Smart regulation and guidance needed to deliver world’s first net zero financial centre

Following extensive engagement with major businesses, financial institutions and NGOs, the Aldersgate Group launches its latest green finance report today, Building a UK Net Zero-Aligned Financial Centre: What Next?

The report states that to reach the Chancellor’s welcome goal of making the UK the world’s first net zero financial centre, the Government and financial regulators must deliver greater guidance and regulatory reform to support companies in taking up new disclosure and reporting requirements and maximise the effectiveness of the UK’s evolving green finance regime.

At COP26, the Chancellor announced important plans to make the UK the world’s first net zero-aligned financial centre. As part of this, large businesses and financial institutions in the UK will, over the next few years, be required to publish new information to help investors assess their exposure to climate-related risks, as well as their plans to reduce emissions.

This will be done in two key ways [2]. First, the implementation of the new Sustainability Disclosure Requirements regime (SDR) will govern how large businesses and financial institutions should disclose their exposure to climate related risks, and how they should report their revenues against a set of sustainable investment definitions to be developed as part of a UK Green Taxonomy. Second, financial institutions and listed companies will be required to publish net zero transition plans from 2023 [3].

The Aldersgate Group welcomes the progress that has been made to date in developing this new framework. However, following extensive engagement with the financial, business, NGO and academic community, today’s report calls on the Government, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) to take several new measures to facilitate the take-up of new disclosure and reporting requirements and maximise the effectiveness of the UK’s green finance regime.

Key recommendations include:

• Providing stronger and clearer guidance to businesses and financial institutions: the Government should set out clear next steps for the private sector on when they will be expected to comply with elements of the new UK Sustainability Disclosure Requirements (SDR) – such as reporting in line with the new UK Green Taxonomy – in addition to producing net zero transition plans. This clarification must include publishing compliance guidance for business. The PRA should also produce a scenario analysis standard and financial regulators should produce sectoral guidance for calculating scope 3 emissions.
• Designing a future-proof, streamlined SDR framework: the Government should look to merge existing reporting and disclosure requirements together under the new SDR framework to make reporting more comprehensive and simpler for companies, including merging the Taskforce for Climate-related Financial Disclosures (TCFD) and the Streamlined Energy and Carbon Reporting (SECR) frameworks, and making it mandatory to publish material scope 3 emissions from 2025. The Government should also design the SDR in a way which allows the disclosure of other environmental impacts to be integrated into the framework over time.
• Ensuring compatibility with other global frameworks: Working closely with businesses, financial institutions, academics and NGOs, the Government should work to ensure that the UK’s reporting and disclosures regime is first and foremost ambitious and science-based, but also sufficiently aligned with other key international frameworks – including the EU’s – to minimise inconsistencies and reporting burden for global companies. This will be important in areas such as the development of the UK’s new Green Taxonomy.
• Building a green finance regime that engages with systemic risk: It is essential that the UK’s new regime incentivises investors to work with businesses to cut emissions in the real economy, rather than just divest from high carbon assets. This could be facilitated by the FCA producing guidance to investors on the best way to act as responsible stewards of capital and the circumstances under which divestment may be appropriate as a last resort. The PRA should also consult on potential changes to capital requirements to incentivise more investment in low carbon infrastructure.
• Accelerating the implementation of the UK’s Net Zero Strategy: Whilst important, better reporting and disclosure will not by itself deliver climate targets. To drive investment in low carbon infrastructure across the economy at the necessary pace and scale, the UK’s evolving green finance regime must work hand in hand with the rapid implementation of the Government’s Net Zero Strategy [4]. Key policy gaps need to be urgently tackled in areas such as power, buildings, transport, heavy industry and agriculture. Other priorities include the need to reform the Emissions Trading Scheme and provide a carbon price trajectory that is more aligned with the net zero target.

A full list of recommendations can be found at the end of this press release.

—QUOTES—

Nick Molho, Executive Director of the Aldersgate Group said: “The UK Government has rightly committed to putting in place a reporting and disclosure framework on climate change that is world leading and science-based. The key to making it a success is to support businesses and financial institutions through the provision of clear guidance, make new rules sufficiently compatible with other major global regimes such as the EU’s, and ensure that the framework encourages investors to engage with high-carbon businesses to help them cut emissions, rather than just divest. We must also remember that better reporting and disclosure cannot by itself deliver our climate targets and that clear policies under the Net Zero Strategy will be essential to incentivise low carbon investment across the economy.”

