Climate change is a growing threat to the economy and society, and the transition to a green economy to mitigate and adapt to climate change requires trillions of dollars of investment every year, globally. India, a global leader in climate action, is committed to transitioning into a green economy. As per various agencies’ estimates, India’s climate mitigation goal by 2070, popularly known as net-zero, needs $10-12.5 trillion in the next 25-45 years. Besides, there is additional capital investment required for climate adaptation — 2.5 per cent of GDP by 2030 as per the Reserve Bank of India, translating into about $100 billion per annum.

 

Mobilising this humongous volume of capital needs all kinds of financial institutions. In India, given a banking-driven economy, the discussion is largely moving around mobilising capital from banks. One of the largest sources of capital, which is missing, is pension funds, currently managing about $600 billion and growing at a rate of 10 per cent per annum.

 

Although a substantial portion, more than 50 per cent, of these funds is allocated in government securities, a significant portion is parked in public equity, corporate bonds, and other financial instruments. Pension funds seldom invest in companies in the climate space. Given pension funds’ long investment cycles, appropriate financial instruments, such as Infrastructure Investment Trust (InVIT), Alternative Investment Fund (AIF) and corporate bonds with credit enhancement, can be deployed to raise capital from them.

 

Most of the financial markets unnecessarily worry or show exuberance on rallies, market dips, and quarterly reports, which make them undisciplined, leading to suboptimal performance. Pension funds, in particular, have a long investment cycle. For example, pensioners who are contributing to pension funds are unlikely to withdraw for several years unless there is an emergency.

 

This long investment cycle perfectly aligns with the investment cycle of climate technology, be it renewable energy, clean transportation, or climate adaptation. Investment in all these technologies and segments could perform better than the broader market, at least better than carbon-intensive technologies, as the economy transitions to a less carbon-intensive economy.

 

Climate change risk, regarded as a systemic risk to the financial system, will affect the financial performance of companies and industries more in the long term. As pension funds have long-duration liabilities, pensioners withdraw funds after a few decades, and they need to be more cognisant of this risk. This has prompted several pension funds in Europe to integrate climate risk into their investment strategies to protect the interests of beneficiaries.

 

Pension funds are low-risk seeking investors and they avoid risky bets, and invest in companies with sound fundamentals and a resilient business model that lasts for decades and withstands all possible kinds of risks, including climate change. Although pension funds are protected from downside risks, given their large exposure to government securities, investment in corporate financial assets is also increasing. As the financial sector develops, pension funds will gradually move away from government securities to corporate financial assets. Hence, it is important that these funds integrate climate change risk in their securities selection and portfolio management.

 

Pension fund regulation on climate risk and pension fund regulators in several countries are asking their regulated entities to disclose the latter’s climate-related risks and opportunities. Although the pace of adoption varies across countries, sponsors and trustees of pension funds are taking notice of these developments in the interest of fund participants. However, pension fund management in India remain largely insulated in terms of climate risk management and reporting due to limited guidance from regulators.

 

Pension funds in India are primarily managed by the Employees’ Provident Fund Organisation (EPFO) and the National Pension System (NPS). While EPFO manages the fund itself, NPS has selected fund managers to manage, although it is the discretion of the investor to choose fund managers. The NPS has a stewardship code for the fund manager to promote responsible investment practice, but it has limited wherewithal to force fund managers to follow the norms in spirit. Beneficiaries are also not aware whether fund managers are integrating climate risks into their risk management strategies.

 

NPS is a member of the International Organisation of Securities Commissions (IOSCO); it outlines a prescription on sustainability risk and opportunities, including climate change, for asset managers, including pension funds. This prescription is meant to standardise climate-related disclosures, ensuring that investors and regulators have access to consistent and reliable information to assess and manage climate risks. Following international best practices could allow Indian pension funds to better assess the transition risks associated with industries exposed to carbon-intensive activities and evaluate the physical risks that may affect government securities and other key assets. NPS can at least start a consulting process, like the Reserve Bank of India did last year, on climate risk and sustainable finance.

 

Pension fund has a crucial role to fill the green financing gap in India while making the fund resilient to climate-related financial risks, and it can start with regulation.