The California Constitution requires members of the retirement board of a public pension or retirement system to discharge their duties with respect to the system solely in the interest of, and for the exclusive purposes of providing benefits to, participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system. Existing statutory law establishes various public employee retirement systems and provides for the administration of the State Teachers Retirement System by the Teachers Retirement Board and for the administration of the Public Employees Retirement System, among other public employee retirement systems, by the Board of Administration of the Public Employees Retirement System.

This bill, on and after January 1, 2019, bill would require those boards to consider the financial climate risk, as defined, of each investment, or potential investment, as part of their discharge of their fiduciary duties with respect to the investment. in their management of any funds they administer. The bill, by January 1, 2020, and annually thereafter, would require the boards to report on include in their comprehensive annual financial reports the financial climate risks of their investments, including the carbon footprint of the investments, alignment of their portfolios with a specified climate agreement and California climate policy goals, the value at risk if these goals are achieved, and the exposure of the portfolios to long-term risks, as specified. The bill would provide that it does not require the boards to take action that is not consistent with their fiduciary responsibilities. The bill would make related legislative findings and declarations.

The California Constitution requires members of the retirement board of a public pension or retirement system to discharge their duties with respect to the system solely in the interest of, and for the exclusive purposes of providing benefits to, participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system. Existing statutory law establishes various public employee retirement systems and provides for the administration of the State Teachers Retirement System by the Teachers Retirement Board and for the administration of the Public Employees Retirement System, among other public employee retirement systems, by the Board of Administration of the Public Employees Retirement System.

This bill, on and after January 1, 2019, would require those boards to consider the financial climate risk, as defined, of each investment, or potential investment, as part of their discharge of their fiduciary duties with respect to the investment. The bill, by January 1, 2020, and annually thereafter, would require the boards to report on the financial climate risks of their investments, including the carbon footprint of the investments, as specified. The bill would make related legislative findings and declarations.

SENATE COMMITTEE ON

Senator Ricardo Lara, Chair

2017 - 2018 Regular Session

SB 560 (Allen) - Public retirement systems: investments: financial climate risk

This bill meets the criteria for referral to the Suspense File.

Bill Summary:

SB 560 would require the California Public Employees’ Retirement System (CalPERS) and California State Teachers’ Retirement System (CalSTRS) to consider “financial climate risk” in the management of their respective funds, including when making decisions about asset allocation, investment levels in individual companies or commingled funds, or in hiring external asset managers.

Fiscal Impact:

• CalSTRS indicates that its portfolio could be lowered by up to $26 million for delaying the realization of investment gains by two weeks if it is required to consider financial climate risk when making investment decisions in private asset classes. With respect to public asset classes, CalSTRS notes that it is a passive investor, and looking at each investment (roughly 8,000 securities) for financial climate risk would require a change in investment strategy and could result in additional unknown, potentially significant investment losses. Additionally, CalSTRS would incur costs that could potentially exceed $250,000 annually to evaluate and report out on the financial climate risk of investments. Finally, unknown and potentially significant additional costs could be incurred for having to align its portfolio with the Paris Climate Agreement and the California climate policy goals.
• CalPERS is still refining its estimate of the bill’s fiscal impact, but indicates that it would incur costs, minimally in the hundreds of thousands of dollars annually, to implement the provisions of the bill. CalPERS invests in more than 60,000 securities that it would be required to track, analyze and report on annually. The bill’s potential impact on CalPERS’ portfolio performance has yet to be determined.

Background:

Under existing provisions of Section 17 of Article XVI of the California Constitution, as amended by Proposition 162 of 1992, the CalSTRS board and CalPERS board have plenary authority and fiduciary responsibility over the investment of retirement plan assets and are required to discharge their duties solely in the interests of the members and beneficiaries for the exclusive purpose of providing benefits. The boards must invest the assets of the plan with care, skill and diligence of a prudent person engaged in a similar enterprise so as to maximize the investments and minimize the risk of loss. The Constitution does allow the Legislature by statute to prohibit certain investments by a retirement board when it is in the public interest to do so and provided the prohibition satisfies the standards of fiduciary care and loyalty required of the retirement board.

Other measures have been enacted by the Legislature to prohibit certain investments by public pension funds. For instance, AB 221 (Anderson, Chapter 671, Statutes of 2007) prohibits CalPERS and CalSTRS from investing in companies that have specified energy or defense-related operations in Iran; and AB 2941 (Koretz, Chapter 442, Statutes of 2006) prohibits CalPERS and CalSTRS from investing public employee retirement funds in a company with business operations in the Sudan, as specified.

