Safeguarding EU workers’ pensions from climate risk

Introduction

Ensuring adequate retirement income for EU citizens is a growing challenge. As public pension systems are increasingly under strain given the demographic trend, the European Commission is promoting the uptake of supplementary pensions. This would shift the burden of securing decent retirement away from EU Member States’ budgets, but expose EU citizens’ to more risk as their retirement income would be invested in capital markets to seek returns.

Occupational pensions are a well-established type of supplementary pension in several EU Member States. They can play a vital role in providing retirement income and long-term investment. European occupational pension funds (IORPs) manage around €2.7 trillion in assets on behalf of over 70 million members and beneficiaries in the EU.^[1] This makes them, alongside insurers, one of Europe’s largest and most long-term institutional investor groups. The size and importance of the IORP sector varies greatly across Member States.

Mobilising pension funds presents a huge opportunity of increased investment available to help finance the transition to a more sustainable economy. This would, in turn, reduce the physical risk from the impacts of climate change and the transition risk of an abrupt, unmanaged move away from unsustainable economic activity that devalues associated investments and creates stranded assets. Amending the IORP II Directive (Directive (EU) 2016/2341), which sets out the rules for occupational pensions in the EU, can create a virtuous circle of investment to help secure EU citizens’ retirement income and shield them from increased exposure to climate risk as part of the shift to more market-based pensions.

I. The risks and opportunities of expanding EU occupational pensions

Pension systems across the EU are commonly structured around three main pillars. The first pillar consists of public pensions. These are typically pay-as-you-go schemes administered by EU Member States and financed through social contributions or general taxation. These provide a minimum level of retirement income. The second pillar comprises occupational pensions, which are set up by employers, either individually or through sector-wide arrangements. They are often funded jointly by employers and employees. These schemes are usually managed by occupational pension funds called Institutions for Occupational Retirement Provision (IORPs) or by insurance undertakings. The third pillar refers to voluntary personal pension savings, where individuals invest in private schemes, which can be incentivised by tax advantages.

A. The three pillars of EU pensions schemes in the EU

As Europe’s population ages and public budgets come under strain, it’s becoming harder for state pensions alone to guarantee a decent income in retirement. In fact, only four EU countries^[2] meet the recommended level of pension adequacy, which is to provide around 70% of a person’s former income.^[3]

This is why the EU is encouraging more people to save for retirement through supplementary pillar two and three pensions. Initiatives like the Pan-European Personal Pension (PEPP) and the Savings and Investments Union (SIU) aim to make these options more widely available and attractive to EU citizens. However, as more people rely on these types of schemes, which are invested in financial markets, their pensions are also more exposed to economic risks. This includes the long-term financial impacts of climate change, to which IORPs are particularly exposed given their long-term investment profile.^[4]

Occupational pensions are already well established in a number of Member States, but the structure and maturity of IORP systems vary widely across the EU. The Netherlands accounts for about 60% of all EU IORP assets, reflecting its large occupational pension system. Other countries with significant IORP markets include France, Germany, Ireland, Italy, and Sweden. Elsewhere in Europe, coverage remains more limited or fragmented.^[5]

At the same time, the EU is advancing broader capital markets reforms through the SIU to help channel more private savings into productive investment. A stronger and more integrated capital market would give European companies better access to long-term financing for innovation, infrastructure, and the green transition. For IORPs, this would create more stable and diversified investment opportunities within the EU that could reinforce their role in supporting the real economy while delivering long-term value for pension savers.^[6]

The IORP sector is also evolving and potentially exposing EU citizens to more risk. Defined contribution schemes are becoming more common, taking over from defined benefit schemes that guarantee an agreed amount of retirement income. This exposes the pension holders to more investment risk. Additionally, larger IORPs are increasingly consolidating small occupational pension funds, aiming to benefit from increased efficiency from economies of scale.

This shift to defined contributions and consolidation, combined with the EU drive to increase market-based pensions through EU citizens’ investment in IORPs, means much more retirement income may be exposed to investment risk, of which climate risk is an increasingly relevant driver. Citizens need to be shielded from bearing the full weight of this risk that increases with the rise of global temperatures and accelerating climate change.

II. Aligning investment and sustainability objectives to reduce climate risk exposure

The IORP II Directive (Directive (EU) 2016/2341) aims to set out common standards for IORP governance, risk management, and supervision to protect pension savers and promote a stable internal market for pensions. IORP II already includes key requirements to consider environmental, social, and governance (ESG) factors as part of the prudent person principle^[7] and to ensure that IORPs invest in the best long-term interests of pension holders. It also requires IORPs to integrate ESG factors in governance systems and to consider ESG risks as part of their risk management processes, including their own risk assessment. These are important requirements and there are indications that they are leading to action from IORPs to address exposure to climate risk. The most recent examples of this are two Dutch IORPs that have withdrawn investment mandates from BlackRock over concerns that it is not taking action to invest more sustainably.^[8]

The European Commission published a proposal to revise IORP II in November 2025. It suggests replacing ESG factors and risks with sustainability factors and risks in some cases to align with the definition in the EU Sustainable Finance Disclosure Regulation (SFDR). This primarily aims to ensure consistency across EU legislation, but is not suggested as an amendment throughout the text of the proposal to revise IORP II. The same definition would need to be extended to the additional reference to ESG factors and risks in Articles 21(1), 25(2g), 282(h), 30, 41(1c) and 41(3c) to ensure this consistency.

