In focus

UK unveils its post-Brexit sustainability strategy

This month we saw important announcements for the UK’s path towards a sustainable future. Last week’s headlines were dominated by the chancellor’s announcement that the UK government plans to issue its first ever green bond in 2021. Meanwhile, this week’s big news is the prime minister’s announcement of a Green Industrial Revolution. Both come almost a year after the EU unveiled its own vision for a carbon free economy.

This activity in the UK raises several questions, not least about how the UK plans fit with the EU agenda on sustainability. We consider some of these questions below. Spoiler alert: it remains to be seen. But here is a round-up of what we know so far.

The announcements go far beyond green bonds, don’t they?

Yes, the statements go much further than that. The bigger news last week was not the first UK green gilt but rather the context in which this gilt was presented. It is part of a broader sustainable finance plan aiming to make the UK economy greener. Notably, this plan itself is part of the government’s ambition for the financial sector altogether after Brexit.

What have a “green taxonomy” and climate-related disclosures got to do with the government’s ambition for the financial sector after Brexit?

There are many sides to this ambition.

First, there are plans relating directly to sustainable finance. Green government bonds is one part. A green taxonomy (an agreed common language to describe sustainable economic activities) to be based on the EU taxonomy, at least at the beginning, is another. Making reporting of climate-related financial information mandatory is another. This is currently voluntary through the Task Force on Climate-related Financial Disclosures (TCFD).

The latter will kick off in waves, starting with listed companies, banks, insurance companies and occupational pension funds with more than £5 billion in assets. All UK-registered companies and asset managers will follow.

The new CEO of the Financial Conduct Authority said last week that the TCFD regime would start on a “comply or explain” basis, as companies may struggle with getting the necessary data. Only after that will the regulator consider tightening the rules and there will be several consultations with the industry in the meantime.

What about measures beyond sustainable finance? Digital currencies and a “Long-Term Asset Fund”?

There are other measures beyond sustainable finance. The government wants to review the listing requirements for companies to join the UK stock market and look into changes that could be made to boost the appeal of listing to companies. It is not the first time that this has been reviewed, it is more complicated than it sounds and the challenge is not specific to the UK.

Furthermore, the UK government wants to venture into the world of digital currencies and develop a framework where these meet the same standards as other payment methods.

It even wants to reform the regulatory framework for investment funds altogether (details to be consulted on) and have a new “Long-Term Asset Fund” launched within a year. This new fund would invest in infrastructure and venture capital, as championed by the Investment Association.

The plans don’t stop there, do they? What is this talk about “equivalence”?

No, the plans do not stop there. The chancellor unveiled guidance on the UK’s approach to equivalence to other countries. Equivalence means that a country considers the regulatory framework of another country as being very similar to its own. This then allows the other country to provide its services to the first country without having to make additional arrangements.

The new guidance is based on three principles that the UK has held for some time: a) the UK should be open; b) as of day one (after Brexit) the UK and the EU will not just be equivalent, but identical; c) equivalence should be based on outcomes rather than ticking lots of boxes.

So, unsurprisingly, the guidance included a very specific note that the UK will be granting equivalence to the EU and European Economic Area member states. It also made a very explicit reference to UK’s “outcomes-based approach” – something the UK has sought from the EU, but it has not been forthcoming. At least on the UK side, this helpfully takes the politics out of any equivalence decisions. 

All in all, green gilts are only one small part in a much bigger agenda to keep the UK financial sector going once Brexit and the changes it will bring really kick in.

What about the ten action points for the Green Industrial Revolution announced by the Prime Minister?

These are the ten action points unveiled by Boris Johnson on Wednesday:

  1. Generate enough offshore wind energy to power every home by 2030
  2. Develop additional energy from hydrogen
  3. Continue existing plans for nuclear power generation
  4. Support electric vehicle manufacturing and the corresponding charging infrastructure
  5. Make public transport cleaner via greater use of green buses and extended cycling infrastructure
  6. Strive towards zero emission planes and ships
  7. Renovate buildings to make them more energy efficient
  8. Develop capabilities for carbon capture and storage
  9. Reforest the country by planting trees and repurposing countryside
  10. Make the City of London the global centre for green finance through the green gilt, carbon offset markets and disclosure requirements

In short, the plan means greener infrastructure, greener energy generation and greener transport. More details on an implementation roadmap will follow and, importantly, it will involve input from UK businesses.

