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Special report: Pension funds grapple with the just transition

Published: 14 May 2024

For pension funds and other institutional investors, the concept of a just transition is becoming increasingly important. While there are plenty of challenges ahead, there are also opportunities to make a real difference.

Broadly speaking, a just transition ensures that nobody is left behind as the world transitions to a net zero sustainable economy | Dilok Klaisataporn on iStock

In the early 1990s, Tony Mazzocchi, the fiery head of the Oil, Chemical and Atomic Workers Union in the US proposed the idea of a ‘superfund’ for workers, as environmental issues began to gain prominence, and job security became a concern.

“We need to provide workers with a guarantee that they will not have to pay for clean air and water with their jobs, their living standards, or their future,” Mazzocchi argued. He went on to call for a just transition, one which would see fairness and equity at the heart of any future environmental debate. Mazzocchi passed away in 2002, little realising how important his legacy would become.

Thirty years after Mazzocchi’s plea, the concept of a just transition has broadened substantially and encompassed not only trade unions, but businesses, vulnerable communities, countries, industries and sectors.  Net zero pledges now cover 92% of GDP and 88% of emissions worldwide, according to The Science Based Targets initiative (SBTi), a corporate climate organisation.

For pension funds and other institutional investors, the just transition is an increasingly important concern. It presents both challenges and opportunities – something we explore in more detail throughout this report.

The International Energy Agency estimates that $3.5trn (€2.7trn) of energy sector investments will be needed on average each year between 2016 and 2050, compared with the $1.8bn that was needed in 2015, while the Organisation for Economic Cooperation and Development (OECD) suggests that a ‘decisive transition’ could boost long-run output by an average of 5% across G20 countries by 2050.

Nick Robins, executive director of the Just Transition Finance Lab – which was set up by the London School of Economics and Political Science (LSE)’s Grantham Research Institute on Climate Change and the Environment earlier this year – believes that institutional investors have a vital role to play in what comes next.

Nick Robins, Just Transition Finance Lab

“They remain key actors in signalling to the rest of the financial system the importance of climate action delivered through a just transition. More than this, pension funds are also pools of workers’ capital, often with union and employee representation in their governance, bringing a direct link to the just transition agenda,” he points out.

Developing financial solutions for the just transition

The Just Transition Finance Lab was set up by the LSE’s Grantham Research Institute on Climate Change and the Environment earlier this year. The Lab’s goal is to become a centre for experimentation and excellence in the financial solutions needed for a just transition.

Executive director Nick Robins says there has been a “welcome recognition” that progress on climate change and nature has to be people centred. He also highlights the challenges ahead. “This recognition is still new and we need to see real action to make sustainability transitions just, not least across the financial system. So, after five years on the work of ‘why’ financing the just transition, the Lab is designed to move to the ‘how’,” he says.

The Lab’s launch report sets out both the opportunities and obstacles facing the just transition in the world of finance, according to Robins. “We highlight four main barriers – the lack of traction in financial decision-making, uncertainty about what good looks like, a lack of rules and incentives and insufficient leadership.

The Lab’s four objectives are designed to respond to each of these pain points, and our focus on financial instruments is starting with the bond and fixed income markets,” he says. It has partnered with the Climate Bonds Initiative to drive a more inclusive transition to net zero.

“The bond market has been one of the most impressive arenas for sustainable finance – green, social, sustainable and sustainably-linked – and Climate Bonds are a very effective market player with high integrity who I’ve known and worked with for more than a decade. They are a natural partner focus for our work in the bond and fixed income markets, where we want to examine how bonds can support the just transition – and not necessarily come out with a new ‘just transition bond’ label. There is growing interest from both issuers and investors on how to do this and we want to provide evidence-based guidance,” says Robins.

Scale of transition

The scope of the change that needs to occur cannot be underestimated, however. A transformation of the nearly $500trn global financial system is needed to bring the just transition to life, according to the Lab.

“When you think about what needs to happen in our society, there are a ton of challenges. The level of restructuring that has to happen is the biggest we have seen since the Industrial Revolution. You will have a big displacement of people and jobs and changes in industry. But it also creates a wide range of opportunities. Jobs might become obsolete, but there will also be opportunities in high-quality green jobs,” says Joe Shamash, investment director at UK impact investor Better Society Capital.

A 2018 report by the Grantham Research Institute on Climate Change and the Environment, in partnership with the UN Principles for Responsible Investment (UNPRI) and others, estimates that demand-side efficiency investments in buildings, industry and transport will need to grow tenfold. Meeting the 2015 Paris Agreement goals will create 24 million jobs in clean energy generation, electric vehicles and energy efficiency, but would also lead to job losses of around 6 million, according to the report.

Defining the issue

Broadly speaking, a just transition ensures that nobody is left behind as the world transitions to a net zero sustainable economy. It means investors and other stakeholders must make sure that the benefits of a greener world are shared by everyone. The just transition covers three key areas: advancing climate and environmental action and ensuring environmental sustainability; improving socio-economic distribution and equity; and ensuring that all communities have a voice for the future, particularly through the inclusion of groups left most vulnerable as a result of the transition.

“The transition to net zero is about  engaging with everyone across society. Everyone has a role to play and everyone has a stake. We think that approaches that recognise this will be the most effective,” says Shamash.

Pension fund engagement

Industry experts believe that pension funds want to engage with the just transition, particularly because they are thinking about their wider responsibilities. Sandor Steverink, senior investment consultant at WTW in the Netherlands, says that Dutch pension funds are thinking about the just transition in the context of the UN SDGs, for example.