The European Commission has also proposed amendments to assess pension holders’ sustainability preferences. This would introduce equivalent requirements to those introduced for sales of investment and insurance products under the Markets in Financial Instruments Directive (MiFID) and Insurance Distribution Directive (IDD). The provisions on sustainability preferences will, however, need to be improved across the board in order to align with the reformed product categorisation rules in the SFDR following the revision of the SFDR.^[9]

Whilst these amendments are important, they do not sufficiently address the exposure of pension holders to climate risk. The existing requirements in IORP II have also not yet led to sufficient change across the sector.^[10] IORPs may still be investing in unsustainable activities that are directly contributing to accelerating climate change and, in turn, to their own climate risk exposure to future stranded assets. Further measures need to be taken to ensure that citizens are shielded against these increasing risks.

A. Risk capital

To ensure that IORPs more effectively manage their exposure to climate risk, they should consider sustainability risks as part of their estimations of the future expected value of the assets they invest in. Additionally, a buffer should be in place where IORPs are currently invested in unsustainable economic activities, to capture transition risk. This should focus on fossil fuels as an asset class since it accelerates climate change and will be most impacted by the transition, which requires fossil fuel phase-out. Buffer calibration should use the logic of loan-to-value ratios, as described in the Finance Watch report Finance in a hot house world.^[11] This logic implies that IORPs’ investments in fossil activities which exceed a defined threshold would be subject to an additional risk capital requirement. The threshold should be set in proportion to the amount of fossil fuels to which an IORP is exposed that can be safely exploited within the carbon budget for a given temperature increase. Please refer to the annex for the Finance Watch amendments to the European Commission’s IORP II proposal.

B. Sustainable investment

IORPs can actively contribute to reducing their exposure to climate risk through investing in activities that support the sustainable transition or that are already sustainable. By investing in a way that is compatible with and contributing to the transition to a sustainable economy, they reduce transition risk in two ways. Firstly, this approach reduces IORPs’ own balance sheet exposure to assets at risk of becoming stranded, and secondly, it reduces the systemic risk of delayed, disorderly transition and the risk of unmitigated climate change. IORPs should implement this approach by driving sustainable investment through their investment decisions and the selection of the mandates that they give to investment managers. Mandates to investment managers should include clear investment criteria and preferred voting and escalation policies. Please refer to the annex for the Finance Watch amendments to the European Commission’s IORP II proposal.

C. Sustainability risk plans

Supervisors need to be able to monitor the effectiveness of the amendments made to IORP II and to track IORPs’ progress towards reducing their climate risk exposure. A key tool to achieve this is through creating a sustainability risk plan, in line with requirements for insurers under Article 44 of the Solvency II Directive.^[12] IORPs and supervisors can use these plans to assess potential deviation from key climate objectives and better understand their transition risk exposure.^[13] IORPs should also disclose sufficiently granular data on their investment in assets exposed to physical and transition risks. This is important both for IORPs’ risk management and for supervisors to have a clear view on climate risk exposure. Please refer to the annex for the Finance Watch amendments to the European Commission’s IORP II proposal.

Finally, a direct mandate to review the adequacy of suggested measures should be included. The timing of the review clauses aims to leave Member States sufficient time to integrate the measures into national law and assess their impact on IORPs.

Conclusion

Occupational pensions are set to become a growing pillar of EU citizens’ retirement income. As the shift towards market-based pension savings accelerates, so too does the responsibility to shield these savings from the growing financial risks posed by climate change. IORPs hold long-term capital needed to finance the transition to a sustainable economy, but this potential can only be realised if the current regulatory framework goes further to create a virtuous circle of sustainable investment to reduce climate risk.

The current IORP II Directive provides a foundation, but it falls short of ensuring that pension savings are protected from climate risks. By introducing targeted amendments, EU policymakers have the opportunity to help safeguard pension adequacy, reduce systemic risk, and mobilise finance for the transition to a sustainable economy.

As things stand, EU pension savers are vulnerable to unmanaged climate risk. Acting now can deliver a more stable, sustainable, and resilient pension system that truly serves the long-term interests of European citizens.

Paul Fox, Senior Research & Advocacy Officer at Finance Watch

paul.fox@finance-watch.org,

+32 28 99 04 32