54.The Government’s Green Finance Strategy, published in 2019, was clear that private finance would have an important role to play in achieving the decarbonisation of the UK by 2050. It noted that:
A strategy to green the financial system as a whole needs to be combined with specific actions to mobilise and accelerate flows of private finance into key clean growth and environmental sectors at home and abroad.
The 2021 Budget reinforced that view, noting that the Government expects the private sector to provide the majority of investment needed to achieve net zero.
55.The Government has acknowledged that the transition to net zero will require significant private finance. Witnesses endorsed this view, and we heard that the industry should be able to provide that finance. This Report now considers what will be needed to ensure that provision is as smooth and effective as possible, including:
56.It has been suggested that in the past, Government policies have changed frequently, deterring low-carbon investment. Nick Mohlo, Executive Director of Aldersgate Group, a membership organisation promoting a competitive and environmentally sustainable economy, told us that:
If you go back to some of the policy developments between 2010 and 2016, we saw a fairly high level of uncertainty across low-carbon investments. The levy control framework, which was the overall pot of funding allocated to renewable energy funding, was delayed on multiple occasions. The fourth carbon budget had been reviewed quite prematurely. The zero-carbon-homes requirement was cancelled in 2015, and that had very negative knock-on impacts on the feeling of investment confidence, but also on the work of other Government Departments that had put a considerable amount of time into developing those policies in co-ordination with business.
Mr Mohlo added that more of the off-shore wind infrastructure supply chain could have been based in Britain had it not been for that uncertainty. He told us that “a lot of the investment uncertainty of the time definitely had some negative impact on their perception of the UK as an investable market and it resulted in a smaller number of supply chain investments than we would otherwise have seen.”
57.Chris Cummings, Chief Executive Officer of the Investment Association, also emphasised the importance of policy certainty to attract investment, adding:
As the investment management industry, the one thing we love to invest in is infrastructure: long-term projects with known investment horizons. It is exactly the type of thing we get excited about. Successive Governments, unfortunately, have changed the policy direction, rules, incentives and so on, which makes it much harder for UK pension funds to invest in infrastructure.
Mr Cummings further noted that “Policy certainty underpins all of this, making sure that Government are thinking long term, especially when thinking about green infrastructure and green investment.”
58.The Government announced in Budget 2021 that the Treasury’s Net Zero Review is looking at how the UK Government can reduce policy uncertainty in order to encourage investment, alongside innovation and technological development.
59.The Government has recognised that private finance will need to play a key part in funding the transition to net zero. If it is to do so, the Government will need to provide long-term certainty in climate-related policy and must ensure that consistent policy signals are sent to investors. We are encouraged that the Government acknowledged these needs in the 2021 Budget.
60.At the November 2020 Spending Review, the Chancellor of the Exchequer announced that the UK would issue its first green sovereign bond or ‘green gilt’. Green sovereign bonds can be defined as debt securities issued by governments where the proceeds raised are used to finance clearly defined projects which have environmental benefits. Following this commitment, the Treasury noted at Budget 2021 that:
The government will issue its first sovereign green bond—or green gilt—this summer, with a further issuance to follow later in 2021 as the UK looks to build out a ‘green curve’. Green gilt issuance for the financial year will total a minimum of £15 billion. The green gilt framework, to be published in June, will detail the types of expenditures that will be financed to help meet the government’s green objectives. The government also commits to reporting the contributions of green gilt spending towards social benefits such as job creation and levelling up.
61.Despite the Government’s announcements on green gilts, in comparison to other European governments, the UK is lagging behind. Germany raised 6.5 billion euros from its first green sovereign bond in September 2020, while France issued its first green sovereign bond in January 2017 raising 7 billion euros. France’s green sovereign bonds are used to fund the government’s ‘Invest for the Future’ programme to “fight climate change, adapt to climate change, protect biodiversity and fight pollution”.
62.This delay in the issuance of a green gilt may have come at a cost in developing other green bond issuance markets in the UK. Dr Daniel Klier, Group Head of Sustainable Finance at HSBC, highlighted that there was not yet a strongly growing sterling green bond market, as there is in dollars and euros, and noted that a benchmark bond issued by the Government was likely to be needed to unlock the sterling market.
