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How will the UK’s financial system deliver net zero?

10 February 2021: The next big wave of UK infrastructure projects will be inextricably linked with the UK’s commitment to meet its net-zero emissions target by 2050. For the first time, the UK’s financial system, the UK’s net-zero commitments and the imperative to invest will have to co-exist.

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Achieving the country’s new target to cut its greenhouse gas emissions to net zero by 2050 will require action in all parts of the economy – retrofitting every building, making the energy system clean and renewable, shifting to electric vehicles, building new hydrogen and CO2 storage sectors, rethinking aviation and shipping, along with tree planting and behavioural change (such as adjusting our diets). A core part of this planning is a series of five-year carbon budgets, as required by the Climate Change Act.

We are on track to meet the third of these budgets – the first two were also met – but we are floundering in the run-up to the fourth (2023-27) and the fifth. In December, the Climate Change Committee (CCC) – the body charged with advising the government on emissions targets and preparing for the impacts of climate change – recommended the sixth carbon budget (2033-2037), the first time a carbon budget has been set in the new net zero context. The challenge is not only to get emission reduction back on track but also to improve the UK’s performance significantly while building back better from the COVID crisis.

In a new development, alongside the sixth carbon budget, the CCC also published the findings of its Advisory Group on Finance in a report called ‘The road to Net-Zero Finance’. The report assesses the UK financial system’s ability to deliver the net zero target. The Advisory Group was chaired by Professor Nick Robins, Professor in Practice for Sustainable Finance at the Grantham Research Institute, who spoke with ICAEW Insights about the role of finance in bringing about substantial, long-lasting change.

“The question we were asked was ‘we have this big objective of net zero by 2050 but what's the role of finance in that?’” says Robins, “and how are we going to raise the finance to pay for change?”

Robins says that the net-zero economy will be far more capital-intensive, with more upfront investment and far less resource consumption and energy use. “We’re already spending about £10bn extra a year on net-zero upfront investments. This needs to grow five-fold to £50bn a year by 2030 before peaking in 2035. This is quite a shift,” says Robins. 

“The Advisory Group concluded that we have the resources. The UK’s financial system has £20tn in assets,” he continues, “the task is to ensure that every financial decision is taken with net zero in mind.” 

To make this happen, the report sets out a package of recommendations for private and public finance, as well as what financial regulations will be needed. 

In return for this investment, the country will gain a range of benefits beyond reducing emissions and avoiding catastrophic climate change. As the country’s resources are shifted away from importing fossil fuels and redirected towards sustainable infrastructure and reskilling the workforce, national income will grow. Health will be improved, and new sectors will develop.

“This transition will have a very strong job creation element. How will we make this change a just transition? How will we deliver positive social benefits in all regions? And how are we going to mobilise the money to achieve that?” he adds. 

While the financial world is increasingly attuned to climate risk, not least with increasing attention from financial regulators, Robins points out that the transition we need is not only about avoiding financing high-carbon assets, but also channelling capital to net-zero opportunities. “Simply being risk-averse doesn't necessarily provide the capital for the energy systems, agricultural systems and business systems we need. It's a shift in mindset,” he says.

“We have the capital and climate commitments in the financial community. The real challenge is to start removing the barriers stopping these investment flows being unlocked.” Adds Robins. “There are still major market and policy failures which undermine the predictable cash flows that investors need. There’s a major gap in the development capital required to build the net-zero investment pipeline. Local authorities and agencies lack the capacity to build regionally specific net-zero plans. Demand for net-zero financial services is mixed: increasingly strong in the energy sector where renewables are growing strongly and very weak in housing where green mortgages remain at the margins.”

The report focuses on six sets of recommendations to break through these and other barriers and achieve this step-change. These relate to strategy, private finance, financial regulation, public finance, the international perspective and tracking.

“The number one recommendation is to do with strategy,” says Robins. The report states that the UK should commit to being the world’s first net-zero financial system. It should focus on making net-zero projects and plans investable, and that all net-zero policies should be designed so that investments are resilient, fair and enable local action.

The second set of recommendations relate to the private finance community. “We need a new generation of financial innovation, going far beyond green bonds. We need to think about how the huge wave of infrastructure investment can be a secure and attractive part of everyone’s pension pot,” says Robins. “This means every one of the more than one million financial professionals in the country needs the skills to support their customers and clients through the transition, whether they are individuals, entrepreneurs or large corporates. And in turn, the users of financial services need products that are transparent about their sustainability impacts.”

The third basket of recommendations relate to financial regulation. It says that the UK should fully integrate climate risk and net zero into financial regulation and monetary policy. “We recommend that all financial institutions should produce a net zero plan,” says Robins.

Next up are the public finance recommendations. “We have a big opportunity to use the post-COVID-19 recovery to fast-track climate investment”, Robins stresses, pointing to the planned issuance of the UK’s first Sovereign Green Bond as a catalytic moment this year. In addition, net zero and sustainability goals should be set for existing public financial institutions, such as the British Business Bank. “The new National Infrastructure Bank, which the Chancellor has announced has the potential to be a real anchor institution for net-zero, working with mayors and regions and crowding in private capital.” 

In the year when the international climate summit, COP26, will be hosted in Glasgow, the fifth recommendation focuses on building the international framework for financing the net-zero agenda. “The UK can take a lead on financing a green recovery as we come out of COVID. We don't want to go back to where we were, which was unsustainable and unequal,” he says.

And finally, as the chartered accountant community knows all too well, what gets measured gets managed, so the sixth set of recommendations is for a new system to track net-zero investment needs and flows.

“What I learned from this process was that the net-zero transition has to be front-loaded,” he says. “If we are to hit our 2050 targets then the next decade will be crucial in terms of the finance sector. What needs to happen is for cutting-edge financing practices to become the norm, so that every mortgage is green, for example. This needs to become common practice, rolled out by every banker and investor.” 

The report states that COVID-19 has acted as a live stress-test for high-carbon sectors such as oil and gas, with the switch to renewable energy and electric vehicles becoming irreversible. New jobs are needed across the country and green sectors offer substantial growth. Later this year, the UK Government will release its national Net Zero Strategy with the policies to deliver on the 6th Carbon Budget and beyond. What it lacks at this moment is the financial plumbing so the money flows to the places that need it.

In the final analysis, there is a tremendous opportunity ahead, says Robins. “There is huge room for leadership and the UK to become the first country to become a net-zero financial system.”

Further reading:

Article series: Infrastructure and Recovery

A plethora of financial, climate, health, societal and business issues have resulted in significant challenges for economies globally. Pressure on public finances, and the need for simultaneous levelling up, will be immense – while private investment must be more enlightened. Where does infrastructure investment fit into recovery?

See the series