What policies are needed to put the whole financial sector on track to deliver net zero?

Posted by Josie Murdoch on 15th July 2021
First published in: Business Green

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2021 is shaping up to be a big year for green finance. Ahead of COP26 in November, where mobilising green finance will rightly be one of the four key themes, the UK government has announced a number of exciting initiatives to mobilise capital towards tackling climate change and biodiversity loss whilst delivering a green economic recovery to the Covid-19 pandemic. These include the newly launched UK Infrastructure Bank, the UK's first green gilt and the roll out of mandatory climate-related financial disclosures by 2025.

However, climate and environmental considerations are still not at the heart of the UK's financial system. Only a third of banks and building societies have set a science-based target or net zero strategy. This comes at a time when UK financial institutions are responsible for 1.8 times the UK's annual net emissions of CO2 and the Climate Change Committee has estimated that some £50bn of additional infrastructure investment will be needed every year from 2030 onwards to put the UK on track for delivering the Sixth Carbon Budget and its 2050 net zero emissions target - with an estimated £4.7bn of additional funding required just for nature restoration. Similarly, the spotlight is on green economic recovery packages, which are currently set to be less green than those committed after the 2008 Global Financial Crisis, and are only expected to deliver 26 per cent of the additional emissions reductions necessary by 2030.

In light of these challenges, the Aldersgate Group worked with leading financial institutions, FTSE100 businesses and civil society organisations to develop the top recommendations to put the whole financial sector on track to deliver the UK's net zero and environmental targets, and unlock private investment which will lead to low carbon innovation, supply chain growth and job creation across the UK, and deliver a green economic recovery. Following this, the Aldersgate Group recommends a range of policies to properly green the UK's finance system.

Embed climate and environmental targets and disclosure at the heart of the financial system

The government should support a review of the existing guidance, standards and definitions governing climate-related disclosures (including the Taskforce for Climate-related Financial Disclosures, Streamlined Energy and Carbon Reporting, and the Carbon Disclosure Project) to ensure a more rapid take-up, as well as greater consistency and comparability between disclosure requirements. We also call 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.

In addition to this, alongside the Bank of England and the Financial Conduct Authority, government 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. This 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.

There is scope for change within the sector itself too. For example, 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.

Collaboration will also be key to embed climate and the environment in the UK's financial system. Policy makers and regulators must 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.

Accelerating private investment in low carbon infrastructure and nature restoration projects

It is crucial that government maximises the impact of targeted public finance to crowd in private finance in complex low carbon and environmental projects. 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.

The government should also 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.

Our findings also suggest that more ambition on carbon pricing and in particular a strengthening of the UK Emissions Trading Scheme (UK ETS) is required. 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 must 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.

Driving global collaboration on green finance

To complement and boost these critical domestic reforms, the UK should translate this to the international level by using 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. These should include carbon pricing, green bond standards and definitions in new green taxonomies.

As a part of this, the UK should use its presidency of COP26 to finalise a rule book for international carbon trading under Article Six of the Paris Agreement. We would also welcome the restoration of the historical commitment of 0.7 per cent of Gross National Income on Overseas Development Aid (ODA), to demonstrate the UK's dedication to international climate finance.

We are reaching a significant opportunity to green the UK's financial system, and boost financing for low carbon and nature restoration projects. It is critical that we take this opportunity.