63.While we heard evidence from finance industry experts, including Chris Cummings, Chief Executive Officer of the Investment Association, that there would be investor appetite for a UK green gilt issuance, the Debt Management Office has also previously suggested to us that green gilts may mean raising finance at a premium compared with conventional gilts.
64.However, some of our witnesses disagreed with this analysis. Professor Nick Robins, Professor in Practice for Sustainable Finance, Grantham Research Institute at the London School of Economics, told us that “it would be very plausible to issue something that could raise money at lower cost for the state”. Chris Cummings added that “having spoken to our members, I am not convinced that there would be a premium for these investments”. Dr Klier agreed, telling us that “at the moment, especially in Germany, we come in at prices that are below the market curve. I do not see any evidence for why we should be at a premium”.
65.While John Glen MP, Economic Secretary to the Treasury, confirmed that there had previously been value for money considerations around sovereign green bonds, he noted that “market conditions have materially changed, […] and that is why we announced it.”
66.We welcome the announcement in the 2021 Budget of a timetable for the issuance of the UK’s first green sovereign bond or ‘green gilt’. However, the UK is lagging behind other countries in the issuance of these green bonds. This runs the risk of holding back the development of a private sterling green bond market. Although concerns about the potential for green bonds to be a more expensive form of debt for the Government seem to have dissipated to a degree, the Government should none the less set out its tolerance, when issuing such bonds, for them to be more expensive than other forms of Government debt.
67.As part of its monetary policy operations, the Bank of England operates a Corporate Bond Purchase Scheme (CBPS). The Bank describes the CBPS as follows:
The Corporate Bond Purchase Scheme (CBPS or “the Scheme”) was launched in August 2016. It imparts monetary stimulus by lowering the yields on corporate bonds, thereby reducing the cost of borrowing for companies. It does this by triggering portfolio rebalancing into riskier assets by sellers of assets, and by stimulating new issuance of corporate bonds.
The Asset Purchase Facility (APF) currently holds £20 billion of corporate bonds under the CBPS. This represents a small fraction of the total holdings of the APF, which is currently planned to reach £895 billion, and the total market of corporate bonds eligible for the Scheme, which amounts to £160 billion.
68.These corporate bond purchases by the Bank may be being used to fund carbon-intensive activity. This can be seen in the Bank’s own published Taskforce on Climate-related Financial Disclosures (TCFD)-compliant disclosures. In his foreword to those disclosures, the Governor of the Bank of England noted that:
…the carbon intensity of our holdings of UK sterling corporate bonds (2% of the portfolio) reflects the position of the UK market generally. However, there remains a gap between the associated carbon outputs of these holdings and the Paris goals. This demonstrates the additional work needed to meet the UK’s goal of net-zero emissions by 2050.
69.Positive Money, a campaign group seeking to “make money and banking work for society”, noted what the impact of these holdings meant for the net zero target:
‘Greening’ the Bank of England remains a key step in facilitating the transition to a Net Zero economy by ensuring financial flows are aligned with the government’s climate targets. As Britain’s central bank, the Bank of England is currently overseeing a financial system which is significantly out of step with the UK’s legally binding commitments under the Paris Agreement. As former Bank of England governor Mark Carney told the Treasury Committee in October 2019, the global financial system may be funding temperature rises of more than 4C, more than double the 1.5C aimed for in the Paris Agreement. Indeed, the Bank of England’s own asset purchases are currently aligned with a 3.5C increase in temperatures by the end of the century, which the Bank has defended as simply mirroring the market, which the MSCI Reference Portfolio suggests is funding 3.7C warming.
70.In his appointment hearing in March 2020 with us for the role of Governor of the Bank of England, we asked Andrew Bailey about excluding fossil fuels from future bonds purchases. He told us:
The original policy with the corporate bond programme was to hold essentially a portfolio that mimicked the corporate bond markets—in other words, it was a neutral portfolio. That was done deliberately. The Bank of England is not in there, picking companies; it is completely neutral. Whatever the market is, we hold the neutral portfolio. The question you rightly raise is whether we should shift that to say, “Given the public interest in climate change, we should shift the make-up of the portfolio to being one that is on the way to net neutral,” or however you want to define it. I think there is a very strong argument for doing that.