Josie Murdoch, Senior Policy Officer at the Aldersgate Group said: “The UK’s new reporting regime is a welcome advancement on the success of the TCFD and will create a strong foundation from which businesses can better identify climate risks and greenhouse gas emission sources. This knowledge will be vital to help financial institutions and corporates alike produce plans to address climate change in a holistic and systemic way. The recommendations in our report will help streamline implementation and ensure new reporting requirements truly lead to decarbonisation. Going forward, financial regulation should gradually increase in ambition as we move towards 2050, including by l allowing for more comprehensive measures to be introduced to tackle scope 3 emissions and other damaging environmental impacts.”

Professor Tim Jackson, Director of the Centre for the Understanding of Sustainable Prosperity (CUSP) said: “Keeping 1.5 alive means developed economies making deep cuts in carbon emissions before the end of this decade. This vital goal leaves no room for complacency and requires a rigorous attention to the decarbonisation of financial markets. CUSP is delighted to be working with the Aldersgate Group to develop detailed policy proposals for a Net Zero aligned Financial Centre.”

Alexander Burr, ESG Policy Lead at Legal & General Investment Management (LGIM) said: “In recent years, we have been very encouraged to see the Government taking a leadership role in establishing a sustainable finance system in the UK. The Sustainability Disclosure Regime (SDR) will be at the heart of this and is the framework by which the various pieces of regulation will be pulled together. We have been encouraged to see the breadth the regime will have across the UK market, its recognition of broader systemic risks (such as biodiversity), and its international alignment with the IFRS ISSB.

The Government now has the challenging task of giving the SDR its teeth. The new regulations must be appropriate, robust and ambitious, as well as being accompanied by clear guidance and education for the entire market. As a long-term investor, committed to active ownership, we want to see the SDR being used as a lever to accelerate all parts of the economy towards the transition to net zero.”

Olivia Whitlam, Head of Sustainability at Siemens plc said: “At its best, mandatory reporting can inform investments, educate business and drive action. However, this must be balanced with the effort required which may be better spent delivering on carbon reductions. By aligning reporting requirements on all UK business, ensuring inter-operability with international standards and incorporating consideration of double materiality and co-benefits, well thought through reporting mandates can be used to drive a robust system to decarbonise our business and investment ecosystem which benefits all stakeholders.”

Martin Baxter, Director of Policy and External Affairs at IEMA said: “For the finance system to play its full role in the net zero transition and deliver on the UK’s wider environmental ambition, we must ensure that appropriate standards, metrics and disclosure requirements are in place to improve accountability and transparency of delivery in the real economy. The recommendations in the Aldersgate Group report set out a clear pathway to bringing the clarity and coherence that is needed to position UK Finance Centre at the heart of the net zero transition.”

Robbie Epsom, EMEA Head of ESG at CBRE Investment Management said: “We welcome these recommendations from the Aldersgate Group; if adopted these measures would support financial institutions and large corporates with improving their awareness of climate risks and enable them to realise their net zero ambitions. The transition to net zero will only be successful with collaboration across the whole economy. Support in accessing the right information or data, defining what counts as green and providing a systematic framework to allow informed procurement or investment decisions based on comparable and consistent KPIs will all be key to catalysing the Green Finance sector. These recommendations should help position the UK as a leader in Green Finance.”

Martin Casey, Director of Policy and External Affairs at CEMEX said: “For the finance system to play its full role in the net zero transition and deliver on the UK’s wider environmental ambition, we must ensure that appropriate standards, metrics and disclosure requirements are in place to improve accountability and transparency of delivery in the real economy. The recommendations in the Aldersgate Group report set out a clear pathway to bringing the clarity and coherence that is needed to position UK Finance Centre at the heart of the net zero transition.”

Gavin Templeton, Partner at Pollination said: “Support is coalescing to transition the economy around a net zero, nature positive future, and the UK is well positioned to seize the many opportunities this will bring. It is now incumbent on financial institutions and corporates to present a clear science-based climate strategy encompassing their vision for net-zero emissions. However to do so, they need a framework which can flex to incorporate other, emerging disclosure requirements, including those related to nature. Momentum is building to ‘green’ finance, but gaps still remain in the Net Zero Strategy to ensure a just and orderly transition for the entire economy.”

Karen Ellis, Chief Economist at WWF said: “Businesses have a key role in tackling climate change and large companies will soon have to publish credible plans on how they will cut their climate emissions to net-zero by 2050. But the private sector can’t do it all by itself. Government must create an enabling environment for business and finance to drive the investment needed to decarbonise the real economy and unlock opportunities that will create jobs and wealth as well as tackling the climate emergency.”

