Mitigating and adapting to climate change is expected to present economic challenges and opportunities as the UK seeks to pursue ‘green growth’. The Government sees green finance as central to this transition.
While there are various definitions of green finance, the Government’s focus is “aligning private sector financial flows with clean, sustainable and resilient growth.”
The Government’s 2019 Green Finance Strategy includes three objectives to achieve this: ‘greening finance’, ‘financing green’, and ‘capturing the opportunity’. This Insight explores these objectives.
Key green finance terms
Some of the terms used here do not have a set definition. The interpretations we have used are set out below. Some of these reflect the Government’s view on these terms as set out in the 2019 Green Finance Strategy.
Green finance: There is no single agreed definition of what constitutes ‘green finance’. Various definitions from different groups are available from the Chartered Banker Institute. The Government’s focus is on: “Aligning private sector financial flows with clean, environmentally sustainable and resilient growth.”
Green growth: Also referred to as ‘clean’ growth. There are various definitions (see for example OECD and UN) but the Government have defined it as: “growing our national income while cutting greenhouse gas emissions.” While the UK has already made progress with green growth, green finance could promote further green growth. Estimates suggest the UK low-carbon economy was around 2% of total Output in 2015 but could grow to 8% by 2030. This growth rate is over four times faster than the rest of the economy.
Green lending: Lending money, by providing loans or purchasing bonds, in line with environmental principles.
Green bonds: A bond is a type of loan where investors buy debt from a bond issuer (e.g. a company). This is effectively an I-Owe-You which can be traded on financial markets. Green bonds use the money raised for green activities, such as renewable energy projects.
Green funds: A fund is a pool of money invested for specific purposes. Green funds are invested according to certain environmental criteria.
Climate-related reporting/disclosures: Organisations disclosing information on their governance, strategy and risk management processes related to climate change.
Contracts for difference: A Government policy to support low-carbon power projects. The contract pays a developer the difference between an agreed price for the power they generate, and the projected wholesale price for power for a set period. If the wholesale price exceeds the agreed price, the developer pays back. More information is available in Support for low carbon power.
The Government’s aim on ‘greening finance’ is “mainstreaming climate and environmental factors as a financial and strategic imperative.”
The financial sector has already taken steps to integrate environmental considerations into its activities through a variety of green financial products.
The chart below shows that globally green lending has grown significantly since 2012.
This is dominated by ‘green bonds’ – debt instruments with proceeds earmarked for green activities. Green loans, which also finance green activities but are not traded on financial markets, currently account for around 4% of total green lending.
Recent years have also shown substantial growth in green funds. These funds pool savings and invest them according to certain environmental criteria.
Shareholders are also directly engaging with companies on climate change, including through coalitions such as Climate Action 100+, which calls for companies to curb emissions and strengthen ‘climate-related’ disclosures.
London has been ranked the world’s top financial centre for the quality of its green finance offering. However, it scores less well on market depth, e.g. for green bond issuance the UK did not feature among the top 15 countries in 2019.
Stakeholders have recommended the Government issues a UK sovereign green bond to “catalyse further issuance of corporate green bonds.” While the Government does not plan to issue a sovereign green bond, it is keeping this under review.
Risks to the financial system
Further to the physical risks of climate change, there are transition risks associated with moving towards an environmentally sustainable economy. The Bank of England reported that new rules, technologies and changes in consumer behaviour could affect the value of investments in high-emission sectors, such as fossil fuels.
The Bank announced it will conduct its first climate stress tests on the UK financial system in 2021. These will explore the possible risks associated with various climate change scenarios.
‘Climate-related’ reporting (or disclosures) refers to information published about companies’ governance, strategy and risk management processes related to climate change. It also includes metrics and targets to assess and manage the possible risks and opportunities.
Initiatives like the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) improve the transparency and availability of such climate-related information. The TCFD provides an international framework for companies to develop more effective climate-related financial disclosures, using existing reporting processes.
Improving global climate-related reporting is one of the Government’s priorities for the international climate change conference (COP26), now taking place in the UK in 2021. The former Governor of the Bank of England Mark Carney, who has been appointed the Prime Minister’s COP26 Finance Adviser, said he will “work with authorities to commit to pathways,” to make climate-related reporting mandatory.
The Government said it expects all listed companies and large asset owners in the UK to publish climate-related information in line with the TCFD framework by 2022. An interim progress report is expected to be published by the Government by the end of 2020.
The Government’s aim on ‘financing green’ is “mobilising private finance for clean and resilient growth.”
Meeting the UK’s net zero target is projected to cost 1-2% of GDP. Businesses will provide the majority of the required investment, so attracting private finance for decarbonisation has been described by the Environmental Audit Committee as “crucial.”
Policies to finance green
An established ‘financing green’ policy is the mechanism to support low-carbon power projects, known as ‘contracts-for-difference.’
Developers compete for contracts with a fixed price for power generated over a set period. This provides certainty of return on investment. The policy helped attract £92 billion of private investment in clean energy from 2010-2018. This investment helped technologies to mature and costs to fall, to the extent that some projects are now built subsidy-free.
Other existing policies include:
- The Industrial Strategy’s ‘Sector Deals’, where the Government and industries agree commitments including investment.
- Government-established funds with matched private and public investment, such as the Clean Growth Fund for innovative clean technologies.
The Government’s Green Finance Strategy includes proposals for further policies to help finance green growth. These include more investment through new public-private funds and establishing long-term policy frameworks through new regulations, including on energy efficiency standards. It also plans to address market barriers, including by supporting local green finance for example.
Commentary on Government policy
Government support for financing green has attracted criticism, especially where that support is financial.
Advocates of Government support say it’s needed to address market failures to encourage green technologies, and offers various beneficial returns. However, some have questioned the cost of subsidies while others argue markets can solve the problem with the right incentives.
Stakeholders have also suggested some Government policy has hindered UK green growth. The criticism includes inconsistency on onshore wind, zero-carbon homes, and carbon capture and storage policy, as well as the 2017 sale of the Green Investment Bank.
The Environmental Audit Committee criticised UK Export Finance (a Government body that supports UK businesses’ access to finance for international projects) on finding that £2.5 billion (96%) of energy sector support between 2013/14 and 2017/18 went to fossil fuel projects.
Capturing the opportunity
The third aspect of the Government’s Green Finance Strategy is “capturing the opportunity.” The Government wants to “cement UK leadership in green finance” globally, and has established the Green Finance Institute (GFI) to help achieve this.
Through public-private collaboration, the GFI aims to unlock barriers to capital flows for the domestic and international transition to net zero.
The opportunity of green finance has already been raised in parliamentary debates and select committee inquiries, with further inquiries and a Treasury review ongoing. In the private sector, new financial solutions to accelerate green finance are being developed. For example, a coalition established by the GFI are piloting solutions for energy efficient homes.
Green finance is expected to be raised at COP26 and is already being discussed in relation to the economic recovery from the coronavirus. Some stakeholders have said the pandemic presents an opportunity to “build back better”; using green finance to transition to a more sustainable future.
- The Government’s Green Finance Strategy (July 2019), and the Green Finance Taskforce report to Government (March 2018).
- Green Finance (May and June 2018), The House of Commons Environmental Audit Committee.
- Guide to Green Finance, (2019 – free to download), London Stock Exchange.
- The Green Finance Institute’s webpage.
About the authors: Suzanna Hinson is a researcher at the House of Commons Library, specialising in energy. Erik Tate is a policy analyst at the House of Lords Committee Office.