Notably, the term Green Industrial Revolution was coined by the Labour Party in its 2019 election manifesto and included some aspects of the above plan. Theoretically, this may mean cross party consensus for the implementation of this plan going forward.

Is this the UK version of the EU Green Deal?

Pretty much.

One thing to note about the UK’s ten-point action plan is that it includes sustainable finance, that is, what the Chancellor was talking about last week. So in this sense, it is similar to the EU Green Deal and how that relies on the EU Sustainable Finance Action Plan to support the delivery of the political ambition.

Both the UK and EU initiatives have the economy and competitiveness at the heart of them. At the moment, the EU Green Deal is the more ambitious project. But this is natural as it has a head start given that its plan of action and implementation started almost a year ago.

Isn’t sustainability a common goal?

Indeed, environmental sustainability is a common goal and not a competition. It is a matter for every country in the world to carve out its own path to cutting down greenhouse emissions. The UK has set itself a net zero emissions target and is now putting together the pieces of its sustainability puzzle.

It does not start with a blank canvas. Theresa May’s government had already kick-started the race towards a greener economy with its Green Finance Strategy in 2019. There were three objectives:

  • “greening finance” which means embedding the concept of environmental sustainability within everything the financial services sector does;
  • “financing green” which means channelling more money towards investments that help build a greener economy, such as green infrastructure;
  • “capturing the opportunity which is an umbrella expression to mean “ensuring the UK recognises the (environmental and commercial) opportunities and becomes a leader in this space”.

Some of what the Chancellor announced last week is part of the Green Finance Strategy, such as the TCFD disclosures. But other announcements are new, for example the green UK government bond which the government in 2019 “[did] not consider to be value for money compared to the core gilt programme, which remains the most stable and cost-effective way of raising finance to fund day-to-day government activities (including existing and new green expenditure)”.

Where is the money going to come from?

It is going to be a combination of public and private funds. More details will probably follow in the near future. For now, we know that the Prime Minister has stated that the government will mobilise £12 billion of public money and “potentially three times as much from the private sector”. Presumably the measures announced last week by the Chancellor will help with the latter. This means a total investment of £48 billion with a 25% to 75% split between public and private money. It is not entirely clear over what period. The new UK green gilt will probably contribute to this.

By comparison, the EU Green Deal has identified a gap of €260 billion per year until 2030 – that is €2.6 trillion in total. €1 trillion of this is going to come from a combination of public sources, such as the EU budget and the European Investment Bank. A further €225 billion is going to come from EU bond issuance for the (still-to-be-formally-agreed) EU Covid Recovery Fund, as 30% of that fund (€750 billion) is dedicated to actions that fight climate change. This leaves €1,375 billion to come from the private sector so that the public-private split for the EU plan is 47% to 53%.

Will the new UK green government bonds be a game-changer?

It depends. All we know at the moment is that the green bond issuance will start in 2021 “subject to market conditions” and that there are already plans for more issuance in the future – assuming that market conditions will permit that issuance. The money from these bonds will go to finance projects that will “tackle climate change”, infrastructure and green jobs. And this is all the detail there is for now.

As debated many times, green bonds work (as in, help the transition towards a more environmentally sustainable economy) if the money really goes towards green projects. The best way to ensure that they do is to ring-fence them from other government debt, otherwise they are no different from standard government borrowing which can then be used for anything (such as building a third runway for Heathrow Airport).

So far, there hasn’t been any concrete commitment to ring-fence these bonds. It is, therefore, likely that there will be a lot of focus on exactly how these bonds are structured to avoid greenwashing, which means being environmentally friendly in name but not substance.

There are other details to sort out too, not least of which is pricing. For it to be an attractive proposition for investors, the bonds will need  a higher yield than the non-green gilts, which makes it more expensive for the government. Lower yields make it cheap for the government to borrow for green projects but it will not be as attractive for investors as the non-green gilts. But maybe the government will go for the more attractive terms for investors to signal their intent to the market and help it take off.

