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The latest in our ESG Country Snapshot Series.
Europe has made its mission clear: it wants to become the global “standard setter” on sustainable finance. But when in June it named the Technical Expert Group that would take its agenda forward, something else was made clear, too: the UK was not invited to the party. Most of the dates targeted in the EU’s Action Plan on Sustainable Finance are post-Brexit and, while 25% of the High Level Expert Group on Sustainable Finance (HLEG) – set up in 2016 to create the foundations of the Action Plan – were UK representatives, the new group saw that figure slashed to 6% (although arguably, the London Stock Exchange remains present via its sister company, Borsa Italiana).
“The UK has moved into pole position as this agenda hots up” – Ingrid Holmes, Hermes IM
Just weeks later, UK Chancellor Philip Hammond announced the creation of a national Green Finance Institute, with its own heavy-hitting advisory committee. ESG stalwarts such as Lord Nicholas Stern, Dame Helena Morrissey, Fiona Reynolds, Ben Caldecott and Ian Simm are joined by newer faces with potentially major mainstream influence: the Prudential Regulatory Authority’s Sarah Breeden; HSBC’s Group Head of Strategy and Global Head of Sustainable Finance, Daniel Klier; London Stock Exchange plc’s CEO and former Head of the Government’s Financial Stability Unit, Nikhil Rathi. For a full list of members, see here.
It was the latest in a series of signs that, after a few relatively somnolent years, the UK is waking up to how big sustainable finance has become and how hard it needs to work if it wants to convincingly call itself a leader.
“There is a huge amount going on globally, but I do think the UK has moved into pole position as this agenda hots up,” says Ingrid Holmes, one of the five Brits on HLEG, and – after eight years at climate think-tank E3G – now Head of Policy and Advocacy at Hermes Investment Management. “The last six months has seen a number of major developments.”
The UK as a centre for green finance
One of these developments is the Green Finance Institute itself. As well as having an impressive advisory panel, the Institute – which RI understands will be ‘hard launched’ next spring – is co-financed and convened by the Government and the Corporation of London and is likely to absorb the existing Green Finance Initiative, set up by the pair in 2016 to provide expertise and leadership on green finance, promote London as a ‘hub’, drive innovation in financial products and advocate on regulation and policy.Members of the Initiative include BlackRock, Amundi, HSBC, the London Stock Exchange, PwC, KPMG, Barclays, Aviva Investors, SEB, Legal & General, JP Morgan, Investec, Bank of America Merrill Lynch, Credit Agricole, Generation and Hermes Investment Management.
As well as absorbing the Initiative’s membership, the Institute will have its own staff and governance structure, and may broaden its focus (and name) from green to sustainable, in a bid to capture growing global momentum around the Sustainable Development Goals, and mirror more closely the EU’s agenda. It will look at topics including TCFD implementation, green loans, bonds and project finance, fintech, developments in corporate governance and stewardship, and the role of ‘corporate Britain’. According to the UK’s City Minister, John Glenn, speaking at an event in July, “the Institute will stand as a quality mark – as sign of the UK’s green finance expertise under one unified brand”.
The Institute was one of the key recommendations that came out of the Green Finance Taskforce – a body set up by the government last September, chaired by Sir Roger Gifford (who also chairs the Institute’s advisory panel) and including many of the same members. Its task was to spend six months coming up with recommendations on how the public and private sectors could collaborate to “accelerate the growth of green finance and the UK’s low-carbon economy”.
In addition to recommending the creation of a Green Finance Institute, its 95-page report, published in March, said the UK should join the growing list of sovereign green bond issuers. While the asset class continues to mushroom globally (and the London Stock Exchange has listed 78 green bonds), the UK has seen only a handful of deals, and – unlike the US, France, Sweden, India, China and others – public institutions have played barely any role. In 2014, Transport for London issued a £400m green bond, but it has notably not returned to market. The UK’s Debt Management Office told RI that HM Treasury was considering the Taskforce’s recommendations “and will be responding in due course”. But, it added, “the government does not have any current plans to issue a UK sovereign green bond.” It said the government’s objective of cost minimisation means it will continue to focus on benchmark gilt issuance across various maturities – both nominal and inflation-linked. “We believe that this is currently the most efficient and cost-effective way for the government to borrow from the financial markets in the long-term.” RI also reported in 2016 that the UK’s Municipal Bond Agency, created in 2014 to help local authorities issue debt directly, had discussed the potential of issuing green bonds and was “quite excited” about the possibility, but no further progress has been made, RI understands.
