‘Dramatic increase’ in stress testing predicted

A third of European, Australian and North American pension funds expect industry spending on stress testing and scenario modelling to “increase dramatically” due to climate risk and illiquid assets, according to a new study.

The study was conducted by Ortec Finance, a data analytics provider to the financial sector. A total of 201 pension fund managers responsible for $1.9trn assets under management based in the US, UK, Australia, Canada, the Netherlands, Switzerland, Denmark, Finland, Norway and Sweden took part in the survey.

Thirty-three percent of respondents expected a “dramatic increase” in spending on stress tests and modelling, while 54% predicted a “slight increase”.

The research found that the biggest factor driving this increased spend in stress testing is the growing focus by pension funds on illiquid, unlisted and esoteric assets as the search for yield intensifies.

Climate risk scenarios

It also noted that the second leading cause for the spending increase was climate risk scenarios, which are developed to help pension funds work out their net-zero plans.

Lisa Eichler, director of strategy and markets for climate and ESG solutions at Ortec Finance, told Net Zero Investor: “One of the biggest components driving an increase in expenditure on stress testing and scenario analysis is modelling climate risks.”

Eichler explained that the amount spent on stress testing for climate risks varies per company, but on average this now accounts for approximately 20% of expenditure in this area, compared to almost nothing two years ago.

“The threat of climate change on pension schemes is rising dramatically and the stakeholders are acutely aware of this and are investing heavily to develop a better understanding of their exposures and risks, to better understand what their options are in mitigating or reducing these,” she added.

Other reasons for the expected increase of pension funds’ spending on stress testing and scenario modelling include rising regulatory pressure leading to a demand for more reporting, growing focus on transparency, increasing risks for schemes and technological advances.

Marnix Engels, managing director for pension strategy at Ortec Finance, said: “Pension funds need to manage their balance sheet effectively in order to achieve long-term objectives while dealing with short-term risks.

“That includes identifying major risk sources some of which were previously not adequately accounted for and modelled such as climate risk as well as looking at future pensions, contributions, and funding levels.”

Almost all funds (97%) agreed that the more sophisticated range of investment strategies pension funds can deploy due to enhanced technology requires improvements in stress testing and scenario modelling as well as more frequent monitoring of assets, liabilities and funding levels.