UK should seize unique opportunity to green its financial system

In a new report published today [1], the Aldersgate Group urges the Government to use the UK’s current leadership position on climate change and the environment, and its ongoing review of financial services regulations [2], to embed environmental sustainability into the rules governing the UK’s financial system and influence similar changes to international rules and standards. The Group also calls for the publication of more detailed and comprehensive policy commitments to accelerate and lower the cost of private investment in the low carbon and nature restoration projects needed to meet the UK’s climate and environmental targets.

The report – which is based on extensive engagement with leading financial institutions, FTSE100 businesses and civil society organisations – sets out a range of recommendations to: (i) more deeply embed climate and nature restoration targets into the decision-making of financial institutions, businesses and Government; (ii) accelerate and lower the costs of private investment in green projects; and (iii) work closely with international partners in areas of mutual interest, such as carbon trading, disclosures and green taxonomies.

~ The key findings of the report will be discussed at a webinar on Tuesday 22 June at 9.30am with John Glen MP, Economic Secretary to the Treasury, and a range of senior speakers from the business, financial institution and NGO community. [3] ~

The UK Government has made welcome commitments on green finance since the publication of the Green Finance Strategy in 2019, including mandating that disclosures are aligned with the recommendations of the Taskforce on Climate-Related Financial Disclosures (TCFD) by 2025, and launching the new UK Infrastructure Bank with a mission to support the delivery of the net zero target. The Government has also rightly identified mobilising green finance as one of the four key themes at COP26.

However, climate and environmental considerations are still not sufficiently embedded in the UK’s financial system, with only a third of Prudential Regulation Authority-regulated banks and building societies having a science-based target or net zero strategy. [4] Whilst private investment into low carbon and environmental projects is on the rise, it remains insufficient, with some complex projects facing significant market barriers in areas such as heavy industry and nature restoration. This comes at a time when the Climate Change Committee estimates that some £50bn in additional infrastructure investment will be needed every year from 2030 onwards to put the UK on track for the Sixth Carbon Budget and its 2050 net zero emissions target. [5]

In light of these challenges, the Aldersgate Group’s latest report Financing the future sets out a range of recommendations to put the whole financial sector on track to deliver the UK’s net zero and environmental targets, whilst simultaneously unlocking private investment to drive low carbon innovation, supply chain growth and job creation across the UK. The report highlights that the ongoing review of the regulatory framework governing the UK’s financial services sector – made necessary by the UK’s departure from the EU – provides an opportunity for the UK to lead the way in incorporating environmental sustainability into the regulatory framework governing its financial system and, in doing so, influence key changes to the international financial rules and standards.

Key recommendations include:

Accelerating the take-up of climate-related disclosures

• The Government should support a review of existing guidance, standards and definitions governing climate-related disclosures (including the TCFD, Streamlined Energy and Carbon Reporting, and the Carbon Disclosure Project) to ensure a more rapid take-up and greater consistency and comparability between disclosure requirements. The report also calls on regulators to provide guidance to improve voluntary reporting of scenario analysis under the TCFD, with a view to introducing mandatory scenario analysis from 2025.

Embedding climate and environmental targets at the heart of the financial system

• The Government, Bank of England and the Financial Conduct Authority should consult on a roadmap to introduce regulation that requires financial institutions to produce net zero targets and transition plans in the 2020s, with regulation starting no later than 2025. Part of this consultative process should involve regulators providing guidance to support and encourage all sub-sectors of the financial services industry to publish net zero transition plans and targets on a voluntary basis, with guidance to be published no later than 2022.
• Pension fund managers should be required to automatically enrol new beneficiaries into Paris Agreement-aligned pensions funds and proactively engage with existing beneficiaries to outline the benefits of transferring fund holdings into Paris-aligned funds and environmental, social and governance (ESG) schemes.
• UK policy makers and regulators should work together to set capital treatment for banks and insurers in a way that reflects the long-term risks of assets to financial stability, to incentivise more strategic asset allocation in environmentally sustainable assets and a transition away from high carbon or environmentally damaging assets.

Maximise the impact of public finance to crowd in private investment

• Maximise the impact of targeted public finance to crowd in private finance in complex low carbon and environmental projects [6]. In particular, the recently launched UK Infrastructure Bank (UKIB) should be strengthened by including environmental resilience as part of its mandate, ensuring that it is able to tackle different market failures as market conditions evolve and by increasing its capitalisation over time. There should be a joined-up strategy to ensure that the focus of the UKIB and the Government’s green sovereign bond issuances are carefully co-ordinated to maximise the impact of public finance in overcoming market barriers.

Introducing strong policy signals to accelerate private investment in low carbon infrastructure and nature restoration projects

• The Government should accelerate and lower the cost of private investment in low carbon infrastructure and services by publishing a detailed and cross-Government net zero delivery strategy ahead of COP26. This should set out the key policy decisions that will be adopted over the next five to ten years on a sector-by-sector basis to put the UK on a credible pathway towards its net zero target. [7]
• The Group also calls for more ambition on carbon pricing and in particular a strengthening of the UK Emissions Trading Scheme (UK ETS). This should include Government rapidly consulting on the alignment of the UK ETS with the net zero target, setting a rising carbon price trajectory throughout the 2020s, gradually phasing out free emission allowances and expanding the scope of the scheme to a growing number of economic sectors where feasible.
• Building on the Dasgupta Review commissioned by HM Treasury, urgent efforts should be made to embed the value of nature into economic policy and investment decision making and accelerate private investment in nature restoration projects. This requires strengthening the target setting and delivery process in the Environment Bill, making reporting in line with the new Taskforce for Nature-related Financial Disclosures (TNFD) mandatory in the 2020s, and working towards the introduction of a mandatory requirement for businesses to prepare and publish biodiversity loss mitigation and adaptation targets, and associated transition plans.

