Pension funds ‘overwhelmed’ by inconsistent transition regulations

Divergence in regional approaches holds back net-zero progress

Access to capital, a long-term view of risk and return and the nature of their investments in infrastructure and energy projects mean that pension funds play an integral role in scaling up transition finance. With their ability to bring together the necessary actors, including investors, fund managers and governments, pension funds must leverage their influence and capital to drive sustainable capital markets.

That was the call to action from participants at OMFIF’s roundtable on the role of pension funds in transition finance. The event brought together representatives from banks, pension funds, asset owners and managers as well as private financial institutions to analyse what needs to be done to scale up transition finance.

‘How do we bring everyone to the table and also build trust? How do we view this as an opportunity for innovation but also doing a public good?’ asked one participant. They urged that it is important not only to have the ‘right’ people at the table, but also that the needs and risk tolerances of everyone are understood and accounted for. ‘We need to get comfortable with a new kind of risk.’

The roundtable participants agreed that ‘Transition finance includes both the long-term horizon and the short-term sprint.’ Pension funds must embrace a range of sustainable products and tools to raise the capital required for the transition.

Regional differences

There is wide divergence between European, Asian and North American approaches to transition finance. In the US and Canada, investors seek a clear promise of return or, at the very least, a subsidy such as the Inflation Reduction Act provides. In Europe and Asia, transition finance is led by taxonomies and frameworks.

The number of frameworks and regulations currently operating in Europe were identified as a ‘real pain point’ in markets. Participants acknowledged that while these frameworks are essential to starting a discussion that will ‘create big change later on’, there are drawbacks to having to meet so many different requirements. One audience member pointed out that a lot of pension funds had already started to take major steps in their transitions, but the regulations had pulled them back. They said: ‘We run the risk of meeting the targets but missing the point.’

On the other side, funds in North America face very few regulations or requirements, meaning they often do not know where to begin. Meanwhile, emerging markets are ‘falling into a big black hole’ because they do not have the same resources to meet disclosure requirements that developed countries do. ‘Do we just not invest in them?’ asked one participant. To close the gap, there needs to be clear, simple and consistent guidelines that are easy to understand and apply.

There is also a risk that overly prescriptive taxonomies in Europe risk making all sustainable portfolios the same. Latin America was held up as an example for how to avoid this. Every major country in Latin America is working on a taxonomy of its own, tailored to its specific needs and priorities, rather than simply copying the European model. However, there was some scepticism among participants about whether this will actually increase the flow of capital to those countries.

Changing the focus

One participant from a pension fund said that funds most often look at investing in green assets to decarbonise their portfolios. But there is a need to change things ‘from the inside’. One approach is to invest in raw materials, such as steel and plastics – highly polluting industries – to begin changing their processes and reducing emissions.

Participants at the roundtable said there was a reluctance to pursue this strategy due to the immediate increase in investors’ carbon footprints. But they also pointed to a greater focus on ‘intentionality’, meaning investors are starting to care more about the impact of their investments doing good, rather than just making a profit.

While a lack of clarity and consistency in transition standards persists, it is clear that sovereign funds and pension funds are beginning to seriously engage with net-zero goals. Funds are taking ‘active ownership’ over browner assets, implementing transition plans, green strategies and requirements and divesting their portfolios. Clear and simple guidelines that are consistent between regions will be crucial to scaling up transition finance over the next few years.

Emma McGarthy is Head of the Sustainable Policy Institute and Sarah Moloney is Chief Subeditor of OMFIF.

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