What is the most important bit of regulation for achieving sustainable finance?

Opinions here may vary depending on whom one asks. The one thing that everyone seems to agree on is how important it is to have a common language. There can be no market if different market participants use a term in different ways. So having a common taxonomy is very high up on the priorities list of things to do to achieve sustainable finance. 

Also quite high up on that priority list is corporate disclosure – that is, what information companies (of any kind, independently of listing and size) provide on sustainability in their annual accounts and other publications such as dedicated corporate responsibility reports. This is where all the data inputs for any analysis come from. Without that, there can be no meaningful measurement or rating. And without those, it is impossible to classify an investment as environmentally (or indeed socially) friendly. This is why a widespread recognition of the TCFD standard is important and very welcome.

The good news is that there is additional work from international standard setters which may be getting less media attention but is crucial in all this. For example the IFRS Foundation Trustees are currently consulting on a global approach to sustainability reporting, the World Economic Forum is consulting on ESG performance metrics and contribution towards the UN’s Sustainable Development Goals (SDGs), and five setters of company reporting standards have issued a statement of intent to work together towards a common standard.

The UK government and financial regulators have already expressed strong support for this work. In parallel, the UK’s Financial Reporting Council recently published the results of its thematic review on climate-related disclosures, outlining clear areas for improvement and raising the expectations bar for companies, boards, auditors and investors. So there is a definite momentum there.

Will the UK follow the EU agenda on sustainable finance?

After 1 January 2021 there will be no obligation on the UK to follow the EU. And we shouldn’t forget that last week’s announcements were all about the UK strategy for financial services after the end of the transition period.

So far, what we know will happen is that the UK will onshore, that is implement, all EU regulation valid on 31 December 2020. This includes the high-level rules of the EU Taxonomy regulation but not its technical standards (the finer details). The forthcoming EU regulation on disclosures for asset managers and investment products (including funds) will not apply as this will take effect in March 2021.

The UK signalled that at least for the Taxonomy it will apply it but keep it under review to monitor if it is fit for purpose for the UK market. The question then is, what happens with the broader package. Could the UK choose to implement it?

Going back to the 2019 Green Finance Strategy, the government had stated that it “commits, in relation to green finance, to at least match the ambition of the three key objectives included in the EU’s Sustainable Finance Action Plan”. This was because the UK had been “closely involved” in the taxonomy, disclosures and benchmark regulation.

What the UK government is saying now is: “Given the global nature of the industry, there will be interactions with related international initiatives, including those that derive from the EU’s Sustainable Finance Action Plan. Proposed TCFD-aligned requirements would as far as possible be consistent with and complementary to these initiatives.”

This may sound less aligned with the EU rules than the 2019 statement but the UK may choose to stay close to the EU rules for two reasons. First, so as not to look like a laggard given that the EU initiative is well underway and the UK one is practically starting now. Second, many in the industry will be pointing out the practical issues of having a different regime in the UK compared with the EU; an issue that particularly affects cross-border business.

The reality is that any guess now would be rather speculative as, less than a month and a half before the end of the Brexit transition period, a large piece of the puzzle is still missing: the exact terms of the UK’s relationship with the EU from January 2021.

Will the whole sustainable finance package work?

It depends. The experience so far with the EU sustainable finance agenda has shown that making the economy greener needs careful coordination and timely implementation, but there are dangers in ramming legislation through too fast. For example, the UK should avoid situations where they set disclosure rules for investment products before having first assessed whether companies are reporting the data needed for these product disclosures.

The EU agenda has also recognised that sustainability is not only about climate change but also other environmental issues as well as social outcomes and good governance. The UK framework should consider social and governance factors because sustainability is not only about the environment. 

There may be differences between the UK and the EU approach along the way. Brexit means that the UK can develop its own framework and tailor components of EU regulation to get a better fit for the UK.

But, ultimately, achieving sustainability, tackling climate change, and eradicating poverty are global goals. Achieving them will take a global effort for which global (and not just EU-UK) alignment of rules and standards is essential. Divergences for political purposes may mean that we risk delaying or even missing completely the opportunity to create a global and liquid market for sustainable investment.