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

Net Zero in Finance

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

The upcoming wave of new UK infrastructure projects is likely to be closely connected with the UK’s commitment to reaching the net-zero emission target by 2050. In today’s world, the UK’s financial industry and related investment plans will be integrated with the challenge of reaching net-zero.

Achieving the net-zero target will require action in every part of the economy. This includes enhancing buildings, transitioning to a renewable energy system, shifting towards electric vehicles, promoting hydrogen and storage sectors and implementing major changes to carbon-heavy industries, as well as our lifestyles. 

A large component of these plans is implementing a series of 5-year carbon budgets, as laid out in the Climate Change Act. At present we are on track to meet the third of these budgets, but needing more action on the lead up to the 4th budget (2023-27) and the 5th. At the end of 2020, the Climate Change Committee (CCC), the advisory group for the government on emission targets and managing climate change impacts recommended implementing a 6th carbon budget for the period of 2033-2037. This would be the first time a carbon budget has been delivered within the context of a net-zero approach. The challenge involves not only improving emissions reduction levels but improving the performance of the UK while enabling a sustainable recovery from the pandemic. At the same time, the CCC announced the findings of its Advisory Group on Finance report called ‘The road to Net-Zero finance’. The report details how capable the UK financial system is of reaching the net-zero target. Nick Robins, the chair of the advisory group recently discussed the report and the role of finance in creating long term changes. Professor Robins explained that the key question asked was that we have laid down an objective of reaching net-zero by 2050, but what responsibility does finance have, and how do we intend to raise the finance to pay for the change?

Robins believes a net-zero economy will be more capital-intensive, with higher initial investments and significantly less resource and energy consumption. Robins highlights that we are currently spending approximately an additional £10 billion each year on net-zero upfront investments. This figure needs to increase to £50 billion a year by 2035, which is a considerable shift. The Advisory Group report declares that we have the necessary resources and assets to enable these changes. The challenge is ensuring that every financial decision focuses on a net-zero approach.

The big investment plans will generate several benefits beyond the obvious reductions in emissions and avoiding the impacts of climate change. As we make the transition away from imported fossil fuels and redirect this towards sustainable infrastructure and retraining the workforce, the national income will grow, health and wellbeing will improve and new sectors will emerge. It won’t be easy and this transition will involve a major job creation focus and so we need to be prepared to make this change, ensuring benefits are spread in all regions and that we are capable of allocating the money to meet these measures.

While the financial world is continuing to focus more on climate risk, the transition requires looking beyond the financing of high-carbon assets and funnelling capital towards net-zero opportunities. Robins points out that being risk-averse is positive but doesn’t necessarily generate the capital requires for the energy, agricultural and business systems that we need. It requires a complete change in mindset.

We have the capital and climate targets in the financial industry. The key challenge is to eliminate the barriers that hinder these investment flows. Robins points to certain market and policy failures which fail to provide the predictable cash flows that investors are looking for. There remains a gap in the capital required to develop the net-zero investment pipeline and varies greatly between industries. For example, the energy sector has a very strong demand for net-zero financial services, whereas it remains relatively weak in the housing market.

The road to net-zero report focuses on six recommendations to break down these barriers and achieve real change. These factors relate to strategy, private finance, financial regulation, public finance, the global perspective and tracking.

Strategy: The report believes the UK should commit to becoming the first net-zero financial system, focusing on making net-zero projects investable and all net-zero policies enable fair and resilient investment.

Private Finance: The report explains that we need to look beyond green bond and utilise financial innovation and consider how infrastructure investment can form a secure and appealing part of individual pensions. This requires financial professionals having the skills and knowledge to support customers and clients through this transition.

Financial Regulation: The report believes the UK should integrate climate risk and net-zero into financial regulation and monetary policy, encouraging all financial services business to generate a net-zero plan.

Public Finance: Robins believes we have a great opportunity to utilise the post-pandemic recovery to accelerate climate investment. Additionally, net-zero and sustainability goals should be applied to public financial institutions. The National Infrastructure Bank announced by the Chancellor could be a driving force for net-zero, collaborating with regions and leaders in private capital.

International Framework: With the upcoming International Climate Summit, COP26 in Glasgow, the next recommendation is developing the international framework for financing net-zero. The UK has the potential to take a lead on financing a green recovery, moving forward towards a more equal and sustainable way of working.

Tracking Net Zero Investment: Robins explains that the net-zero transition needs to be ‘front-loaded. In other words, we need to take action now, invest and implement the necessary measures to generate long term results. If we are to reach our 2050 goals than the next few years will be critical for the finance industry. The innovative new steps need to become normality for finance.

The pandemic has represented a test for high-carbon industries and an irreversible transition towards renewable energy and electric vehicles. New jobs are required nationwide and the green industry can offer substantial growth. The year the UK Government will announce its national Net Zero Strategy, with measures on delivering the 6th Carbon budget. What is needed at the moment is the financial strategy to ensure investment flows to the right places. There is a massive opportunity for the UK to shift its focus and become a leader in creating a net-zero financial system.

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