Proposed Law:

This bill would, among other things, do the following:

• Define “financial climate risk” to mean material financial risk posed to an investment by the effects of the changing climate, including, but not limited to, intense storms, rising sea level, higher global temperatures, economic damages from carbon emissions, and other financial risks due to public policies to address climate change, shifting consumer attitudes, changing economics of traditional carbon-intense industries, and other transition risks.
• Require CalPERS and CalSTRS to consider financial climate risk in their management of any fund they administer, including when making decisions regarding the fund’s asset allocation, increasing, decreasing, or maintaining investment in individual companies or commingled funds; or hiring external asset managers.
• Require CalPERS and CalSTRS, by January 1, 2020, and annually thereafter, to include in its comprehensive annual financial reports, the financial climate risk of its investments, including the alignment of their respective portfolios with the Paris climate agreement and California climate policy goals, the value at risk if these goals are achieved, and the exposure of the portfolio to long-term risks.
• Provide that the required reports of CalPERS and CalSTRS shall include the methods and results of the boards’ engagement related to environmental factors with companies that are the most carbon intense, such as utilities, oil, and gas produces, within the portfolio. The bill defines specific components that are to be included in the report.
• State that nothing in the bill shall require CalPERS or CalSTRS to take action that is not consistent with their constitutional fiduciary responsibilities.

Related Legislation:

• SB 32 (Pavley, Chapter 249, Statutes of 2015), requires the Air Resources Board (ARB) to ensure that statewide greenhouse gas (GHG) emissions are reduced to at least 40 percent below the 1990 level by 2030.
• SB 185 (De León, Chapter 605, Statutes of 2015), prohibits CalPERS and CalSTRS from investing in thermal coal companies, as specified.
• SB 350 (De León, Chapter 547, Statutes of 2015), established targets to increase retail sales of renewable electricity to 50 percent by 2030 and double the energy efficiency savings in electricity and natural gas end uses by 2030.

Staff Comments:

As noted above, SB 560 would require the CaISTRS and CaIPERS boards to consider the financial climate risk of each investment, or potential investment, as part of their discharge of their fiduciary duties with respect to the investment, and also would require an annual report on the financial climate risks of their investments.

CalSTRS notes that no other state has enacted legislation requiring their pension funds to consider financial climate risk but notes that the European Parliament enacted legislation that requires retirement fund managers to take into account environmental, social and governance (ESG) risks and that France enacted Article 173, which requires a wide range of investors to report on how they integrate ESG, and specifically climate change, factors in assessing risk.

CalPERS has historically viewed climate change as an investment issue, adopted investment beliefs and principles in that regard, and consistently engages companies, other institutional investors, governments, and non-governmental organizations to formulate strategies to address the risks and opportunities posed by climate change and transition to low- and no-carbon energy sources.

CalSTRS has its own well-established and longstanding process for thoroughly vetting the ESG risks of potential investments. The board adopted its Statement of Investment Responsibility in 1978 and more recently a list of 21 risk factors that help the board identify and evaluate investment risks relating to the existence of conditions such as recognition of the rule of law, shareholder rights, human rights, the environment, acts of terrorism and other unsustainable practices and governance crises with the potential to hurt long-term profits. CalSTRS also has a divestment policy to respond to external or internal initiatives to divest of specific companies or industries, but believes that active and direct engagement is the best way to resolve issues. Consequently, the CalSTRS board has initiated divestment efforts of its own such as the CalSTRS Benchmark Modification Policy in June 2002 to remove tobacco companies from the benchmarks of all CalSTRS managers and has effective divested of tobacco from passive managers; and, has begun the divestment process with two publicly traded U. S. companies that manufacture firearms, as specified.

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SENATE COMMITTEE ON

PUBLIC EMPLOYMENT AND RETIREMENT

Dr. Richard Pan, Chair

2017 - 2018 Regular

Bill No: SB 560 Hearing Date: 4/24/17

Subject: Public retirement systems: investments: financial climate risk

SOURCE: Environment California (co-source)

Fossil Free California (co-source)

DIGEST: This bill requires California Public Employees’ Retirement System (CalPERS) and California State Teachers’ Retirement System (CalSTRS) to consider financial climate risk in their management of their respective funds, including when making decisions about asset allocation, investment levels in individual companies or commingled funds, or in hiring external asset managers.

ANALYSIS:

Existing law:

1. Pursuant to the California Constitution provides that:
   1. The respective boards of California's public retirement systems have "plenary authority and fiduciary responsibility for investment of monies and administration of the system."
   2. The Legislature retains its authority "to prohibit certain investments by a retirement board where it is in the public interest to do so, and provided that the prohibition satisfies the standards of fiduciary care and loyalty required of a retirement board pursuant to this section."
   3. The members of the retirement board of a public pension or retirement system shall discharge their duties with respect to the system solely in the interest of, and for the exclusive purposes of providing benefits to, participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system."
2. Requires CalPERS and CalSTRS to not invest in certain companies, as specified, or to report on engagement with those busineses in efforts to achieve goals related to conditions in Northern Ireland, Sudan, and Iran, as specified, provided that such requirements conform to the systems’ fiduciary duties.
3. Requires CalPERS and CalSTRS not to invest in thermal coal companies and to report on engagement with those businesses in efforts to achieve goals related to transitioning from thermal coal to cleaner forms of energy production, as specified, provided that such requirements conform to the systems’ fiduciary duties.
4. Provides that board members and other covered persons, as described, shall be indemnified from the General Fund and held harmless by the State of California from all claims, demands, suits, etc., sustained by reason of any decision to restrict investments in Iran or Sudan pursuant to relevant provisions of law.

