UKSIF Chief Executive James Alexander says government action is needed urgently to support investors and fulfil net-zero 2050 ambitions.
In January, ESG Investor asked: Is Brexit Green?, in an article highlighting scope for divergence from regulatory EU initiatives such as the Green Taxonomy and the Sustainable Financial Disclosure Regulation (SFDR). In April, the UK Sustainable Investment and Finance Association (UKSIF) published a new policy vision document which went some way to answering the question. In short, the UK’s future can be as green as it wants to be, but that sustainable future urgently requires public sector leadership as well as private sector support and innovation.
According to James Alexander, UKSIF Chief Executive since October 2020, the policy vision’s recommendations were emboldened by consultation with the organisation’s 270+ members, which include campaigning non-profit organisations such as ShareAction and WWF, as well asset owners and a wide range of other financial service providers.
“Our members increasingly see themselves as supporting the reshaping of the economy and the transition to the future,” says Alexander, who was recently Director of the City Finance Programme at the C40 Cities Climate Leadership Group, where he developed a facility to provide sustainable infrastructure finance to cities globally.
One of the report’s eight themes is ‘Facilitating a net-zero future’, which it sees as requiring greater clarity of vision from the UK government, for each sector of the economy, as well as interim targets from businesses and financial services providers, not just for 2030, but 2025 too.
“Net zero is the topic on everyone’s lips, and also a big source of uncertainty,” says Alexander. “The government hasn’t defined what the economy of 2050 might look like. We have this ten point plan for a green industrial revolution, but we need some meat on the bones, and we need it really quickly. We have to understand where we should be investing and how we should be stewarding. Fundamental things like how we heat our homes, what we eat or how we get around are not clear.”
Countdown to 2050
Based on an average five-year election cycle, we can assume six UK parliaments before 2050, meaning each one needs to steer approximately a sixth of the journey to net-zero emissions. And if the aim is to get halfway by 2030, a lot more than a sixth of the journey needs to be navigated in the next two parliaments, with emissions perhaps needing to be cut by a quarter by the time of the 2024 election. “There is a huge amount to do,” says Alexander.
The UK Climate Change Committee, established in 2008 to advise UK governments on climate policy, agrees. “This defining year for the UK’s climate credentials has been marred by uncertainty and delay to a host of new climate strategies,” the committee said last week, as it published two progress reports on cutting emissions and adapting to climate change.
Among its many recommendations, the committee called for a net-zero test to be applied to every area of government policy for compatibility with its climate ambitions, echoing UKSIF’s proposal to HM Treasury for every Budget statement to include a dedicated section explaining how taxation and expenditure decisions will support progress toward a net-zero economy.
“We were pleased to see net zero put into the mandate of the Bank of England and the Financial Conduct Authority, but what about the government? How are they demonstrating that they’re putting every decision through that lens? This is the prism through which we need to start looking at everything. For our members, that net-zero target is starting to filter through their entire organisations,” says Alexander.
Another key policy theme for UKSIF is a ‘Just Transition for the UK’s Workforce’, highlighted in the policy vision via several short- and long-term funding proposals, as well as a call for integration of carbon pricing into the UK tax system, penalising carbon-intensive projects.
A just transition has the potential to be the “glue” between the government’s ‘levelling up’ agenda and its net-zero ambitions, says Alexander, referencing the jobs that can be created through retrofitting and installing across homes, businesses and infrastructures, as part of the move toward renewable energy sources.
“There are big things government can do in terms of ‘just transition’ and winning itself the mandate to act on the basis that the number one thing that people care about – their jobs and livelihoods – will not be negatively affected, because of the enormous opportunities,” says Alexander.
But this requires greater regulatory certainty, indicating how regulation of industries will evolve over time. “It’s important to convince people that the direction of travel is irreversible, in the same way Prime Minister Boris Johnson talks about an irreversible unlocking of lockdown,” he observes.
The stewardship challenge
Investors are already playing their part in effecting a just transition through their scrutiny of the decarbonisation strategies of investee companies.
Alexander sees investors’ stewardship and engagement activities as critical to the transition to a sustainable, net-zero economy, but says there is a gap in how firms are being supported in adapting to low-carbon business models, below the heavy emitters most frequently being engaged by asset managers and owners.
“If you can change the way the biggest emitters work, you can change a lot. But there are a lot of firms that don’t fall into that category,” he says, noting that investor coalition Climate Action 100+ engages with just eight UK-listed firms. Effective engagement is required across the FTSE 350 and beyond, he argues, as part of a national collaborative effort to achieve transition, encompassing investors, industry and government.
“That’s important not just for the long-term health and continued value-add of investments, but also from the UK’s macroeconomic perspective,” asserts Alexander. “If we can’t get our companies to transition to provide the goods and services necessary for the economy of 2050, those needs will be filled by firms from elsewhere. It becomes an existential question about the future of our economy and where the jobs and wealth are being created in 2050.”
Notwithstanding the challenges for investors in interpreting transition plans and factoring them into their investment decisions, Alexander is less worried about whether asset owners and managers can exercise effective engagement and stewardship across diverse portfolios, than the ability of many listed firms to make transition part of their business strategy.
