Lessons from first European pension sector climate stress test

EIOPA’s climate stress test focuses on what is known as transition risk. The participating pension institutions worked through an economic scenario based on the impact that would arise if governments implemented unexpected and robust carbon pricing to meet their climate targets.

The scenario studied has a limited downward impact on the participating Dutch pension institutions. This is because the scenario combines a fall in variable-yield investments with rising interest rates. Both effects largely offset each other.

Climate scenarios are surrounded by great uncertainty. EIOPA emphasises that it may be useful for future stress tests to explore a range of different scenarios. Alternative transition scenarios that lead to different interest rate and inflation trends may have a greater impact on pension institutions. They can help pension institutions gauge the robustness of their strategic investment policies to climate risks.

The EIOPA scenario includes downward shocks to equities and corporate bonds that depend on the economic sector of the investment. The stress test thus contributes to understanding the climate sensitivity of investments within a given asset class. A number of participating Dutch pension funds, in cooperation with the Federation of the Dutch Pension Funds and DNB, opted to explore this aspect of the stress test in further detail on a voluntary basis. Only Dutch pension funds participated in this in-depth exercise.

For investments in the Dutch energy industry, they refined the EIOPA shocks to calculate a specific shock for each investment. As an example, the methodology results in a significantly larger shock for an investment in fossil power generation than for an investment in renewable power generation.

EIOPA concludes that refining stress test shocks, as applied by Dutch pension funds, can increase understanding of the climate sensitivity of investments within a given asset class. This can inform the investment choices which pension institutions must make. Future stress tests may apply more granular shocks to explore the climate sensitivity of investments in a specific asset class and/or economic sector.