Other recommendations from the Taskforce include creating a ‘Centre for Climate Analytics’ to improve climate risk data, and establishing a £100m ‘Local Development Finance fund’ to support clean infrastructure projects.
Some of the proposals around infrastructure are reflected in a subsequent report from the Government’s National Infrastructure Commission – its first assessment of the country’s economic infrastructure needs and priorities, released in July. The report is an overarching assessment, not a sustainability one, but tellingly, its key recommendations include: “Making a switch to low-carbon and renewable sources for both the country’s power and heating”; dealing with flood resilience; reducing waste; and working with councils and the private sector to roll out electric vehicle charging points. NIC will work with Government, which has up to a year to respond to the report, to establish the recommendations as UK policy, it states.
“In the event that some of the ideas being floated do develop, most will need parliamentary support and legislative backing,” points out Holmes, saying she is reassured by what seems to be “strong cross-party consensus” and “a high degree of alignment” between the recommendations being made and the activities of government and policymakers.
It’s not just the Green Finance Taskforce and the NIC making recommendations to Government, either. UK Parliament is playing a huge role is moving the needle too, through its Environmental Audit Committee (EAC) – a long-established Select Committee whose job is to scrutinise the environmental performance and policy of all government departments and public bodies. In November, it launched an inquiry into climate finance, and the outcomes have already caused ripples in the market.
Made up of backbench MPs, and chaired by MP Mary Creagh, the EAC began holding round-tables and hearings at the start of 2018. In February, it wrote to the 25 largest UK pension funds, asking them to explain if, and how, they were addressing climate risk and impact in their investment decisions. A month later it had 27 responses (two additional ones from the London Pension Fund Authority and the MPs Pension Scheme, who responded voluntarily), which are now published on its website.
The majority of the funds claimed to consider climate risk – 20 have “performed at least one action” on the topic, while for 12 it has reached board level. However, the EAC described a minority of the funds (it identified four “less engaged” schemes, including Aviva and Lloyds) as “worryingly complacent”.
Climate-focused law firm Client Earth this week wrote to the trustees of 14 of the least engaged funds, according to the EAC, asking them to make public statements to their members about how they are addressing climate risk, and “putting them on notice that legal action by scheme members could follow if they fail to take these risks seriously”.The EAC Inquiry culminated in two reports: one on mobilising finance for clean energy projects and one on what the UK government was doing to embed sustainability in financial-decision making. Both reports included recommendations, and the Government has now responded to both. The EAC slammed the government response to the report on clean energy, saying it made “no commitment” to address the collapse in investment in recent years, or to publish strategies for achieving carbon targets. The response to the green finance report has been received but won’t be published until next month.
One of the main focuses for the second EAC report was the role of the financial regulators, which are coming under increasing scrutiny over ESG and climate risk. The four key regulators are the Pensions Regulator (tPR), the Financial Conduct Authority (FCA), the Financial Reporting Council (FRC) and the Prudential Regulatory Authority (PRA), which is hosted by the Bank of England. Between them, they run a group called the UK Regulators’ Climate Forum, but – beyond the Bank of England – their public efforts have been pretty sluggish compared with some of their overseas counterparts.
In March, the EAC wrote to Michael Gove, the Secretary of State for the Department for Environment, Food and Rural Affairs (DEFRA), urging it to “formally require tPR, the FCA and the FRC to produce adaptation reports in respect to their public functions”.
The context of this request lies in something called the Adaptation Reporting Power (ARP). The UK’s 2008 Climate Change Act requires DEFRA to monitor how UK companies and institutions are adapting to climate change by, every five years, asking relevant sectors and bodies to disclose their climate strategies. The Bank of England was asked to do this in the last round of reporting, in 2014, prompting its work on the UK insurance industry, which it regulates. It is also now working on the banking sector, and RI understands it plans to publish an ‘expectations document’ with conclusions from its work on both sectors later this year.
Now, the other three regulators are under pressure to engage with the ARP, in the hope it will kick-start a similar process for their respective regulated industries.
And indeed, this summer DEFRA complied with the EAC’s wishes and formally invited all three, as well as the Pension Protection Fund, to participate in next year’s round of reporting. The PPF and tPR both told RI they were engaging with DEFRA and others, but did not confirm whether they would publish a climate strategy under the ARP (tPR already has investment guidance stating that trustees could consider climate change when it is a financially material factor). The FRC – the regulator that oversees corporates, auditors and actuaries in the UK – told RI it would be taking part. Many in the market believe this will manifest itself, in part, through regulatory support for the TCFD recommendations in corporate reporting, so it’s a potentially major step forward for the UK market. The London Stock Exchange released its guidance on ESG reporting for issuers in January.