Firms that don’t necessarily have ESG or net-zero transition teams need different inputs from investors, he says, compared with a multinational that already has many of the resources and answers to deal with complex challenges. “When you are a smaller company, you may need your investors to help to you figure out these answers and solutions. The real challenge could be in how we get these small- and medium-sized companies to make this transition,” he says.
At least part of the answer is further collective action from investors, suggests Alexander, not least because such firms will typically account only for a small part of most portfolios. “It could mean stewarding specific impacts, for example identifying the group of 20 UK-listed companies with challenges around water supply, or emissions, or supply chain,” he says. “Grouping together and working collectively with investors and companies can bring sectors together in a more targeted way.”
Divergence from Europe
Beyond the rapid roll-out of climate reporting in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), the UK regulatory landscape for the sustainable investment sector remains unclear for now.
Alexander sits on the UK government’s new Green Technical Advisory Group (GTAG), charged with helping to define the environmentally sustainable economic activities which can be invested in by UK-registered green funds. Members will provide advice on the “market, regulatory and scientific considerations” that should shape the technical screening criteria of a UK taxonomy, thus protecting investors against greenwashing. Drawn from business, finance and academia, the group will meet quarterly for at least two years, and will make its first recommendations in September.
GTAG, which recently held its first meeting, will advise on “any deviations from existing international frameworks or taxonomies”, including the EU’s Green Taxonomy, which will be used from next year by asset managers to provide more detail on the ESG claims of their EU-registered funds.
Earlier this month, the importance of consistency was emphasised with the release of a set of principles recommended for consideration when developing regional and sector-specific climate finance taxonomies, by the Global Financial Markets Association and Boston Consulting Group.
Within GTAG’s terms of reference, Alexander says three parameters are particularly important for the UK taxonomy. The first is the primacy of science in determining the permitted investible activities on the path to net zero. This has proved challenging in Europe, where lobbing by vested interests, notably in the power generation sector, have led to accusations of deviation from the guidelines set by the EU Technical Expert Group on Sustainable Finance.
“You can take the politics out by reminding people what this is and what it isn’t. Something not being in the taxonomy does not equate to attempting to shut down that industry overnight,” says Alexander.
“Also, the taxonomy ought only be used for the purpose for which it is designed,” he says, noting that the EU Taxonomy has been proposed as a guide for channelling public funds in post-pandemic Europe. “It is not a short-term tool for distributing government funding in the Covid-19 recovery period, but that’s how it’s beginning to be considered.”
Third, a UK green taxonomy needs to be as decision-useful as possible. This means ensuring it captures a wide a range of activities, potentially including transition activities for a limited period, with sunset clauses allowing the phasing out of investment in certain sectors, as technology and innovation offer better long-term solutions.
More shades of green?
According to Alexander, another area in which there is potential scope for the UK to learn from the European experience is the distinction between different categories of green funds. A wide spectrum of funds with sustainability characteristics can be categorised within SFDR’s Article 8, ranging from one that simply screens out coal, to one with much more sophisticated levels of analysis and / or engagement. Increasingly, pension funds are considering Article 8 status as an entry-level expectation, but the breadth of the category can lead to an uneven playing field.
“It stands to reason that those firms that are not putting in so much effort can lower fees and so potentially are in a stronger position than the leaders, which should be the ones benefiting from this whole process,” says Alexander.
UKSIF has been exploring options for creating sub-categories or delineations for UK-registered funds, whilst maintaining broad alignment with the distinctions already established by SFDR. The objective is to “allow those leaders to really demonstrate their leadership position” without needing to make the leap to Article 9 status, where ESG outcomes are the core purpose of the fund.
On the one hand, any new sub-categories should be clearly defined and easily understood, says Alexander, on the other, they should not be ranked in a hierarchy, rather as different but equally legitimate approaches to offering sustainable investment opportunities to investors with differing priorities.
“I don’t think the challenges are impossible to overcome, but they do require a lot of thought and industry engagement,” he says.
Different routes; same destination
More broadly, Alexander suggests the UK’s departure from the EU offers scope for a principles-based regulatory framework for sustainable investment, allowing for more flexibility compared with the EU approach, which he characterises as providing a somewhat rigid set of rails, permitting little room for divergence or interpretation.
“How you get there is what industry, not regulators, should be figuring out, because that’s where you get innovation, best practices and new ideas,” he says, suggesting a principles-based approach may also have greater potential to accelerate over time.
But Alexander does not underestimate the importance of international collaboration and coordination, in the run-up to COP26 and beyond. The UK’s expertise in the finance sector should, he says, help to guarantee significant progress on ‘mobilising finance’ one of the four key themes in Glasgow. Alexander draws parallels with the galvanising impact of preparations for an Olympic Games. “It sets a pretty firm deadline for demonstrating progress. It concentrates peoples’ minds,” he says, pointing to the slew of net-zero commitments already seen in the first half of 2021.
A continuation and deepening of these commitments and further collaborative progress on standards coordination are important elements of a successful COP26, says Alexander. “More coordination will be really important. A bad scenario would be where every country has its own definition of green, taxonomy and disclosure regulations.”