Influencing international rules and standards and driving global collaboration on green finance

• Building on domestic reforms, the UK should use its leadership position on the global climate agenda following the G7 summit and its presidency of COP26 to encourage a greater focus on environmental and climate considerations in the rules and standards governing international financial markets. This should include collaborating with key international partners, including the EU, on areas of common interest such as the development of green taxonomies and climate and nature-related disclosure requirements.
• The UK should use its presidency of COP26 to finalise a rule book for international carbon trading under Article 6 of the Paris Agreement. The Aldersgate Group would also welcome the restoration of the historical commitment of 0.7% of Gross National Income on Overseas Development Aid, to demonstrate the UK’s dedication to international climate finance.

Nick Molho, Executive Director, Aldersgate Group said: “Meeting the UK’s net zero emissions and nature restoration targets is a significant investment challenge, most of which will be met by the private sector. Providing clear policy commitments and fully embedding the UK’s climate and environmental targets in the way the financial sector operates are key to attracting the level of private investment we need and lowering the cost of finance. The regulatory review made necessary by the UK’s departure from the EU provides the UK with the opportunity to be a world leader in greening the rules governing its financial system and becoming a genuinely world class centre for green finance; the Government should seize it.”

Ian Dickie, Director at eftec, said: “The potential environmental markets on biodiversity, carbon and nutrients etc are now real. The Government needs to provide clear rules, adequate governance and invest to leverage private finance; this will give confidence to investors and benefit the environment. The Aldersgate Group message, that good environmental regulation is good for the economy, has never been more relevant”.

Stephanie Maier, Global Head of Sustainable and Impact Investment, GAM Investments, said: “The recent Net Zero by 2050 report from the International Energy Agency provided compelling evidence of the enormous effort that will be needed to decarbonise the sector; private finance and investment have a pivotal role in supporting both this and the transformation of the whole economy. This report from the Aldersgate Group sets out recommendations for Government and financial regulators to facilitate and accelerate this transformation by capitalising on the opportunity presented by COP26.”

Raphaëlle Vallet, Manager, Sustainable Finance, Green Investment Group, said: “Achieving Net Zero requires a colossal effort across the public and private sectors. We urgently need to mainstream sustainability throughout policy frameworks and investment decisions. Aldersgate Group’s report is an excellent contribution to the agenda, with practical steps that will help drive finance towards a net zero future.”

Sam French, Business Development Director, Johnson Matthey, says: “The recommendations for financing green projects and infrastructure in Financing the future are critical to accelerate innovation in areas such as hydrogen and CCUS, and drive emissions reductions across the UK. In particular, it is vital that the Government uses carbon pricing as a tool to drive funding towards low carbon technologies, by aligning the UK Emissions Trading Scheme (ETS) with net zero and the EU ETS, and giving stability to businesses through a carbon pricing escalator. In addition, developing supportive business models for hydrogen and CCS will be essential to enable businesses to invest in these new markets allowing the UK to position itself as a leader in both deployment and the associated supply chain.”

Paul Morling, Economist at the RSPB, said: “Our future economic prosperity depends on the choices we now take to build back better from Covid and the centrality of climate and nature in recovery strategies. Greening finance is an urgent priority and this report sets out the necessary actions to effect the sustainable transition we need to see for our wellbeing, future generations and nature.”

Bevis Watts, Chief Executive Officer at Triodos Bank, said: “We are pleased to support the findings of this important report. We welcome the calls to support investment in areas such as nature-based solutions, but while increasing interest in the environmental crises and net-zero is encouraging, we now need a step change in the ambition of the financial sector to have any hope of meeting the scale of the challenges we face. Achieving this will require drastic changes to the structures of our financial systems and the regulation that supports it.

Robust, science-based net zero targets are critically important and we also need to recognise the inherent value of our environment and the challenge we have to redesign systems to reflect much more than a financial bottom line. It is time for the finance sector to play its role and use more imagination in how economic outcomes can be linked to investment in nature alongside the broader social needs outlined in the UN Sustainable Development Goals. This is central to developing a new economy built on values rather than value, and that has an integral connection to societal health and environmental limits.”

Julia Barrett, Chief Sustainability Officer at Wilmott Dixon, said: “Private sector investment will be essential in helping the UK meet its climate and environmental objectives and secure a green recovery, as today’s report by Aldersgate Group makes abundantly clear.  For businesses, the publication of a comprehensive and joined-up Net Zero Strategy by Government ahead of COP26  will be fundamental to demonstrate the direction of travel for each sector in the run up to 2050, helping them allocate capital in the most efficient way to meet these milestones.

In the construction sector specifically, binding regulatory standards and tax incentives to drive investment in energy efficiency and low carbon heat in existing buildings will be key. Furthermore well-designed and properly enforced, ambitious environmental regulations will help mobilise investment in the infrastructure, innovation, skills and supply chains needed for the whole sector to meet net zero.”