71.Sarah Breedon, Executive Director for UK Deposit Takers Supervision at the Bank of England and its executive sponsor for work on climate change, emphasised this point. She told us that “what we have said we will do—and we will do—is think about how best to attach conditionality, working with Treasury, which needs to agree it, given that it decides our remit, for the corporate bonds we purchase as part of our quantitative easing approach.”
72.At Budget 2021, the Chancellor provided the Monetary Policy Committee of the Bank of England with a new remit letter, in which he amended its remit to reflect the importance of environmental sustainability and the transition to net zero: “I am today updating the MPC’s remit to reflect the government’s economic strategy for achieving strong, sustainable and balanced growth that is also environmentally sustainable and consistent with the transition to a net zero economy.” In response to this new remit letter, the Bank made the following announcement:
In the coming months we will provide more information about our proposed approach to adjusting the Corporate Bond Purchase Scheme (CBPS) to account for the climate impact of the issuers of the bonds we hold, with a view to adapting our approach by the time of our next scheduled round of reinvestment operations in 2021 Q4.
73.There has been criticism of this change of remit. Lord King, a former Governor of the Bank of England, told the House of Lords on 12 March 2021 that:
When asset purchases commenced in 2009, the framework was established to ensure that the Bank did not become the arbiter of credit allocation among different sectors and different companies. But the new remit requires the bank to do just that, and to “reflect the importance of environmental sustainability and the transition to net zero” in its purchases of corporate bonds. Some may argue that this is a harmless gesture; after all, given the inflation outlook, it is far from obvious that there will be new asset purchases by the Bank. But what seems a harmless gesture today may prove damaging tomorrow. I know that climate change arouses passions, but that is no reason to embroil the Bank of England in what should be the responsibility of government. Climate change and declining biodiversity are serious issues that merit proper debate. Fiddling with the Bank of England’s remit, while at the same time taking no action on a carbon tax and freezing fuel duty again, are gestures, not a coherent policy. More importantly, they are the first steps on a slippery slope to undermining the independence of the Bank, and we cannot afford to lose that.
74.We note the new remit provided to the Monetary Policy Committee, which will allow it to rebalance its Corporate Bond Purchase Scheme to take account of the climate impact of the bonds it holds. We will continue to scrutinise this process and will examine how any changes are enacted, and how those changes impact on the other policy objectives and the independence of the Monetary Policy Committee.
75.We heard a proposal for reform to facilitate green finance from Chris Cummings, CEO of the Investment Association, who told us that his major recommendation for regulatory change was to create a new ‘long-term asset fund’:
This is a new fund vehicle that we have been spending a lot of time talking to our friends at the Treasury and the FCA about, which allows retail investors and particularly DC pension funds to invest in infrastructure. […] It is a new fund structure, which is specifically designed to address the long-term investment issues.
76.Sheldon Mills, then Interim Executive Director for Strategy and Competition at the Financial Conduct Authority, told us that:
We are working closely with the Investment Association in relation to long-term asset funds and trying to ensure that we have the right balance of enabling that innovation in the market, getting coalition from asset managers and others around this new type of vehicle and having the right level of consumer protection and risk in relation to that, so that we have the right badges on it and, when those funds are potentially distributed, the right types of investors can come into them. I am not saying that they are made to be risky, but they are a different type of investment than retail investors might be used to. We are working very closely with the Investment Association, and we hope to finalise that as quickly as we can.
77.In November 2020, the Chancellor announced the launch of a new type of ‘long-term asset fund’ which would allow pension savers to invest in infrastructure assets. In the same month, the Treasury, the Bank of England and the FCA convened a working group to facilitate investment in productive finance. The minutes of The Productive Finance Working Group Steering Committee note that:
The Working Group should draw on a large amount of existing work on the barriers to investment in productive finance. Its focus should be to identify practical ways to address both the operational and demand side barriers, and set out a clear roadmap for their implementation. This would support the Chancellor’s public commitment to set up a Long-Term Asset Fund (LTAF) later this year.
The minutes also note that “a successful outcome for the Working Group would be to have facilitated the launch of at least one LTAF, with capital having been committed from a broad range of investors”.
