Environmental Audit CommitteeWritten evidence submitted by the City of London Corporation


1. The City of London Corporation has long been a proponent of low carbon, green and socially responsible investment and “green finance”. It has sought to raise awareness of the opportunities within this field, and to encourage the development of appropriate fiscal and legal environments to support its growth.

2. The Corporation is actively involved in working with the impact investment community and is hosting a conference organised by Global Impact Investment Network (GIIN) on 10th and 11th October 2013 at the Guildhall.

3. The City of London Corporation launched its own social impact investment fund in 2012, which invests in organisations which are designed to create positive social impact.

The City of London Corporation’s Role in Supporting Green Finance

4. The knowledge and expertise found in the City means that it is well placed to contribute to tackling the environmental challenge. UK financial and professional services are an asset not just for London but for the nation as a whole, and there is much to offer the expanding cities of the developing world. Not only are there particular strengths in construction, engineering and infrastructure services, there is expertise in financing large scale projects and strengths in the legal sector to help provide the best legal framework The UK is also the world leader in risk management and insurance services

5. Through its research programme, the City seeks to highlight opportunities and emerging issues that are coming over the horizon in order to ensure that businesses in the City are well placed to deal with them. This is why the City of London Corporation is embarking on a new project as part of its London Accord Programme called “Tomorrow’s City”. This aims to foster dialogue between businesses, decision-makers and civil society organisations which will study how these challenges can be met.1

What are the main drivers behind institutional investors’ decisions on the type of investments they include in their portfolios?

6. There is a spectrum of investors with different expected returns. Getting the right type of capital allocated to the projects on offer is a critical part of the fine tuning of the marketplace.

7. For mainstream investors, “green investment” has become a less than meaningful term; there is only investment which is expected to make a profit, and investment which is not. Within this context sustainability is an assessment tool and “enhanced analytics” is used to determine the impacts of ESG (environmental, social and governance) factors on investment values. By and large, environmental benefits are positive externalities, not primary aims, and dependent on other factors such as discounting rates and the longevity of investment strategies.

8. A more niche area, is the field of impact investment which seeks an environmental (or more often a social) return in addition to a financial return. The latter is sometimes below market rates.

9. With respect to the future of green investment both elements should be given consideration. While the financial returns will impact at the macro-economic scale, the social and environmental returns have an important role to play at the local level. Community energy projects, open space provision and social enterprise have the potential to impact directly on peoples’ lives.

How effective are the financial markets in matching available finance to the required investment in renewable energy and other green projects? To what extent is a potential “carbon bubble” a real risk?

10. There is less than perfect efficiency. However, the issue is less to do with a shortage of funding than a shortage of projects meeting the risk/return on investment expectations of investors.

11. There is a very real risk of a carbon bubble. However, barring an energy price shock akin to the 1973 oil crisis, the policy and legal changes required for it to burst are complex and largely reliant on international agreement (or the failure to reach such an agreement). Changes are therefore likely to be telegraphed sufficiently in advance for markets to adjust. In 2007 the City engaged TRUCOST to conduct an analysis of the carbon footprint of the equity investments contained in a portfolio managed by the City of London Pension Fund. The study found that the fund was 11% less exposed than its peers and identified the key investments carrying carbon risk. The report was passed to the fund managers for consideration in future investment decisions.

What should the Government be doing to help redirect finance to help fill the multi-billion pound green finance gap? How can “political risk” to investors from changes to the Government’s energy and environmental policies be reduced? Can the Government ever remove political risk or are more innovative financial instruments that offset those risks the solution?

12. One possible way of reducing policy instability is to issue index linked carbon bonds. The London Accord’s model2 for index-linked carbon bonds underwrites the risk associated with investment in an uncertain policy environment. Environmental policy is subject to political shocks. The index-linked carbon bond hedges this regulatory risk.

13. Traditional bonds are negotiable interest-bearing or discounted certificates of debt that are issued by a government in order to raise cash.3 In exchange for investing a sum of money, the investor receives from the issuer an annual return usually in the form of an interest payment until maturity and then a fixed sum to repay the principal

14. An index-linked carbon bond is a government issued bond where the base interest rate is fixed, but actual interest payments vary depending on whether or not the issuer keeps an environmental promise. In effect the regulatory risk is unbundled from other project risks, including base rate risk, and managed separately. For example:

the interest paid on the bond may escalate if the verified greenhouse gas emissions of the issuer breach a promised maximum in a given year;

annual payments may de-escalate if feed-in tariffs for renewable energy in the country concerned rise above pre-agreed level; and

interest payments may go up or down with the market price of emissions allowances as quoted by a particular source of market data.

15. An investor in an index-linked carbon bond receives a better yield if the issuing country’s targets are not met. If governments deliver effective policies that meet their aspirations for carbon reduction, they get cheap money by paying a lower interest rate on the bond. If governments fail to meet their green targets, they pay a higher interest rate on the bond. Investors in index linked carbon bonds can proceed with projects or technologies that pay off in a low-carbon future because, if the low-carbon future fails to arrive, the issuing government will pay them higher interest rates on government debt.

16. The idea of index-linked carbon bonds was described in a London Accord team paper presented to the World Bank Government Borrowers’ Forum at Ljubljana in May 2009 which concluded that the concept fits the current economic climate and the current questionable status of environmental commitment.4

Is greater direction to banks needed to encourage them to increase their lending to renewable energy and green projects?

