The Lab’s Head of Climate Safe Banking analyses the UK government’s newly updated Green Finance Strategy, and argues it has three major weaknesses that need to be addressed if the UK is to play a leading role in meeting vital climate and nature targets.
By Jon Dennis
The Strategy was published last month alongside a raft of other climate and energy policies and consultations, and is a key test of the government’s plans to meet its ambitions for net zero finance and ensure the UK financial system drives the goals of the Paris Agreement.
Some progress has been made since the first iteration, including: clarification of next steps for the UK Green Taxonomy (which will classify which economic activities are sustainable), a commitment to consult on climate transition plans for the UK’s largest companies, greater incorporation of nature into the green finance framework, and a commitment to publish a series of net zero investment roadmaps.
Ultimately, however, the Strategy falls short of the ambition required to truly transform the UK’s financial system in response to the climate and nature crises due to three key weaknesses, namely: an over-reliance on non-mandatory disclosure, a lack of comprehensive policy reform across the real economy and not fully utilising financial regulators.
Dangers of a disclosure-first approach
The strategy reaffirms the government’s commitment to disclosure as one of its primary policy levers for green finance. This includes the promise of a Sustainability Disclosure Framework (SDR), the incoming UK taxonomy and transition plans. Disclosure is also a prominent feature of the government’s updated Net Zero-Aligned Financial Centre framework.
While the public availability and consistency of sustainability data is important to functioning markets, the effectiveness of this data as a lever for change is based on assumptions that often do not hold true.
Firstly, the premise – rooted in the market efficiency hypothesis – that all information available to the market is reflected in the value the market assigns to companies (through their share value) is highly contestable. For example, recent research finds little evidence that companies are considering climate-related matters when preparing their financial statements.
A second assumption relates to the idea that a lack of information is a major driver in financial markets’ continued facilitation of the climate crisis in the ways they lend and invest capital. The reality is far more complex: other structural and cultural barriers are at play, including short-termism, which prioritises the immediate bottom line and often ignores risks that materialise over longer time horizons.
A third assumption is based on the consistency and quality of the disclosure itself, which has regularly been proven to fall short. Recent analysis shows, for example, that only 5% of FTSE100 companies have a ‘credible’ transition plan. This is compounded by the government relying on disclosure on a ‘comply or explain’ basis, rather than making requirements outright mandatory. This approach will lower disclosure rates as it presents an opt-out for disengaged companies.
Future iterations of the Green Finance Strategy should reposition disclosure as supplementary to bigger forms of market intervention to truly shift mainstream finance in line with what the science demands.
The elephant in the room
If the government wants to be a true leader on green finance it needs to implement a far more ambitious and comprehensive set of policy reforms for the real economy, placing climate and sustainability objectives at its heart. This would require much higher levels of state expenditure and associated incentives, including in hard-to-transition areas of the economy like buildings and agriculture.
While the government’s Green Finance Strategy (and accompanying policy documentation) does provide more clarity than previously in some areas (for example, around key public financial institutions and net zero roadmaps), it falls short in providing the strength of signal the finance sector needs to really mobilise capital at scale.
In contrast, the United States’ Inflation Reduction Act and the EU’s Green Industrial Deal demonstrate a step-change in public policy, as they provide significant financial support for green investment and the technologies of the future. Action on this scale is crucial, as to reach net zero in line with a 1.5˚C trajectory, estimates have shown that, globally, funding for low-carbon energy sources must rise to $4 for every $1 allocated to fossil fuels over the next decade.
Using all the tools in the toolbox
Another powerful tool the government should employ to accelerate alignment and elevate green finance is financial regulation.
The Strategy recognises that UK regulators ‘have an important role to play’, with a consultation for regulating Environmental, Social and Governance (ESG) rating providers and further work planned on stewardship and fiduciary duty. However, these changes are relatively piecemeal and the government could go much further. One way to do this would be to introduce a clear statutory objective for regulators to actively align the finance sector with climate and nature goals. This would instigate a series of changes by regulators which would drastically increase accountability across the financial system, for example, through stronger mechanisms for non-compliance.
A statutory objective would also promote action to more comprehensively address systemic threats caused by climate change, which over the medium to long term are far greater than current pressures posed by inflation and related global energy security.
Becoming a global leader in green finance and aligning the UK’s globally important financial centre to climate goals are laudable and necessary objectives. However, the scale and urgency of the challenge means the government needs to be bolder and braver. This means moving beyond disclosure-based policy and embracing deeper forms of market intervention, including ambitious economy-wide policies and establishing a stronger role for the regulator.