78.While in his proposal, Mr Cummings argued that such a long-term asset fund might be available to retail investors, this has been subject to debate at the Productive Finance Working Group Steering Committee. The January 2021 minutes note that:
The Steering Committee discussed the intended target market for the LTAF [Long Term Asset Fund]. This will be an important question for the TEG [Technical Expert Group] to explore ahead of future Steering Committee meetings. Some members, whilst recognising that the LTAF was unlikely to be a product for the mass retail market, nonetheless, wanted an LTAF to be available to sophisticated segments of the retail market, as well as institutional investors. Others commented that, as this was a new product which would be investing in asset classes not traditionally available to retail investors in an open-ended structure, and which might require notice periods exceeding a year, it would not be suitable for most retail investors. Careful consideration, along with input from the advisory community, would be required about how it conforms to tax wrappers (for example, ISAs, SIPPs). One member noted that listings on exchanges can help provide access to retail investors.
Given the challenges of distributing a new product to the retail market, some members thought the initial focus should be on delivering an LTAF for institutional investors (most notably large DC pension schemes), before facilitating access to retail investors at a later stage.
79.When the Chancellor announced in November 2020 that this new type of ‘long-term asset fund’ would launch, he explained that it would do so within a year. However, the Investment Association recently announced that a regulatory consultation from the Financial Conduct Authority was required before any new fund could launch.
80.We note the debate at the Productive Finance Working Group Steering Committee on retail access to the ‘long term asset fund’ (LTAF). There should be clarity about who will have access to the LTAF. The Chancellor and the financial regulators should set out the timeframe for the launch of the announced ‘long term asset fund’ to allow pension savers to invest in long-term projects. We would expect that such an LTAF would be focused on providing a net-zero compliant product.
81.We heard evidence that regulatory restrictions under Solvency II were preventing insurance companies from investing in long-term infrastructure assets. Solvency II is the European Directive on the taking-up and pursuit of the business of Insurance and Reinsurance, which came into force on 1 January 2016. The Bank of England describes Solvency II as setting out the “regulatory requirements for insurance firms and groups, covering financial resources, governance and accountability, risk assessment and management, supervision, reporting and public disclosure”.
82.Huw Evans, Chief Executive Officer of the Association of British Insurers, told us that:
We have to support the Government and lobby them to change the Solvency II framework so that insurers are in a position to invest in a much wider range of sustainable ESG assets that fully meet the task of policyholder protection and of delivering sustainable returns over the long run, but that enable insurers to put their £2 trillion-worth of assets to much more sustainable and good use going forward.”
This point was also emphasised by Aviva in its evidence to the previous Committee, where it argued that:
Regulators should work to ensure that capital requirements reflect true long-term sustainability risks, and do not disincentivise long term sustainable investment. For example, Solvency II should be reformed so that it no longer discourages insurers from investing in green infrastructure.
83.In October 2020, the Government announced a review of Solvency II and published a call for evidence. In his foreword to that call for evidence, the Economic Secretary noted that “The review will be guided by our objectives: to ensure a vibrant and prosperous insurance sector, to provide long-term capital to support growth, and to uphold high standards of policyholder protection and promote the safety and soundness of firms.”
84.The Treasury should, as part of its review of Solvency II, consider reforms that could improve the funding of sustainable green infrastructure while maintaining the financial stability of insurers.
85.On 25 November 2020, as part of the launch of the UK’s new National Infrastructure Strategy, the Chancellor of the Exchequer (the Rt Hon Rishi Sunak MP) announced a new UK Infrastructure Bank which will draw private finance investment into new infrastructure projects. The National Infrastructure Strategy described what the Bank would do:
86.Prior to this announcement, some witnesses to our inquiry had broadly supported a state-owned national investment or infrastructure bank. However, Professor Nick Robins, Professor in Practice of Sustainable Finance, Grantham Research Institute at the London School of Economics, reflected on the Green Investment Bank, the Government’s state-owned investment bank which invested in offshore wind, waste and biomass, energy efficiency and small scale renewables from 2012 until its sale in 2017. Mr Robins said that
The Green Investment Bank was neither one thing nor the other. It was neither a classic, long term public infrastructure bank, like KFW in Germany or the European Investment Bank, and it was not a fully profit-making private sector investor […].
He noted that there would not be a role for “a niche green investment bank, but for what is called a policy bank, a national investment bank to support development of the Government’s economic policy”.
