The financial sector and the UK’s net zero transition – Report Summary

This is a House of Commons Committee report, with recommendations to government. The Government has two months to respond.

Author: Environmental Audit Committee

Related inquiry: The financial sector and the UK’s net zero transition

Date Published: 28 November 2023

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Across the world, private banks are investing trillions of US dollars into fossil fuels, despite the pledges agreed upon by global governments in the Paris Agreement to limit global warming to 1.5°C, and despite the commitments made by 550 financial institutions signed up to the voluntary Glasgow Financial Alliance for Net Zero. While the current ratio of investment capital in low carbon energy compared to fossil fuels is 0.9:1, this needs to quadruple to 4:1 by the end of the next decade.

The UK Government announced its ambition to become the first net zero-aligned financial centre when it hosted COP26 in 2021. It published its latest Green Finance Strategy, which sets out in detail the Government’s ongoing and future work towards achieving that aim, in March 2023. However, we found that many financial institutions headquartered in the UK are still not clear enough about the extent to which they are still financing companies not aligned with the Paris Agreement. We are also concerned that the UK Government could be perceived to be sending mixed signals to investors about the balance of energy security and net zero.

The financial sector’s impact on energy security

New fossil fuel Initial Public Offerings are still being approved in the UK and the Government has recently announced that new oil and gas licences can be approved for fossil fuel extraction in the North Sea. At present the UK is one of the financial centres with the highest amount of fossil fuel assets that are at risk of being devalued, or ‘stranded’, before they are extracted, due to changes in energy consumption. We recommend that the North Sea Transition Authority should calculate what the impact to the UK taxpayer and to company profitability would be of requiring the cost of decommissioning to be absorbed for new oil and gas licences through the introduction of duties on operators. The scientific consensus is clear that planned production of fossil fuels is already enough to exceed safe climate limits, however there is a wider viewpoint, from government and the financial sector, that this continued reliance has a meaningful role to play in energy security and net zero pathways.

We would like to see the Government publish regular reporting on its progress towards achieving greater energy independence while staying on track to meet its 2050 net zero target, including an assessment of the effect of scope three emissions on global efforts to limit global temperature rise to 1.5°C. We repeat our recommendation from our report Accelerating the transition from fossil fuels and securing energy supplies for the Government to commit to a date by which it no longer issues new oil and gas licensing rounds. Balancing the UK’s capacity for ramping up renewables while it manages the decline in extraction from the North Sea is crucial to ensuring a secure supply of energy but cannot be used as an excuse to continue to pursue new oil and gas exploration unabated. We recommend that the notion of “energy security” should increasingly shift towards renewable energy, which can support greater energy independence while reducing reliance on fossil fuels.

Reporting requirements

Current disclosure requirements for companies to reveal their net zero transition plans are on a “comply or explain” basis: this is required by the Financial Conduct Authority for listed companies and large asset owners, and the Government is considering extending this “comply or explain” requirement across the wider economy. However, companies can circumnavigate this requirement by simply disclosing they do not have a plan. While the UK leads globally on mandatory green finance reporting, it is deferring its decision on mandatory requirements to have a transition plan—to which it first committed at COP26—and the Government risks losing ground as a global leader in this area. There is a delicate balancing act between robust legislation to ensure compliance in this area and remaining competitive in international markets by mitigating against the risk of companies no longer headquartering in the UK. However, we are concerned that leaving decisions on publishing transition plans to the market alone will not change behaviour and recommend that the Government should seriously consider requiring companies to have and to publish net zero transition plans.

We recommend that companies who publish transition plans should follow a compulsory framework so that they can be held to account with consistency. We welcome the work that the Government has progressed through the publication of the Transition Plan Taskforce’s disclosure framework for transition plans. However it is not clear whether the Government intends to make this framework compulsory in the longer term, and it appears to be light on ‘just transition’ principles—the idea that no community should be left behind in the move to net zero. Reversing nature loss is also an area that we consider the framework could expand on, to enable companies to incorporate pathways to reversing nature loss in their long-term strategic plans.

Climate-related financial disclosures are an important aspect of achieving net zero, with consistency of approach required, in our view, not just across companies and sectors but borders as well. Without a set of unified standards, the risk of greenwashing intensifies, where companies may advertise their policies as being more climate friendly than they actually are. We therefore welcome the Government’s intention to introduce a Sustainability Disclosure Requirements framework (SDR), including the commitments it has made to adopt the International Sustainability Standards Board standards, to consult on scope 3 emissions reporting, and to adopt the Taskforce on Nature-related Financial Disclosures reporting (TNFD). To maintain its global leadership on climate-related financial reporting, we recommend that Ministers set out an implementation timetable for the SDR and commit to making TNFD reporting mandatory.

