/ 20 September 2019

Pensions must note climate risk

Risky investment: The legal opinion is clear that even those pension funds that are not governed by the Pension Funds Act must consider the risks associated with climate change when making investment-related decisions.
Risky investment: The legal opinion is clear that even those pension funds that are not governed by the Pension Funds Act must consider the risks associated with climate change when making investment-related decisions. (Paul Botes/M&G)




As far back as 2011, the government recognised the potentially catastrophic effects that climate change could have on South Africa in the medium to long term.

The National Climate Change Response white paper 1 stated: “Even under emission scenarios that are more conservative than current international emission trends, it has been predicted that by mid-century the South African coast will warm by around 1 to 2°C and the interior by around 2 to 3°C. By 2100, warming is projected to reach around 3 to 4°C along the coast, and 6 to 7°C in the interior. With such temperature increases, life as we know it will change completely …”

In the same year, regulation 28 of the Pension Funds Act (PFA), 1956 was published, requiring pension fund trustees to consider environmental, social and governance factors when making investment decisions.

ClientEarth, a nonprofit environmental law organisation, and Just Share, a nonprofit shareholder responsible investment organisation, commissioned international business law firm Fasken to provide a legal opinion on the question of whether the boards of pension or provident funds are required under South African law to take into account climate-related risks and opportunities when making investment-related decisions on behalf of their funds.

The answer is an unequivocal “yes”, both for funds regulated by the PFA and for those, such as the Government Employees Pension Fund (GEPF), that are not.

The opinion, prepared by pension lawyer Rosemary Hunter, finds that a failure to consider material financial risks arising from climate change would probably amount to a breach of duty by the board of a pension fund, under both the common law principles and regulation 28 of the PFA.

Regulation 28 pension funds

Regulation 28 sets out a number of principles that must be applied by a fund and its board. One of these is that, “before making an investment in and while invested in an asset, [the board must] consider any factor which may materially affect the sustainable long-term performance of the asset including, but not limited to, those of an environmental, social and governance character”.

This principle must also be adhered to by anyone to whom any investment-related powers and functions of the fund are delegated, for example asset managers and asset consultants.

Climate change is a material financial risk. Climate change risk must therefore be considered before making an investment in and while invested in an asset.

Those not governed by the PFA

Some pension funds are not subject to the Pension Funds Act, because they have been established by statutes other than the Act, and because their liabilities either have been or are now underwritten by the state. The largest of these is the GEPF, which is also the largest overall fund in South Africa by asset value.

The legal opinion is clear that these funds are also required by common law principles to take into account any factor that may materially affect the sustainable long-term performance of the fund, including those of an environmental, social and governance character. In other words, funds not regulated by the PFA must also consider the risks associated with climate change when making investment-related decisions.

Key legal findings

• The boards of pension funds must exercise the powers of the fund in the best interests of the fund, which means for the sole purpose of fulfilling its objects over the long term. Decisions relating to the investment of the fund’s assets must therefore be taken with due regard for the risks, both long-term and short-term, associated with those investments. These include climate-related risks;

• Pension funds that are well managed, and which conduct their investment activities in a manner designed to ensure their long-term sustainability, will serve the best interests of both the fund’s current members, those who may become their members in the future and the dependents of current and future members, viewed as a whole;

• A pension fund’s dependence

on its board for the proper exercise of the fund’s powers and fulfilment of its duties means the board and each of its members occupies a position of trust, and owes a fiduciary duty to the fund when acting in that capacity. In other words, board members owe the duties of good faith, care and diligence to the fund;

• Pension fund trustees derive their powers from legislation, including the Constitution, and the rules of the fund. They do not derive them from any “mandate” given by those who elected or appointed them;

• In exercising the powers of a fund, the board must protect the existing rights of the fund’s members, but it is not entitled to advance their interests if this would be inconsistent with its fiduciary duty to the fund. The interests of the fund’s members and their dependents, and future members of the fund, must be viewed as a whole and treated as subordinate to those of the fund itself, particularly as they may not always coincide;

• This means that, although it may be to the advantage of some of a fund’s current members for it to take certain actions in the short term, if it is evident from information before the board that it would not be in the long-term interests of the fund for it to take such actions, then the board must not take those actions on its behalf. Instead it must ensure that it follows the course of action best aligned with the long-term interests of the fund;

• If the board fails to properly consider relevant information, or, having considered it, fails to give it appropriate weight when making decisions, then it will be acting in breach of its duty to act in the fund’s best interests;

• A failure to take into account risks associated with factors such as climate change, which may be relevant to the likely long-term performance of a specific investment, or the fund’s investments as a whole, is likely to amount to a breach of the duty of care and diligence;

• Each board member must apply his or her mind to the issues before the board, including the likely environmental, social and governance risks associated with any particular investment. A board member may not leave this to other board members or delegate the duty to third parties. He or she cannot remain ignorant when compliance with these duties means that he or she must seek information, nor can he or she blindly accept information and advice from third parties;

• Board members must therefore take all reasonable steps to acquire the information in relation to the risks associated with climate change as they may require, to make informed decisions when taking such risks into account when exercising the fund’s investment powers;

• The board of a fund is entitled to appoint appropriately qualified and authorised third-party investment managers to exercise some or all of the fund’s investment powers. But, to comply with its legal obligations, the board must still:

a) Ensure that the terms of appointment bind the investment manager to comply with the fund’s investment policy statement and legal duties, including its policies in relation to the application of environmental, social and governance factors to the assessment of investments; and

b) Monitor and supervise the conduct by such investment managers of their functions and the fulfilment of their duties;

• If necessary, the board should make it a condition of its appointment of an investment manager that the manager procures the approval of the Financial Sector Conduct Authority of the conclusion of an agreement between them on terms incorporating such duties;

• If a fund suffers financial loss as a result of negligent failure by one or more board members to act with due care and diligence in the formulation of the fund’s investment policies and strategies, and/or the implementation of those policies and strategies (including in the mandating of third-party investment managers to exercise on behalf of the fund), those board members may be held liable to compensate the fund for its loss;

• As the management of investments ordinarily entails the exercise of discretion, and the fund will be dependent on any appointed investment manager for the exercise of that discretion, such investment manager occupies a position of trust in relation to the fund. As such, the common law imposes on the investment manager a duty to exercise the powers delegated to it in good faith, with due care and diligence, and in the best interests of the fund. This includes the evaluation of investments taking into account the risks associated with climate change; and

• Investment managers must not place themselves in a position in which their duty to the fund conflicts with or is inconsistent with the direct or indirect interests of the investment manager.

In light of these findings, the opinion also recommends that the 2007 nonbinding guidance note from the Registrar of Pension funds (PF 130), which states that “the primary obligation of [a fund’s investments] is to provide optimum returns for its beneficiaries” should be withdrawn.

The legal opinion was commissioned to support the boards of pension funds in the exercise of their fiduciary duties and to build climate competence, so that they can carry out their functions in a way that contributes to the resilience and prosperity of South Africa.

Tracey Davies is executive director of Just Share. Joanne Etherton of ClientEarth is the project lead for climate finance