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Fossil fuel bond failure leaves UK’s largest pension funds open to legal risk

Many of the UK’s biggest pension providers are failing to use a critical financial lever in their engagement with fossil fuel companies and are opening the door to legal risk, environmental lawyers warn.

ClientEarth has written to the UK’s 12 largest pension funds in the UK to say that the investors have yet to focus on their bond investments, which are a much bigger yet lesser-known source of fossil fuel financing.

The letter calls on trustees to:

  1. Cease providing capital through bonds to any energy sector company unless:
    1. The company has a just and credible net zero transition plan with specific targets aimed at ending the use of and support for fossil fuels in line with the net zero greenhouse gas emissions modelled pathways of the Intergovernmental Panel on Climate Change (IPCC) and International Energy Agency (IEA) that limit warming to 1.5°C with no or limited overshoot;
    2. and the bond documentation includes covenants requiring implementation of that transition plan (the ‘Bond Covenants’),
  2. Exercise, directly and/or through their asset manager(s), effective stewardship in relation to implementation of the transition plans of investee energy sector companies
  3. Communicate the Investment Conditions to all current and prospective investee energy sector companies.

Existing legal duties require pension schemes to protect their beneficiaries from financial risk, with climate change posing an existential threat to the sector.

By failing to use these levers, funds are exposing themselves to legal risk, lawyers said.

“Bonds are one of the main ways fossil fuel companies finance their expansion and pension funds investing in them run the risk of breaching legal duties. These funds have an enormous opportunity before them: by attaching climate terms to bonds, they can help turn the tide of the energy transition and reduce their own legal risk.”
Catriona Glascott, lawyer at ClientEarth

Lawyers highlighted that many pension schemes have committed to transition to a net zero portfolio and claim that climate change underpins their investment strategies. However, a significant amount of pensions money remains invested in fossil fuels.

According to Make My Money Matter, UK pension funds wield a staggering £3 trillion in investment power. Of that, more than £88 billion is bolstering the fossil fuel industry with almost a quarter done through bond investments.

These schemes are bound by existing legal duties – known as fiduciary duties – to protect their beneficiaries. Schemes are increasingly being required to demonstrate to regulators that they have properly considered the risk climate change poses to their portfolios.

“Pension scheme bond holdings span decades, but many include some of the riskiest investments long-term: fossil fuels.

“Fossil fuel projects have a high chance of being rendered obsolete in coming decades as the world’s energy system transitions to renewables. Pension beneficiaries are having their funds thrown behind risky projects for potential short-term profits – a strategy that risks undermining long-term reward for customers.

“Pension schemes – which promise a secure future in principle – have the chance to make that both a planetary and material reality for beneficiaries. They can make bond financing dependent on climate commitments and ensure that credible company transition plans are a condition for investment.”
– Glascott added

ClientEarth's letter to the UK's twelve biggest pension funds on their bond investments

Go to letter