Ensuring responsible investment for a just transition to net zero

The Smith Institute supported the All-Party Parliamentary Group for Local Authority Pension Funds inquiry into ‘Responsible investment for a just transition’

This report is based on evidence sessions and written submissions to that inquiry from investors, industry, academics, community groups, trade unions, and other non-government organisations.

The inquiry report seeks to inform politicians, policymakers, stakeholders and the public on the roles and responsibilities that investors can play, with the support of their members and government, in enabling a just transition to net zero carbon emissions.

The following sets out the main findings of the inquiry:

What is a just transition?

A just transition is broadly interpreted as a pol­icy approach to climate action which seeks to ensure that the benefits of a shift to net zero are shared, while supporting those most im­pacted by the change.

The following components of a just transi­tion to a net zero carbon economy were described to the inquiry:

• It is about moving to a net zero carbon econ­omy in a just way for society – and thus com­bines environmental and social considera­tions.
• It is about the fair distribution of climate ‘goods’ (such as new jobs and cleaner air) and climate ‘bads’ (such as higher costs associat­ed with decarbonisation and job losses in certain sectors and places).
• It is about both maximising the opportunities of a green economy and mitigating the risks.
• The social dimension is about workers, con­sumers, supply chains and communities.
• It is about both the process and the outcome: engaging and involving stakeholders to ensure that all social groups have support and op­portunities in transitioning to a net zero car­bon economy.
• It involves a planned and orderly transition.
• It is a global issue, affecting UK and interna­tional communities and supply chains.

The financial materiality of a just transition

The inquiry concluded that not fully consider­ing a just transition poses a material risk to investors. It also considered that the implemen­tation of binding carbon reduction targets at all levels and by all actors requires a clear recog­nition and effective policy response to the social costs and consequences of such a transition.

Without action, climate change is set to be an environmental and human catastrophe. It is widely accepted by economic policymakers, investors and companies as posing significant material risks.

However, it was also clear from the inquiry that the costs and benefits of climate action will inevitably be uneven for countries, workers, communities, consumers and supply chains. The social and economic impacts will also be spatially different and affect the vulnerable and least protected the most.

There was also a clear view in the inquiry from investors, including from Local Government Pension Scheme (LGPS) funds, that responding to climate change did not – and could not – mean ignoring their fiduciary duty. This response did not preclude green invest­ment and efforts to secure a just transition, but stressed that any steps taken “had to make financial sense”. However, as discussed later in the report, a common view stated in both the oral and written evidence was that part of a pension fund’s fiduciary duty meant consider­ing the financial implications of climate change and with it the need for a just transition.

As such, taking a long-term view, the risks to investors from unanticipated or sudden acceleration in climate deterioration needs to be assumed and nobody can be sure when the worst effects will bite. Therefore, there are risk reduction reasons to ensure that all long-term investors are including the move to a just tran­sition in their portfolio construction and invest­ment selection decisions. Just focussing on performance over the next year, may mean sub-optimal long-term outcomes.

What can investors do?

Many investors are actively supporting the shift to net zero and keen to decrease their exposure to carbon risk. However, investors alone cannot meet national carbon reduction targets and ensure a just transition.

Nevertheless, there was consensus in the evidence to the inquiry that investors have an important role in supporting a just transition to net zero, and, because of the financial impli­cations, an obligation to consider just transition issues.

To mitigate the financially material risks of an unjust transition, the following action points were recommended to the inquiry:

• Recognise the just transition challenge: Inves­tors should include reference to a just transi­tion in their policy statements. Part of recog­nising the challenge should include setting aside adequate resources to manage these risks (alongside broader environmental, social and governance – ESG – issues), including scrutinising external investment managers on their approach.
• Understand the risks and opportunities: Funds should understand the material risks. This includes risks around climate change and the social implications of reaching net zero. An appropriate analysis could include which sec­tors are most likely to experience change (and the associated spatial dimensions) with im­plications for consumers, communities, work­ers, and supply chains. Understanding these risks and opportunities involves developing metrics around the scale of change and fully understanding the views and concerns of stakeholders.
• Set expectations: Funds should set clear ex­pectations of companies and how they can address just transition concerns. There are several international legal frameworks (such as international human rights law and inter­national labour law) which set out legal obli­gations for states as well as voluntary frame­works that provide investor guides on expectations for specific sectors. Expectations are likely to include having a strategy to ef­fectively manage the risks and opportunities, approaches to engaging and supporting the main affected stakeholders (workers, supply chains, consumers and communities), their engagement with policymakers, and report­ing their current position and progress against targets.
• Engage companies: Funds and/or their man­agers should engage companies on just tran­sition risks. This engagement is likely to be focused on those companies identified when funds seek to understand where material risks are greatest, and engagement based on the fund’s set of expectations. Where external managers and ESG engagement advisers are used, funds should hold these external parties to account for progress against expectations. Similarly, funds should ensure that collabo­rative engagements on climate change include a just transition as a central theme for discus­sion.
• Capital allocation: Funds need to give due weight to just transition risks in their capital allocation. Policy statements should be used to guide investment decisions, including those of fund managers. There are also opportuni­ties for investing in a just transition. Mem­bership organisations should seek to establish a knowledge hub to support funds in doing so, and funds and pools could consider estab­lishing specific just transition funds to over­come issues around scale.
• Reporting impact: Funds should report on the just transition risks and outline to beneficiar­ies where and why they matter. Funds should have measurable just transition objectives and report against them. Funds (and collaborative initiatives and organisations) should consider how Task Force on Climate-Related Financial Disclosures (TCFD) reporting can be extend­ed to include reporting on just transition risks.
• Engaging policymakers: Investors have a role in engaging policymakers to ensure measures to secure the transition to net zero consider the social dimension. This engagement in­cludes pushing for reforms which will support investors’ ability to consider a just transition (company disclosures for example) and create incentives to invest in a just transition.

What can government do?

The inquiry found that investors are willing to support a just transition to net zero but want a much clearer position from government on just transition plans. Pension funds are seeking gov­ernment support to ensure social considera­tions are factored into an energy transition. It was generally felt that government had yet to embrace the idea of a just transition and had failed to embed concrete actions to deliver it in national policies and plans.

The main findings of the inquiry for govern­ment are:

• Need for a clear and comprehensive just tran­sition commitment: Government should ex­plicitly recognise and articulate a high-level commitment to a just transition.
• A just transition plan: A clear strategy and plan for reaching net zero carbon emissions in a just way (shaped by the views of stakeholders and integrated with existing climate change policies) would help support investment in a just transition and enable investors to engage companies on their just transition plans.
• Company disclosure regulations: Government should consider what disclosures on social risks should be mandatory for companies. Such mandatory disclosures would help en­sure just transition risks are acknowledged and better understood by companies and in­vestors and just transition plans can be for­mulated with stakeholders. As part of this exercise government should consider widen­ing TCFD requirements to include just tran­sition factors.
• Identifying investment opportunities: To sup­port investment which may often be too small for institutional investors, central and local government should consider identifying op­portunities for investors that will support a just transition and maximise the social ben­efits. Government should use its Green Sov­ereign Bond programme to support the just transition by reporting on the social co-ben­efits of investments.
• Crowding in private finance: The investment needed to achieve a transition will require gap funding, incentives, and guarantees from government. Such support should be contin­gent on meeting just transition objectives.
• Just Transition Commission: Government should establish a national (UK-wide) just transition commission, which seeks to outline how the just transition can be delivered and roles of different stakeholders, including in­vestors. This could be complemented by sub-national and sector bodies.

The evidence to the inquiry made plain that if the transition to a net zero carbon economy is viewed as unfair and unjust – as imposed and ill-considered – there will be public resistance and a lack of co-operation, which is likely to impede the implementation of many of the practical measures (and life-style changes) necessary to reduce carbon emissions.

Throughout the inquiry, witnesses stressed the need for capacity building, co-operation, shared learning and social dialogue between all those impacted by a just transition. It was said that pension funds – and the investment community as a whole – should be part of the COP26 mission to: “accelerate action to tackle the climate crisis through collaboration between governments, businesses and civil society.”