“Dutch pension funds have embraced the Sustainable Development Goals. These are part of the Paris Agreement on climate change which includes just transition as an important principle. In the Netherlands pension funds are becoming more selective in the SDGs that they are focused on. Besides their risk aversion preferences, funds are also asking participants for their SDG preferences. However, only a limited number of these SDGs are investable, of which SDG 7 ‘affordable and clean energy’ and SDG 10 ‘sustainable cities and communities’ are the most concrete with the highest probability to meet the risk/return targets. These targets are in general higher than the EU funds related to the Just Transition Mechanism,” he says.

The EU Just Transition Mechanism is a funding initiative launched in January 2020, designed to support regions and sectors most affected by the transition to net zero. While broadly welcomed, some industry commentators believe the mechanism does not go far enough, particularly on the timelines required to phase out fossil fuels.

For pension funds, the issue is challenging, given how much complexity they are already dealing with. “European pension funds are currently exposed to a lot of governance issues in areas like sustainability reporting and cyber security. There is so much regulation they have to fulfil, and they also have a fiduciary duty to pay pensions. That is their prime duty. The just transition is a fantastic thing to look at, but I am not seeing it happening in a big way. The action required is still quite limited,” says Paul Boerboom, founder of European consultancy Avida International and non-executive director at Beam Earth.

Charlotte O’Leary, CEO of UK-based body Pensions for Purpose, says that this is an area where pension funds can make a real difference. “It is important for pension funds to recognise that they can shape the market. That changes your whole perspective in terms of how you approach investments. A lot is being asked of pension funds, but they should be bold and feel empowered.”

Charlotte O’Leary, Pensions for Purpose

She believes that pension funds can build biodiversity loss, climate change and other SDG issues into their strategies. “Thinking about inequality is happening across the board with our members, whether it is local government schemes, corporate schemes or master trusts. We are seeing this happen at various speeds, but it is all growing and moving in the right direction.”

Do pension funds have systemic issues when it comes to the just transition?

More than one-third of Europeans are not saving for retirement, and 40% of people indicate that economic circumstances have negatively impacted their pension contributions, according to a 2023 survey from Insurance Europe.

This, says Charlotte O’Leary, chief executive of the UK body Pensions for Purpose, has implications for a just transition. “There is a cost-of-living crisis. Most people don’t have rainy day funds and they aren’t saving enough into their pensions. The reality is that if we want to shift towards climate solutions, we need to see a greater level of solutions, and that only happens if we address the financial inequity in our system, which is built into pensions,” she says.

O’Leary believes there are systemic issues, with defined benefit (DB) schemes treating employees more fairly than defined contribution (DC) ones. “DB schemes are very well structured. Those members know what they will be retiring on. DC schemes don’t work that way. It is a calculation based on how much you and your employer put in, and at single digital levels, not enough is going in. That has an impact in meeting climate change goals because if we don’t increase those assets, the costs involved in getting into things like climate change solutions are difficult to invest or fund.”

She believes that pension funds have to think about the just transition in broader terms. “This is way more systemic and really about how pension funds are in the world, and how they are structured and the systemic unfairness of that. It’s really about thinking not just about investment risk and opportunity, but about governance risk and opportunity. Once you take that wider view, it changes how you think about your agency, and what levers you have in the system. You start thinking maybe if I collaborate with other pension funds we can go to the government and try and change policy. We can engage companies on their pension contributions,” she says.

Implementation considerations

Regardless of where they are on their journeys, one of the challenges pen-sion funds face is deciding what is ‘just’ and what isn’t. Industry bodies are coming together to tackle those issues. The Impact Investing Institute launched its Just Transition Criteria in 2023, in partnership with 21 global financial institutions, for example.

Elsewhere, in 2022, a group of 12 UK pension funds, representing £400bn in assets under management and led by the Church of England Pensions Board, came together to talk about how to support the climate transition in emerging markets, publishing guiding principles as part of an Emerging Markets Just Transition Investment Initiative.

“Current approaches to the global climate transition do not make sufficient allowances for a differentiated pace of change and the varying level of policy and institutional support across EM, nor do they enable a holistic approach to supporting a just transition at an economy-wide level,” the group pointed out.

Local communities

Industry participants say there is important work to be done closer to home as well, particularly when it comes to empowering communities. CORE Partners, for example, is a partnership between Power to Change and Better Society Capital in the UK, which originally invested in eight solar farms. Since 2017, the group has worked with six community partners to transfer the assets into community ownership, and one of these partners took full ownership in 2021. In December 2023, CORE completed its mission, with five community businesses successfully raising community shares on Ethex, alongside a new junior loan from Better Society Capital and Power to purchase all remaining solar farms from CORE.

“When we think about the just transition we think about how we can ensure that communities play a leading role. You have to think about opportunities for inclusion, and about creating the type of industries that work for everyone,” says Shamash.

He believes that community buy-ins are a big challenge, but that one of the most effective solutions is to ensure that local groups have a stake in what is happening. “You can do this by giving communities a degree of ownership over renewable energy infrastructure in a way that benefits them economically by lowering energy bills or sharing profits. That can be really transformative, to have communities themselves acting as the drivers for change,” he points out.

Whether it is community engagement, working in emerging markets, asset allocation or anything else, pension funds and institutional investors have much to think about as they work to ensure any transition is equitable and just. As we discuss throughout this report, there are areas where they can have a substantial impact, and where there are plenty of opportunities as well. One thing is clear. While the just transition presents complexities, it is not an issue pension funds can afford to ignore.

Additional reporting by Paula Garrido.

This article is part of the ‘Impact Investing and the Just Transition’ report, a collaboration between Impact Investor and our sister publications IPE and IPE Real Assets. The full report will be published as a supplement with the June issue of IPE and available to download here.

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