17. What is required is not market intervention, but the creation of a stable policy environment, coupled with appropriate fiscal and regulatory incentives. Markets rather than governments are most effective at distributing capital efficiently. However, this depends on an efficient and well supported brokerage/intermediary service to help in the allocation of capital, and this is unlikely to be self-financing in the near future.

How can pension funds and other investors be encouraged to re-direct their capital funds towards investments with green objectives?

18. The business case for investment in the green sector needs to be better articulated. It needs to be seen not just as a commercial opportunity that could repay capital plus interest over time, but also as an investment which creates additional positive externalities. Also, industry specific pension funds could be encouraged to target projects related to their own industry—for example water industry pension funds investing in the water industry. We welcome the consideration by certain local authority pension funds’ commitment to investing for longer term impact.

Are fiscal incentives for people/institutions to put funds in green investments needed, and if so what?

19. Fiscal incentives help, as evidenced by the Netherlands’ use of income tax relief for sustainable investments. However, demand management is the key to success. To this end the effective regulation of the water, waste and energy sectors should include a requirement for infrastructure replacement/investment. This will help drive demand and thus make these sectors attractive propositions for investment. Similarly, mandatory green procurement requirements for the public sector, including higher standards of energy efficiency for buildings, are a way to drive demand. Rather than creating an unnecessary burden on industry, carefully considered regulation, and the creation of industry standards can drive innovation and create opportunities. A good example of this is the Clean Air Act passed by the US Congress in 1970, which required a 90% reduction in emissions from new automobiles by 1975. This legislation was responsible for kick-starting a worldwide wave of innovation in engine design by manufacturers, including the invention of the catalytic converter.

How can better information on the environmental impacts of investments and companies be provided to investors? What difference would such information make to investors in practice?

20. Not all investors will necessarily want this information. Some investors, particularly those interested in short term returns, will not place much weight on the impact as long as the financial returns make the investment justifiable. However, others who are looking for longer term value may be very interested in how environmental or social issues can impact on portfolio value. The combination of different reporting regimes, which cover impact measurement and Environmental, Social and Governance reporting, can be confusing for investors.

What are the pros and cons of having a financial transaction tax (Tobin tax) with revenue hypothecated to support green investments?

21. Whether any funding stream can be truly hypothecated to specific investments is debateable. It is not an approach traditionally favoured in the UK by the Treasury.

22. There is also growing evidence of the numerous negative effects an FTT would have on the wider economy. In a study on the impact of Stamp Duty, Oxera found that taxing equity trading had increased the cost of equity by 7–8.5%.5 This in turn had reduced investment by £2.7–6.4 billion and reduced GDP by 0.24–0.78%. In a study for the City of London, London Economics found that an FTT would significantly increase the cost of corporate and sovereign debt, which would decrease business investment by 1.8% and reduce GDP by 0.5%.6

23. The impact on savers has also been well documented. Oxera found that an FTT would reduce the returns of the average pension fund by up to 5.5%.7 Even a more limited FTT such as UK Stamp Duty is estimated to reduce returns by around 1.52%, increasing to 2.38% for equity-based portfolios.8

What can the Government do to help increase the flow of finance to small and community-based renewable energy and green projects?

24. Matching funders with community developers is a good starting point. Big Society Capital is interested in this when there is a clear community benefit from the project and this approach should be encouraged further.

What impact is the Green Investment Bank (GIB) likely to have on the green finance gap? Does it have the right investment strategy?

25. There is little evidence that there is a green finance gap. However, if such a gap did exist, the GIB would have little impact. Due to the high transaction costs associated with venture capital, it appears that the GIB is looking for “shovel ready” large scale projects.

26. Research produced for the City Corporation9 found that Government plays a critical role in the cleantech sector, much more so than in comparable areas like biotechnology or IT. Its most important function is to maintain a joined-up approach to policy and provide consistency for the private sector to develop and invest in new technologies. The successful development of UK cleantech will require the involvement of a broad range of financial institutions, from venture capitalists and banks to insurers, investors and brokers. To this end, venture capital firms should support long-term growth of the cleantech sector through building up the necessary technology and market intelligence to add value to portfolios. In tandem, banks and insurers should improve coverage through small business support and, more critically, provision of debt capital and risk management products. Cleantech firms, both start-ups and more established players, need to improve investment readiness to gain increased investor confidence and support.

1 October 2013

1 A collection of research around this theme can be found at http://www.longfinance.net/tomorrow-s-cities.html

2 http://www.zyen.com/Knowledge/Articles/index-linked_carbon_bonds_gilty_green_government.htm

3 This is increasingly used in the social sector – large charities such as Scope and Golden Lane Housing have successfully raised funds in this way

4 Delivering Copenhagen: The Role of the City’s Financial Services Sector in Supporting Action on Climate Change”, published by the City of London Corporation, 2009

5 Oxera (2007), Stamp Duty: its impact and the benefits of its abolition, prepared for ABI, City of London, IMA and London Stock Exchange, May 2007

6 London Economics (2013), The Impact of a Financial Transaction Tax on Corporate and Sovereign Debt, prepared for the International Regulatory Strategy Group, April 2013

7 Oxera (2012), What would be the economic impact of the proposed financial transaction tax on the EU?, prepared for AFME, ASSOSIM and Nordic Securities Association, January 2012

8 Oxera (2007), Stamp Duty: its impact and the benefits of its abolition, prepared for ABI, City of London, IMA and London Stock Exchange, May 2007

9 Financing clean technology firms in the UK”, Forum for the Future,

Prepared 5th March 2014