Gabrielle Giner, Head of Sustainability at BT said: “BT Group is fully supportive of transparent disclosure and welcomes the Government’s plans for a new Sustainable Disclosures Requirements (SDR) regime to enhance the disclosures process across the economy. Without transparency and accountability, we can’t collectively tackle the challenges we need to achieve genuine emissions reductions across the UK.

For many organisations like BT, Scope 3 emissions constitute the majority of our impact. The SDR – if designed using the recommendations in this briefing – can simplify the way we report and help us to identify the full scope of our greenhouse gas emissions sources and set emissions reductions plans. This enables more targeted focus in our supply chain on the steps they are taking to tackle emissions – in addition to continuing to identify the risks climate change poses to our business. This will make us more resilient to the effects of climate change, as well as dramatically cutting our emissions and helping to deliver the UK’s climate targets.”

Matthieu Weber, Chief Financial Officer at Nestlé UK&I said: “Climate change is one of the greatest threats we face in society today. To meet the goals of the Paris Climate Agreement and stay within 1.5 degrees of warming, we need urgent action and deep emissions cuts from all areas of the economy, and the financial sector is key to achieving this. We welcome the recommendations to drive increasing disclosure and transparency through a common and aligned framework. This move is essential if we are to be able to track progress and foster collaboration towards tackling the climate and nature crises we face.”

Bevis Watts, Chief Executive of Triodos Bank UK: “The reality is we are currently a very long way from having a net zero-aligned financial system. There are multiple points of influence that will drive change, including government, central banks or regulators, banks themselves, shareholders and all of us as customers of banks. We are supportive of the recommendations within this report and the steps that should be progressed with urgency if we are to set the financial sector in the right direction to drive a rapid low carbon transition.”

—FULL LIST OF POLICY RECOMMENDATIONS—

Part 1: Building a clearer and more impactful climate risk reporting regime

1. As soon as possible, BEIS and HMT should outline further details for their vision of what reporting against the new Sustainable Disclosures Requirements (SDR) framework will look like, including guidance, so businesses can begin to prepare for the regime change ahead of new primary legislation receiving Royal Assent.

2. From 2025, the Government should use the new SDR to create a framework for businesses to look at identified climate risk and sources of emissions in a holistic way by integrating existing requirements, including merging the recommendations of the Taskforce for Climate-related Financial Disclosures (TCFD) and the Streamlined Energy and Carbon Reporting (SECR) within the new framework

3. The Government should design the new SDR framework in such a way as to make integrating other environmental disclosure requirements possible over time – for example, reporting on due diligence for forest risk commodities, or mineral procurement.

4. By 2025, the Prudential Regulatory Authority (PRA) should publish a scenario analysis standard, to enable companies and LLPs to conduct quantitative scenario analysis

5. By 2023, financial regulators should publish official guidance to encourage reporting of material scope 3 emissions on a voluntary basis from 2024.

6. From 2025, the Government should make material scope 3 emissions reporting mandatory – but allow for the use of proxy data to calculate emissions.

7. The UK Government should encourage the International Sustainability Standards Board (ISSB) to publish biodiversity metrics as soon as possible.

8. The Government and regulators should prioritise interoperability on disclosures between new UK regulation and European and global regulatory initiatives.

9. The Government should use the UK’s active engagement with the G7 and G20, and the remainder of its COP Presidency in 2022, to advocate for the adoption of internationally compatible green finance regulation and standards in other key financial centres.

Part 2: Encouraging market participants and financial institutions to engage with systemic risk

10. When consulting on amending regulatory capital frameworks (also known as introducing capital treatment) in Q4 2022, the PRA must address the link between capital allocation and causes of climate change.

11. The FCA should open a consultation on producing a framework to guide investors on the best ways to become responsible stewards of capital, as soon as possible.

12. By 2025, financial regulators should be given the mandate and responsibility for overseeing implementation of net zero transition plans.

Part 3: Tackling broader financial sector issues

13. Financial institutions and corporates must ensure they have access to the right skills to produce disclosures, net zero transition plans and set science-based targets.

14. The Government must set public policy frameworks and decarbonisation pathways which are stable and long-term, including implementing and addressing gaps in the Net Zero Strategy.

15. The Government must use public finance tools such as the UK Infrastructure Bank and the green gilt to de-risk climate-related investments and crowd-in private finance to low carbon and nature markets.

16. When the Government begins tracking private financial flows into low carbon solutions, the UK Green Taxonomy should be used as a benchmark.