17 September 2021

By trainee Carly Phillips-Jones

Historically, climate change initiatives have been funded almost exclusively by charitable organisations, donations and public sector grants and subsidies. Examples include the WWF Climate Crisis Fund through which 100 per cent of donations are made to climate crisis projects, and the government’s £289 million Industrial Energy Transformation Fund which provides businesses in energy-intensive sectors grants worth up to £14 million. Government intervention remains vital to cultivating the delivery of private investment in climate change, and the use of public money to enhance biodiversity, facilitate carbon storage and improve air quality can also help to boost private sector funding.[1]

However, according to analysis produced by WWF, only £145 million of the 2021 spring budget was devoted to environmental spending. Taken in the context of the UK’s targets under the Paris Agreement and the UN’s estimation that around $3.5 trillion per year in global energy investments is required to limit global warming to 1.5°C, it is clear that this is not enough on its own.

Therefore, although the prime responsibility for climate change policy sits with governments, the private sector will ultimately need to help deliver that policy, and thus the achievement of climate change targets. The priorities of COP26 – the UN Climate Change Conference taking place in Glasgow in November this year – are based around 'green finance' funding private sector initiatives, ultimately turning 'billions committed to climate investment through public channels into trillions of total climate investment'.[2] This article will consider the role that the financial industry is playing in supporting these 'green finance' initiatives and the challenges it continues to face.

What is green finance?

Green finance - also known as 'nature finance', 'eco-finance', 'climate finance' and a whole host of other terms – is essentially any financial activity that has been created for the purpose of a better environmental outcome. Examples include: a bank granting a loan to a company to invest in a fleet of electric vehicles; financial advisors discussing lower-carbon alternatives with clients; or a pension fund making investments in the development of green technologies. The key to finance being genuinely 'green' is that environmental factors are considered and prioritised throughout the entire financing process, from determining who to lend to or invest in, through to ex-post monitoring and risk management processes.

What is being done to further green finance?

The Network for Greening the Financial System (NGFS) is a network of 83 central banks and financial supervisors that aims to accelerate the scaling up of green finance and develop recommendations for central banks' role for climate change. Back in 2019, the NGFS recommended four key actions for the financial sector:

  1. Integrate the monitoring of climate-related financial risks into day-to-day supervisory work, financial stability monitoring and board risk management.
  2. Integrate sustainability into portfolio management.
  3. Collaborate to bridge the data gaps to enhance the assessment of climate-related risks. Public authorities should share and if possible make publicly available any climate-risk data.
  4. Build in-house capacity and share knowledge with other stakeholders on management of climate-related financial risks.

Thus far, financial institutions have displayed their commitment to taking these actions, including the UK’s largest pension fund, the National Employment Savings Trust, announcing that it would begin to divest from fossil fuel exposure. In addition, several large banks in the UK have signed up to the Partnership for Carbon Accounting Financials, through which, financial institutions measure and disclose the greenhouse gas emissions privately financed. In July this year, the Bank of England also put certain banks and insurers through stress test scenarios to determine their level of exposure and resilience to climate change[3]. The increasing influence of Environmental, Social and Governance (ESG) factors, and investors’ demands for their consideration, is also evident in that, according to Morningstar[4], in the first quarter of 2021 the advancement of inflows into European 'sustainable' funds totalled €120 billion, 18 per cent more than in the first quarter of 2020. These examples show how the finance industry is already playing an important role in monitoring, analysing and challenging climate change risks, and helping to facilitate greener financial decision-making by individuals and businesses.

Regulators and regulation are also increasingly driving change, with ESG reporting requirements being an example of this. These apply to regulated firms such as asset managers, pension providers and listed issuers, and require ESG-related disclosures to be made in accordance with the Financial Conduct Authority’s (FCA) overarching principle of consistency and to fairly reflect the materiality of ESG considerations within a fund’s objectives and strategy.[5] The FCA has also recently bolstered the regime by issuing further guidance for ESG and Sustainable Investment Funds aimed at ensuring that there is transparency in the description and marketing of funds, and that 'greenwashing' (i.e. making unsubstantiated or exaggerated claims that an investment is environmentally friendly) is challenged across the industry. In addition, further regulation in the UK is on its way, including to help the UK realise its ambition to become the first country in the world to make Taskforce on Climate-related Financial Disclosures (TCFD) aligned disclosures mandatory across the economy by 2025.

The Bank of England’s stress test exercise is another example of certain regulators seeking to steer investors and the financial industry towards climate change action by demonstrating the investment downsides that could result from inaction. Certain commentators, however, feel that because the outcome of the Bank of England’s stress tests has not yet been translated into adjustments to capital requirements further action may be needed, and that to have a material impact on climate change, central banks, financial institutions and private investors need to commit collectively to a more ambitious solution to 'green the financial system'[6].

What challenges might the financial services industry need to overcome in connection with the advancement of green finance?

One challenge is adapting to change - in coming years, green finance and endeavours to tackle climate change may well result in changes in policy, regulation, technologies and consumer behaviour, thereby creating a degree of uncertainty and presenting a degree of risk for investors and financial institutions. On one hand this may mean that certain industry participants are slightly cautious about letting go of low-risk, profitable investments despite them not being green, but on the other such assets simply present a different kind of risk in that their returns and attractiveness are likely to diminish as climate change policy (and regulation stemming therefrom) continues to advance, and investor demand for green investments continues to grow.

Another type of change, and thus challenge, that green finance could present, particularly for the major central banks such as the Bank of England, is to their role - i.e. moving from being 'market neutral', as they traditionally always have been, to promoting the growth of the 'green' economy. Those arguing in favour of change of this nature, and the need for a more interventionist approach to be adopted, include Rishi Sunak, the Chancellor of the Exchequer, who has stated that the Bank of England must 'reflect the government’s economic strategy for … the transition to a net-zero economy.'[7]

Looking ahead

It is clear that the finance industry has an important role to play in tackling climate change. Progress is already being made, both in general and by the finance industry specifically, but there is a lot still to be done if the Paris Agreement goal of limiting global warming to 1.5°C is to be achieved.

To build on what has been done to date, clear strategy and action will be needed, and challenging decisions will need to be taken (including by the finance industry). However, the drivers for such change and the growth of a 'green' economy are there - as the effects of climate change become more prevalent, with extreme weather like severe storms, flooding and wildfires being reported on around the world, governments, policy and regulation will increasingly prioritise tackling the problem, as will leading businesses, investors, and the finance industry.

[1] https://www.rspb.org.uk/our-work/policy-insight/wildlife-and-the-economy/financing-nature/

[2] https://ukcop26.org/wp-content/uploads/2020/11/COP26-Private-Finance-Hub-Strategy_Nov-2020v4.1.pdf

[3] https://www.bankofengland.co.uk/climate-change

[4] https://www.skadden.com/-/media/files/publications/2021/08/esg-in-2021-so-far-an-update/fn1a_europe_esg_q1_2021_flow_final.pdf?la=en

[5] https://www.fca.org.uk/publication/correspondence/dear-chair-letter-authorised-esg-sustainable-investment-funds.pdf

[6] https://blogs.worldbank.org/psd/moving-ambition-action-toward-greener-financial-system

[7] https://www.bankofengland.co.uk/-/media/boe/files/letter/2021/march/2021-mpc-remit-letter.pdf?la=en&hash=C3A91905E1A58A3A98071B2DD41E65FAFD1CF03E

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