Green taxonomies are a classification tool to determine the sustainability of an activity or investment and are useful for tackling greenwashing and providing clarity to organisations. The Government has given the Green Technical Advisory Group (GTAG) a remit to deliver a green taxonomy for the UK. But due to delays instigated by HM Treasury, there is not currently a firm date for completion—though Ministers told us that a two-year period of voluntary reporting against the taxonomy would likely begin in 2024. We recommend that the Government seeks to introduce a green taxonomy for the UK as soon as possible and ensure that it becomes mandatory after the period of voluntary reporting ends. It is unfortunate that GTAG’s remit expired before the testing period of voluntary disclosures could begin. We urge Ministers to heed the group’s calls for a long-term institutional home for the UK green taxonomy.

Investing for net zero

Securing and monitoring financial investment along the pathway to net zero is essential in attracting private capital. One potential method is the use of ‘blended finance’ approaches, which combine different sources of private and public investment. The UK Government referred to various methods of blended finance in its Green Finance Strategy, not least the UK Infrastructure Bank (UKIB), which we heard creates £4 of private capital for every £1 of public funding invested in regional growth and tackling climate change. We urge the Government to keep to its ambition of setting out its future plans for net zero blended finance solutions by the next spending review.

The Government is also publishing net zero roadmaps for various sectors, with further roadmaps promised as it seeks to articulate investment needs alongside government policy and funding. We welcome these roadmaps, particularly for nature, and while there is not a consensus between the financial sector and environmental groups as to whether an economy-wide net zero investment roadmap is needed, the sector specific roadmaps have been broadly well received.

In the absence of an economy-wide net zero investment roadmap, it is crucial to track the shifting of financial flows to determine whether they align with net zero pathways. The Government committed to tracking private investment into the net zero economy in its 2021 ‘Net Zero Strategy’. We welcome the commitment in the Government’s Green Finance Strategy to commission external research on investment tracking methodologies, but would like to see the Government go further by turning this research into a formal mechanism to track both net zero and nature-related financial flows, as well as investment in high-carbon projects, either by using an existing independent body, or by creating a new one.

Carbon markets are trading systems to buy and sell carbon credits to help offset and reduce emissions. There are two types of carbon markets: compliance and voluntary. Interest in voluntary carbon markets is growing since Article 6 of the Paris Agreement was approved at COP26, allowing countries to cooperate voluntarily to reach emissions reduction targets set in their Nationally Determined Contributions. Independent bodies are developing guidance internationally for buyers of carbon credits, and much of this work is driven by civil society organisations in the UK. We applaud the UK Government and civil society for leading the way in building a global voluntary market and recommend that the Government launch its promised consultation on voluntary carbon markets without delay.

Carbon pricing is important as currently the price of most goods do not include the impact of their associated carbon emissions. However, a lack of alignment across borders suggests that there are inherent risks to carbon pricing schemes. A solution would be a Carbon Border Adjustment Mechanism (CBAM), a certificate scheme that aims to level the playing field to cover differences in carbon pricing across borders. We have previously recommended that the UK Government adopt a CBAM in our report Greening imports: a UK carbon border approach, since when the European Union has now launched its own CBAM. We warn that, having been a long-standing leader in climate finance, the UK risks falling behind by failing to install mechanisms to mitigate carbon leakage. We reiterate our recommendation that the UK Government move quickly to adopt a CBAM.

The effect of UK government policy on global and local investment

The City of London has been ranked as the top green finance centre globally for four years running. We urge the Government to do more to leverage the global leadership position that it holds to align other financial centres with net zero objectives and encourage more consistent rules and systems across borders. While there is detail and ambition in the Green Finance Strategy on how the Government intends to leverage influence on the global stage, there has been criticism of the Government’s position and its ability to maintain momentum to achieve net zero by 2050. Without a strong response to its zero-carbon energy needs, the Government could diminish its role as an international leader in tackling climate change.

Local authorities have an important role to play in achieving net zero, through delivering grants for projects at the household level, collaborating with financial institutions, and sourcing private finance for scaling up of net zero aligned projects. These are not without their challenges, with two main barriers identified in our inquiry.

Firstly, there is a fragmented funding landscape with a lack of clear pathways to fund net zero projects. While grant funds are available, the model is overly competitive and inefficient. We welcome the introduction of a Crown Commercial Service website to provide a ‘one stop shop’ of information on net zero grants that are available to local authorities. This goes some way to delivering the Government’s promise in its Net Zero Strategy to explore the simplification of net zero funding for local authorities. But we call on the Government to move away from competitive grants, without reducing the total funding available, to provide core funding for all councils across their own services. We also recommend that the Government consider issuing some funds on a needs basis and for place-specific measures.

The second barrier is a lack of technical expertise, either through a need to upskill the workforce or high demands on under resourced teams. While we welcome the Government’s work to support local authorities with technical support and advice through local hubs, UKIB, and the Green Finance Institute, we suggest that an exercise to map which areas are most in need of technical support is the first step to achieve its local net zero goals.