Why covenant assessment should be front and centre of your TCFD report

Let me start by saying I am not an employer covenant specialist; I predominately help pension schemes with their investment decisions. However, having both produced and reviewed some of the early TCFD reports, as well as being involved in producing PwC's year one market review on the subject, one aspect that stands out for me is the limited consideration of the employer's exposure to climate-related risks. While some schemes have touched upon the employer covenant, the focus has often been on highlighting risks without providing a clear understanding of the potential implications or opportunities. These assessments have predominantly been qualitative in nature, lacking more comprehensive analysis.

When we contemplate the potential impacts of climate-related risks on pension schemes, two primary concerns arise: affordability (or lack of) and sponsor prospects. Naturally, a significant risk would be if the employer's financial position deteriorates to the point where funding gaps cannot be met to support the scheme's journey plans. Moreover, the simultaneous occurrence of impaired employer balance sheets and investment losses on scheme assets poses an even greater threat—an entirely plausible scenario given the nature of climate risk.

To truly address these risks, I believe a more integrated approach, reminiscent of Integrated Risk Management, holds immense value for trustees preparing their TCFD reports. Such an approach would consider the interplay between funding, investment strategy, and covenant strength, providing a holistic understanding of the scheme's risk exposure. Armed with these insights, trustees can make informed decisions to shape the scheme's strategy accordingly.

In light of these considerations, there are several sensible actions that trustees could consider:

• Firstly, a breakdown of the impact of physical and transition risks on both the scheme and employer should be provided over relevant time horizons aligned with the scheme's journey planning.
• Secondly, a clear framework for risk identification and monitoring should be established, empowering trustees to take proactive mitigating actions when necessary.
• Finally, it would be prudent to explore the potential impacts on both the scheme's assets and the employer covenant concurrently at key points in time, even if done qualitatively.

As we continue down the path of climate-related financial disclosures, it is crucial for pension schemes to embrace a more comprehensive and forward-thinking approach. By integrating covenant assessment with the broader framework of risk management, trustees can unlock greater value for their schemes and ensure they are well-prepared to navigate the challenges posed by climate change.