A review of Nest’s climate change targets and an assessment of how they are planning to achieve their ambitious goals.
Overview of Nest approach
In July 2020 Nest published its first Scheme-wide climate change policy setting out an ambition to align its investment strategy with limiting global warming to 1.5C by reaching net zero emissions across its investment portfolio by 2050 at the latest and halving financed emissions by 2030 from a 2019 baseline. The policy was designed to guide all areas of Nest’s investment process including asset allocation, manager selection and monitoring, stewardship and public policy.
Asset allocation and manager selection and monitoring are closely linked. Nest has committed to decarbonise their whole portfolio by 2050 at the latest in line with the net zero target set out in their climate change policy but they are mindful that methodologies are still being developed to assess portfolio alignment with specified temperature goals across asset classes. Nest’s portfolio is made up of different asset classes and individual portfolios managed by external fund managers. While Nest have set a scheme-wide net zero target, it is crucial that they work with external fund managers to develop portfolio-level strategies aligned with their net zero target.
Ahead of publishing the climate change policy, Nest met with all of their existing suite of managers to discuss their own climate policies, and how best to implement Nest’s climate commitments within the asset classes they manage for the scheme. As part of this process, they assessed each managers’ climate change policies against a benchmarking system which was developed internally. It assesses the managers’ alignment with climate change policy and external standards and covers areas including climate change risk management, stewardship, public policy and disclosure. It also takes into account specific challenges in different asset classes such as data availability.
Based on this assessment and the meetings held, Nest wrote to all fund managers at the end of 2020 to set out three top-line expectations across all mandates:
- Reporting: Nest expects its fund managers to report on the climate-related risks and opportunities in the portfolio they manage for the Scheme using the TCFD framework. This includes reporting on the carbon intensity of the portfolio and conducting climate change scenario analyses to inform reporting requirements.
- Reducing emissions: Nest expects its fund managers to develop a strategy to align the portfolio with the 1.5C global warming limit. This includes analysis of how to halve financed emissions by 2030.
- Voting: Nest expects its fund managers to exercise their voting rights and engagement resource to positively influence the companies in their portfolio to transition to a low-carbon economy.
In addition to these three headline expectations, Nest set time-bound, mandate-specific climate-related objectives for their existing managers, which cover topics such as improving data coverage and quality and developing an escalation process for engagement on climate change.
Nest expect all objectives to be met by 2023 at the latest and they meet with fund managers at least bi-annually to discuss progress. Where a manager is not progressing on their climate change objectives, they will be placed on a watch list as part of Nest’s manager monitoring process. Continued lack of progress could lead to termination of a mandate.
The core expectations are now a requirement of their standard tender process for new investment mandates, and managers that cannot demonstrate their commitment to meeting these expectations will not be selected. During 2020, Nest ran a selection process for three private equity infrastructure mandates. Climate change was a key consideration during the selection process and several managers were screened out as they did not believe that their approach was sufficient to meet Nest's climate change objectives.
Progress to date
In total, Nest set 66 objectives (including both the headline objectives and mandate-specific objectives) across 23 portfolios and 13 fund managers. There has been some positive progress so far:
- Reporting: Only one fund manager is not currently a TCFD signatory due to insufficient resource, down from 4 at the end of 2020.
- Stewardship: All of Nest's four listed equity fund managers are now part of the ClimateAction 100+ engagement initiative and have included climate change in their voting policies. Nest are also pleased to see increasing support for shareholder resolutions. During the 2021 voting season, in aggregate their fund managers voted ‘For’ on 70.45% of shareholder proposals, a greater level of support than that of the general shareholder average (23.01% votes in favour on average).
There has also been progress on the mandate-specific objectives. As of 31 March 2021:
- 51% of objectives had been met
- 14% of objectives were on track
- 18% of objectives were in progress
- 17% of objectives had not progressed
Climate change scenario analysis and net zero alignment pathways have been the most challenging objectives for their fund managers to meet. Nest are working with managers to translate top-down targets into portfolio-level targets, using a fair share approach depending on the asset class and region and reflecting the different starting points and rates of decarbonisation, for example across developed and emerging markets.
To date, Nest's work on asset class-based portfolio tilts has focused on public markets where data coverage and quality is much better. They have also been engaging with private markets managers on improving the data coverage and quality of the Scheme’s investments to better understand climate-related risks and opportunities in these assets. Currently, their developed and emerging market equity mandates and global investment grade fixed income portfolios use climate change metrics in the portfolio construction process.
Nest has been a supporter of the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and has included a TCFD statement in its annual report and accounts since the 2017/18 financial year. From October 2021, Nest will also be subject to new climate change disclosure requirements under the Pension Schemes Act 2021.
Nest engaged with the Department for Work and Pensions (DWP) and The Pensions Regulator (TPR) on the proposed disclosure requirements and responded to a number of consultations. To prepare for these new requirements, Nest used the DWP’s draft statutory guidance to develop its 2020/21 TCFD report and identify any potential gaps and challenges before the regulations come into force.
One of the most challenging aspects of the report was to identify and measure appropriate metrics and targets. This year Nest requested information on individual portfolio-level carbon emissions from all fund managers for the first time. While all managers responded to the request, it was found that data coverage and quality vary significantly across asset classes. Many companies still do not report scope 3 emissions. Gaps in reporting are sometimes filled by data providers that estimate scope 3 emissions based on a company’s activities. In private markets there are also some gaps in reporting on scope 1 and 2 emissions. Nest also requested that fund managers provide metrics using the GHG Accounting and Reporting Standard by the Partnership for Carbon Accounting Financials (PCAF) using enterprise value including cash (EVIC) to attribute corporate emissions to equity and bond investments. However, not all managers were familiar with this standard and many still used Weighted Average Carbon Intensity (WACI) as the core metric which uses revenues for the attribution factor instead. Due to these inconsistencies Nest was not able to aggregate the data at scheme-level and currently only tracks and reports this data at the individual portfolio level.
Nest are currently working on translating long-term climate policy objectives into a short-term strategy and targets for 2025. As part of this, Nest will continue to work with external managers on implementing climate change policy and will review and update objectives accordingly.
Katharina Lindmeier, CFA
Arun Kelshiker, CFA; Tarik Ben-Saud, CFA; Alexander Beecraft, CFA; Andrew Burton; Alistair Byrne, PhD, CFA; Olivier Fines, CFA; Alistair Jones, IMC; Maria Nazarova-Doyle, CFA; David Rae, CFA; Issac Tabner, PhD, CFA, ASIP, DipPFs; Natalie Winterfrost, CFA, AMAPPT, FIA.