This bill:

1. Requires CalPERS and CalSTRS to consider financial climate risk in their management of any fund they administer, including when making decisions regarding the fund’s asset allocation, increasing, decreasing, or maintaining investment in individual companies or commingled funds; or hiring external asset managers.
2. Requires CalPERS and CalSTRS, by January 1, 2020, and annually thereafter, to include in its comprehensive annual financial reports, the financial climate risk of its investments, including the alignment of their respective portfolios with the Paris climate agreement and California climate policy goals, the value at risk if these goals are achieved, and the exposure of the portfolio to long-term risks.
3. Provides that the required reports shall include the methods and results of the board’s engagement related to environmental factors with companies that are the most carbon intense, such as utilities, oil, and gas produces, within the portfolio. The bill defines specific components that are to be included in the report.
4. Makes several findings and declarations related to the threat from climate change and the effect on financial investments, as well as references to state and international efforts to address climate risk.
5. Defines “financial climate risk” to mean material financial risk posed to an investment by the effects of the changing climate, including, but not limited to, intense storms, rising sea level, higher global temperatures, economic damages from carbon emissions, and other financial risks due to public policies to address climate change, shifting consumer attitudes, changing economics of traditional carbon-intense industries, and other transition risks.
6. States that nothing in the bill shall require CalPERS or CalSTRS to take action that is not consistent with their constitutional fiduciary responsibilities.

Background

The author states that researchers have outlined four discrete risks to pension fund assets posed by climate change: physical impact risk to the environment and infrastructure; stranded asset risk to carbon assets; transition risk of changing from high-carbon to green energy production; and litigation risk arising from regulatory changes and through attempts to source accountability for climate change damages. “These risks, which can result in material impacts to investments including direct financial losses, must be seriously evaluated in any long-term investments strategy as part of the manger’s fiduciary duty.”

According to CalSTRS, it has a well-established and longstanding process for thoroughly vetting the environmental, social and governance (ESG) risks of potential investments, including its Investment Policy for Mitigating ESG Risks, which uses 21 Risk Factors to evaluate potential investment risk from climate change; its participation in the Climate Risk Disclosure Initiative, which released a global framework for climate risk disclosure; and its work with the Green Initiative Task Force, which annually reports on environmental risk management efforts.

CalSTRS states that no other state has enacted legislation requiring their pension funds to consider financial climate risk but notes that the European Parliament enacted legislation that requires retirement fund managers to take into account ESG risks and that France enacted Article 173, which requires a wide range of investors to report on how they integrate ESG, and specifically climate change, factors in assessing risk.

Related/Prior Legislation

SB 32 (Pavley, Chapter 249, Statutes of 2015), requires the Air Resources Board (ARB) to ensure that statewide greenhouse gas (GHG) emissions are reduced to at least 40 percent below the 1990 level by 2030.

SB 185 (De León, Chapter 605, Statutes of 2015), prohibits CalPERS and CalSTRS from investing in thermal coal companies, as specified.

SB 350 (De León, Chapter 547, Statutes of 2015), established targets to increase retail sales of renewable electricity to 50 percent by 2030 and double the energy efficiency savings in electricity and natural gas end uses by 2030.

FISCAL EFFECT: Appropriation: No Fiscal Com.: Yes Local: No

SUPPORT:

Fossil Free California (co-source)

Environment California (co-source)

350 Sacramento

OPPOSITION:

California State Teachers’ Retirement System

ARGUMENTS IN SUPPORT: According to the author, “A transition to a low-carbon economy, along with the anticipated impacts of climate change, will have significant material financial consequences for long-term investors such as public pension funds. Because climate-related risk will likely have greater impacts on future beneficiaries than on current fund members and retirees, failure to consider long-term climate-related risk when investing today could be viewed in the future as an unreasonable bias favoring short-term gain over long-term stability and growth. This bias, and the failure to appreciate and account for these impacts, is likely to be seen in the future as a breach of fiduciary duty, subjecting fund fiduciaries to liability.”

ARGUMENTS IN OPPOSITION: According to CalSTRS, “the board’s policy is to oppose legislation that infringes on the investment authority of the board. While CalSTRS believes climate risk to be an important consideration in its investments, adding a mandate to consider “financial climate risk” infringes on the board’s authority to discharge its fiduciary duties with ‘due care’. This represents an unreasonable and unnecessary infringement on the board’s plenary authority and fiduciary responsibility.”

According to CalSTRS staff, they are continuing to meet with the author and sponsors to see if the parties can reach agreement on amendments to the bill, and while some progress has been made, as reflected in the recently amended version of the bill, there is still work to be done before CalSTRS can remove their opposition.