Anne Sander is a member of the Trustee Sustainability Working Group and client director at Zedra Governance
Changes in US tariff policy over the last couple of weeks has caused huge gyrations in the equity market and led to higher bond yields in US Treasuries.
For many UK defined benefit (DB) pension schemes this has caused concerns around funding levels and led to collateral calls in some liability-driven investment (LDI) portfolios.
Direct pain has been felt by defined contribution (DC) members who bear the full effect of this volatility; members close to retirement being the ones hurt the most as they have had to decide whether to start drawing down and realising significant capital losses or deferring their retirement.
The Trump tariff swings may have been highly unpredictable and hence difficult to price. However, Trump had projected his intention to use tariffs during his election campaign, even if the scale of tariff changes was unknown.
A false sense of complacency
In a similar way there is a looming crisis of climate change related mispricing.
Climate scientists have been saying for a while that we are underestimating the potential for tipping points. Climate change is a systemic and evolving risk with limited history to fall back on that could assist markets in determining the timing and impact that climate events will have on the value of financial assets.
In addition, the commonly used climate scenarios across the industry and application of actuarial techniques have led some DB pension schemes to produce projection results where increases in mortality more than offset any asset price falls, lulling trustees into a false sense of complacency.
Trump's policy direction to disengage from climate change mitigation activities and remove corporate reporting requirements will reduce the transparency for investors and could lead to even greater asset mispricing going forward.
This policy stance has already seen US based global asset managers pull back from cooperative climate action groups and using their scale to influence the companies they invest in to be more sustainable. There is a risk of other asset managers and countries also slowing down their efforts to improve real world climate outcomes and reducing their reporting.
This will impact equity pricing in several ways:
- Increased uncertainty: With the rollback of climate disclosure rules, there may be less transparency about companies' climate risks, increasing uncertainty among investors, and potentially resulting in higher risk premiums and more volatile equity prices.
- Reduced investor confidence: As different countries and individual US states implement their own climate disclosure rules, companies operating in multiple jurisdictions may face inconsistent reporting requirements. This can create confusion and inefficiencies, affecting investor confidence and equity valuations.
- Market fragmentation: The divergence between jurisdictions regulations can lead to a fragmented market where some companies are more transparent about their climate risks than others. Investors may favour companies with better disclosure practices, leading to disparities in equity pricing that do not appropriately reflect the climate risks for the company.
- Regulatory risk: Companies that fail to comply with regulations may face legal and financial penalties, which can negatively impact their stock prices. Conversely, companies that proactively manage and disclose their climate risks may be viewed more favourably by investors.
- Long-term impact: Over time, the lack of climate risk reporting could hinder the ability of investors to accurately assess and price these risks. This may lead to mispricing of investments, particularly in sectors heavily impacted by climate change, such as energy, agriculture, and real estate.
- Climate risk pricing big bang: When the markets finally get it and climate risk is seen as financially detrimental as it is we could see equity markets fall, recognising the inadequate transition plans of many companies and, bond markets fall, as the inadequate actions of governments are recognised!
Overall, these changes can introduce more complexity and uncertainty into the market, affecting equity pricing and investor behaviour.
DC pension scheme members are likely to face a bumpy road ahead, yet as individuals they are generally least equipped to deal with that volatility and may make poor choices as a result. Pension scheme trustees will need to ensure they determine how best they can prepare DC members for this potential increase in volatility in the returns they will experience. They should also consider how they can use their collective influence to affect climate reporting transparency and government policy for the ultimate benefit of their members.
Anne Sander is a member of the Trustee Sustainability Working Group and client director at Zedra Governance
The Trustee Sustainability Working Group (TSWG) was formed by a group of 13 professional and member-nominated trustees at the end of last year in a bid accelerate the implementation of good sustainability investment practice across the industry. It is chaired by HS Trustees managing director Bobby Riddaway.