The FCA, which regulates contract-based pension schemes, as well as banks, mutual societies and financial advisors, and has already been working with the FRC on improving ESG-related disclosure, did not respond to RI’s request for comment on the ARP, but has recently published a response to the EAC’s concerns over its stance on climate risk. In the letter, it says it will publish a document setting out its approach later this year, focusing on:
1. “Influencing activities that directly impact on the performance and integrity of financial services markets”
2. “Promoting trust and confidence, helping consumers access green finance products they would like to invest in, and ensure that relevant advice and investment management meets appropriate standards”
3. “Setting, supervising and enforcing clear standards to promote trust and confidence, where it is merited and appropriate”.
It adds that it plans to consult on introducing guidance for workplace pensions providers “on considering financial factors (such as ESG risks and climate change) and non-financial factors (such as responding to members’ ethical concerns) when making investment decisions. It plans to do this in the first quarter of next year, as part of wider changes.
This FCA’s final commitment on ESG in investment decisions comes off the back of a long-running debate in the UK around fiduciary duty and the responsibilities of pension trustees, which is currently coming to a head.
The Department for Work and Pensions, which sets the rules for trust-based pension schemes in the UK, requested a Law Commission review into long-term investment and fiduciary duty, and the results were published In 2014. It found too much confusion from trustees, partly because of a requirement to have a Social, Ethical and Environmental (SEE) Clause, which bundles material risks with ethically-based investment decisions. The Commission argued this should be changed to separate the two, so that trustees knew they should consider any ESG issue that was financially material, and were allowed to address non financially-material ESG issues in certain circumstances (for instance, to reflect members’ values), if they didn’t significantly impact returns. But the recommendations never came to fruition, and in 2017, a second Law Commission review – focused on social investing – reiterated the need for clarity on trustees’ duties. This time, the Government said it was “minded” to implement the recommendations, and last month a DWP consultation on the changes was closed, with a conclusion expected later this year.Notably, the Pensions and Lifetime Savings Association (PLSA), which represents the pension industry in the UK and has been broadly supportive of heightened climate and sustainability considerations, responded to the consultation saying it didn’t think climate change should be explicitly mentioned in the updated regulation, as proposed by government.
With both the FCA and the DWP pursuing clarifications on investor duties, all pension schemes in the UK soon look set to have new rules on how to address both material and non-material ESG factors in investment decisions.
The Social Finance Taskforce
In recent years, the discussion around sustainable finance in the UK has focused on climate change – reflecting the global debate – but there are developments specifically on the social side, too. In June, the UK Government responded to a report titled Growing a Culture of Social Impact Investing in the UK, published last year by the Advisory Group on Social Impact Investing. The group, convened by Government, and chaired by Vice-Chair at Allianz Global Investors Elizabeth Corley, recommended co-investment by government, tax breaks, and the development of social impact bonds. Government has now said it will work with regulators and statutory bodies to promote social impact in future frameworks, as well as exploring the potential growth in social impact bonds. Changes will also be made to the Companies Act to improve corporate reporting around how businesses impact on staff and stakeholders. The response said the Department for International Development (DfID) will back the World Benchmarking Alliance as it publishes rankings of company performance on the Sustainable Development Goals. An update on all this is due in the winter, Government said at the time. In the meantime, a follow-up ‘implementation’ taskforce on social impact investment, also chaired by Corley, is convening to carry the work forward. According to its latest update, issued last month, it is consulting on impact reporting, and working with pension scheme bodies on the implications of social impact investing.
As regulators, stock exchanges and others come together to supercharge the supply of sustainability-focused financial products and services, and rewrite the rules that govern pensions, banks, financial advisors, actuaries, accountants and corporates, the UK buy-side has been moving too. Not entirely, as is clear from the EAC report, but there is growth from both private and public-sector funds. One crucial development in the UK is the current ‘pooling’ process of local government pension schemes, to create fewer, larger investment vehicles. Some of these new pension pools have used to the upheaval to push responsible investment up their list of priorities, with some – such as Brunel, Border to Coast and Central – saying that ESG is expected be central to all its investments. Mandates are currently being awarded, both in-house and externally.