UK’s net zero transition? A timely new report is aiming to unite voices across the political spectrum and industry in a conversation about how we can fulfil the nation’s climate investment targets, while also ensuring the best outcomes for savers. It offers a thought-provoking take on how the UK’s sizeable pension industry – with assets worth £3.7trn – can scale up investment in climate solutions in a way that delivers both for policyholders and the planet.

Commissioned by Phoenix Group, the UK’s largest long-term savings and retirement business, alongside Make My Money Matter, the campaigning group co-founded by Richard Curtis, the report estimates that the UK pensions industry could quadruple its investment in climate solutions to up to £1.2trn. That’s up to half of the overall investment required to keep the UK on track to meet its net zero targets. The major roadblocks? A scarcity of investable opportunities and regulatory constraints.

If current trends continue, the UK pensions industry is on track to invest up to £0.3trn in UK climate solutions between now and 2035. While there may be appetite to invest more – over the past two years Phoenix Group itself has invested around £1.2bn in climate solutions in the UK and abroad and says it wants to increase this – pension companies say they are struggling to match their ambition with action.

[See also: Pensions, policyholders and the planet]

The reasons, the report concludes, are twofold. First, while there’s a genuine appetite across UK pensions to scale up investment in climate solutions, there are relatively few scalable climate solution opportunities that require debt financing and can offer steady, predictable returns. Many climate solution opportunities tend to be fragmented with riskier and more volatile returns, especially in the early years. And the second reason, the report finds, lies in regulatory constraints on institutional investors. For example, liquidity constraints, capital charges and fees on pensions limit the appeal of illiquid long-dated investments, which many climate solutions are.

But these barriers are not insurmountable. The report found that to help unlock the full potential of pensions as a force for climate action, government, regulators and the pension industry must consider seven key strategies.

The organisations behind the report proposed these strategies based on assessments of feasibility and potential impact, also identifying several key actions that must take place as a matter of urgency over the next 12 months.

To begin to address the issue of scarcity of investible opportunities, it is recommended that policymakers and regulators develop a UK climate transition plan with sector-specific strategies and clear roadmaps and outline a consistent planning regime to accelerate and scale up climate solutions projects.

Such a framework will give the pension industry and other institutional investors much needed clarity and certainty, and ensure that investments are channelled into areas that can drive the net zero transition. To also start addressing the issue of constraints on the UK pension industry, providing further clarity to consider climate risk and its effect on investments in a long-term prudential strategy will help the industry integrate the net zero transition into investment decisions and engage investee companies accordingly.

This will enable a more consistent interpretation and action across the industry. Additionally, regulators need to lower the capital chargers, or the cash required to compensate investors for risk, for insurers.

Commenting on the report, Bruno Gardner, Head of Climate Change and Nature at Phoenix Group, said, “While it’s exciting to see that pension funds could finance up to half of the investment needed to keep the UK’s net zero transition on track, it’s even more important to have identified why there isn’t already more funding for climate solutions and what can be done about it.” Gardner concluded, “By setting out the scale of the opportunity, we hope to show that making it easier to invest in climate solutions can be good news for policyholders and the planet. Now’s the time for government, regulators and pension companies to come together and act.”

Earlier this year, Phoenix Group published its own Net Zero Transition Plan, in which the company outlined its pathway to decarbonising its entire investment portfolio, set out its commitment to prioritise savers and pledged to be vocal in calling for action and convening stakeholders to drive the wider system change needed to reach net zero.

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