NEW REPORT: The New Economics of Innovation and Transition: Evaluating Opportunities and Risks

Net-zero transition planning for pension funds and other asset owners

We have left it too late to tackle climate change incrementally. We now require a dramatic acceleration of progress through transformational change across society and the global economy. The pensions industry has an undeniably important role to play in supporting the journey to net zero, not least through investing for a world that its beneficiaries would want to live in. While this paper focuses on the UK, it is relevant for pension funds globally.

Acting on behalf of their beneficiaries, pension funds must rise to the challenge of ‘greening’ their investment strategy and portfolio assets. To do so requires fundamental change to the way investment decision making is framed.

We argue that the current net-zero strategies guiding pension funds and other asset owners (we shall simply refer to ‘pension funds’ here) are too strongly influenced by modern portfolio theory. At the same time, official climate scenarios are increasingly regarded as not being ‘decision-useful’.

This practitioner-focused paper sets out how the Economics of Energy Innovation and System Transition (EEIST) programme – initially targeted at net-zero policymakers – can be applied to catalyse a paradigm shift in transition planning in the investment industry.

With net-zero commitments made, credible transition plans will increasingly be expected by beneficiaries, plan sponsors (for defined benefit funds), NGOs and regulators. These plans will need short-term bespoke scenario analysis in order to set interim targets against which reporting will be required.

Drawing on EEIST’s ‘Risks and Opportunities’ methodology, rooted in complexity economics, we recommend that pension funds adopt ‘Decision-Useful Climate Scenarios’. This approach delivers analysis of future investment risks and opportunities through the application of plausible ‘real-world’ narratives.

Inspired by EEIST’s ‘Ten Principles for Policy Making in the Energy Transition”, we propose ‘Ten Transition Planning Principles for Pension Funds’. These principles provide a framework for transformational net-zero decision making and embedding the associated change in risk culture.

The final section provides readers with an overview of the leading transition planning work currently being carried out by the Universities Superannuation Scheme (USS), in which the application of ‘EEIST Thinking’ is clearly visible.

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