87.The National Audit Office found in 2017 that the Green Investment Bank had invested in 100 projects, committing £3.4 billion of its own capital, and “had attracted £8.6 billion of private capital, equating to around £2.50 for every £1 invested”. While the Green Investment Bank attracted investment into the green economy, particularly into off-shore wind, its impact in other sectors was less certain. The National Audit Office recommended that when setting up companies the Government should set out criteria for judging success and develop a framework for evaluating performance, and should ensure that the company’s capital structure aligns with its objectives, and that there are clear arrangements for ongoing financing.
88.Regarding the sale of the previous Green Investment Bank, Sir Amyas Morse, the former Comptroller and Auditor General said:
Ultimately the value for money of the Green Investment Bank intervention will only be seen over time. A key test will be whether the Government needs to intervene again in this way to stimulate growth in the green economy and to help it achieve its climate change commitments.
Only three years on from the sale of the GIB, the Government has decided it does again need to intervene in order to stimulate growth.
89.At Budget 2021, the Chancellor provided more detail on how the UK Infrastructure Bank would operate. He said that it:
will have £22 billion of financial capacity to deliver on its objectives, consisting of £12 billion of equity and debt capital and the ability to issue £10 billion of guarantees. It will draw capital from HM Treasury and be able to borrow from private markets. It will also grow through recycling and retention of return on investments. The government will allocate capital to the Bank in phases in line with its institutional development.
90.However, the Office for Budget Responsibility (OBR) noted in its forecast that:
As an EU member state, the UK received almost €120 billion (or £89 billion) in loans and equity from the EIB between 1973 and 2019. In the five years prior to the EU referendum in 2016, EIB lending averaged £5 billion a year, but it fell sharply in 2017 and was less than £1 billion a year in 2018 and 2019. The Government forecasts that the UKIB will lend and invest around £1½ billion a year (net of lending to local authorities that would otherwise have taken place through the Public Works Loans Board). This would be equivalent to around a third of the financing that was provided by the EIB prior to the EU referendum.
91.While the Government acknowledged that the EIB had previously provided support to UK projects, it noted that an assessment from Vivid Economics for the National Infrastructure Commission “showed that a portion of EIB activity crowded out private investment” and that respondents to the Infrastructure Finance Review echoed this point. The Government’s view therefore is that “where the EIB provided support in well-financed areas, the government anticipates that the private sector will step in without public sector support”.
92.Witnesses to our post-Budget 2021 evidence session were in agreement that the UK Infrastructure Bank’s proposed funding position was not big enough. Paul Johnson CBE, Director of the Institute for Fiscal Studies, told us that “If it is going to be effective, yes, it will need to be bigger. It is considerably smaller than the European Investment Bank, in the amount of money that that was making available. If you are serious about this in the longer run, it is going to have to be a bit bigger.” Rain Newton-Smith, Chief Economist at the Confederation of British Industry, agreed with Mr Johnson: “The initial pot of capital and equity is small. That will need to be scaled up over time. As you point out, it is much smaller than the German equivalent”.
93.Mr Johnson also noted that while there might be a case for starting relatively small, he emphasised the need to focus on how the money is spent, how the institution is set up, and to be clear about the purpose of the UK Infrastructure Bank:
We need to be quite clear about quite what the purpose of these organisations is. […] which is really about lowering the risk for the private sector investment, reducing financing costs, possibly, on the green side, helping to create new investable asset classes and, in particular, being able sensibly to invest in early-stage long-horizon projects with high upfront costs and risks, the sort of things that are particularly important in the green economy.
94.While the Government announced at the Spending Review in November 2020 that it intended that the UK Infrastructure Bank should be operational in an interim manner from spring 2021, and that it would legislate to put the Bank on a statutory footing, the Chancellor’s announcement at Budget 2021 suggested that a framework document providing further details on its operations would be published in the spring ahead of the UK Infrastructure Bank’s launch.
95.In the proposed framework for the new UK Infrastructure Bank, the Chancellor should clarify its governance arrangements, how investment decisions will be made, and how it will ensure that it attracts sufficient private capital. In particular, it should clearly set out how the Bank will meet the Government’s commitment to Net Zero. The Government should also set out how it will incorporate lessons learned from the former Green Investment Bank, and whether it intends that the UK Infrastructure Bank should be funded to offer a lending facility at a level similar to that offered by the European Investment Bank before the UK referendum on membership of the EU.
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Published: 22 April 2021