1. Is the Government’s level of ambition on green finance – and the mechanisms it sets out in the Clean Growth Strategy – sufficient to generate the investment needed for the UK to meet its environmental commitments?

We welcome the scope and ambition set out in the Government’s recently published Clean Growth Strategy. It is consistent with the UK’s international leadership and reflects an understanding that the low-carbon economy is becoming an increasingly important driver of growth, jobs and prosperity.

With regards to ways in which the Government’s strategy could be strengthened we would highlight two points:

1. The important role that financial policy and regulation can and should play
2. The way that the UK could quicken the pace of the transition away from fossil fuel dependence to a low-carbon energy system

The role of financial policy and regulation

• While the ambition of the Government’s Clean Growth Strategy is, overall, unquestionable, active and integrated involvement of financial policy and regulation will be essential if that ambition is to be successfully executed.
• A potential obstacle to achieving a joined-up and coherent policy approach towards green finance is the role played by HM Treasury, a department that has been traditionally institutionally mandated and structured so that it is unable to take into sufficient account the challenges of climate change and carbon risk, which by their nature have a global impact and extend into the long-term. We appreciate that climate change and green finance have moved up the Treasury’s agenda, but more needs to be done if climate and low-carbon objectives are to be mainstreamed into the work of the Department.
• HM Treasury has a responsibility to ensure that the UK’s financial regulators are sufficiently factoring climate change and its implications into their thinking. The Governor of the Bank of England has made his views very clear that climate change poses a risk to the health and integrity of the financial system. However, we remain unconvinced that the UK has the appropriate financial institutional structures to address effectively the climate agenda.
• For example, in consultation with the Committee on Climate Change on the objectives set out in the Climate Change Act, BEIS is responsible for delivering a low-carbon energy system, which may itself present financial risks if transition and delivery are not managed in an orderly fashion. We have seen this play out in other regions – namely, Europe[1] and North America[2] – as a lack of companies’ preparedness for market and policy trends towards decarbonisation led to significant loss of investor value.
• Given the systemic challenges – in the form of risk and opportunity – that are posed by the low-carbon transition, we believe that a cross-Whitehall approach that aligns financial, economic and energy policy (and the work of the relevant government departments) is essential to deliver an orderly transition and ensure that climate risks are not heightened. If capacity to evaluate the financial risks of an energy transition to listed firms does not lie within financial regulators, efforts should be made to ensure that such expertise is drawn upon across government and from civil society.

Transitioning to a low-carbon economy at a faster pace

• Transitioning the UK’s economy to one that is low-carbon will require the systematic curtailment of our use of oil, gas and coal. The Clean Growth Strategy goes some way to explaining how this will be achieved.
• The question we should now ask is how could the UK quicken the pace at which we transition?
• Through its development of coal-fired power stations, the UK led the world into the industrial age. The Government’s decision to phase-out coal-fired power generation by 2025 was, therefore, our “distinctive contribution”[3] to global decarbonisation and has set in motion the Powering Past Coal Alliance.[4] We should strive to be more ambitious and extend this position of leadership.
• According to Carbon Tracker’s recent paper, Lignite of the Living Dead, macro-economic trends towards cheaper alternative/renewable technologies is rendering coal-power increasingly uneconomic. As such, we are encouraged by the proactive approach of the UK on coal power. According to the research, an accelerated phase-out of coal plants could mean that the losses to utilities of €1.7 billion are avoided.[5]
• We also welcome the UK’s leadership of the Powering Past Coal Alliance and would emphasise the opportunity that this presents for increasing broader European and global ambition to phase out the use of coal-fired power.
• Carbon Tracker’s earlier paper, Expect the Unexpected, also places emphasis on the importance of using up-to-date assumptions in the energy systems models that are used to inform policymaking.[6] Greater ambition in our efforts to decarbonise can be stymied by our failure to realise that alternative/renewable technologies are developing more quickly than previously assumed. We would encourage Government to challenge, for example, its measurements of and assumptions on the costs of energy that underpin its long-term energy policy.

2. Given the work being carried out by the EU’s High Level Expert Group on Sustainable Finance, where should the UK’s newly created Green Finance Taskforce concentrate its efforts?

The work of the EU’s High-Level Expert Group on Sustainable Finance (HLEG) is an important initiative and we applaud the participation of so many UK-based organisations within this group. As a basic matter, the Government should harness the expertise and influence of these and other UK-based organisations as it executes and develops its domestic Clean Growth Strategy.

With regards this question, we highlight two points:

1. The unique contribution that the UK can make to the HLEG’s two imperatives for Europe’s financial systems
2. The importance of enhanced disclosure

The UK’s contribution to two primary imperatives: financial stability and financial sector expertise

• In its Interim Report, the HLEG set out two imperatives for Europe’s financial system. The first is to “strengthen financial stability and asset pricing”. The second is to “improve the contribution of the financial sector to sustainable and inclusive growth”.[7] We believe that the UK is perfectly positioned to lead efforts that ensure these imperatives are met.
• Since September 2015, the Bank of England has led global efforts to better understand the risks that climate change poses to financial stability. This leadership has spawned the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) and stimulated public interventions from central banks and macro-prudential authorities across the world.
• The UK Government should ensure that this leadership continues, particularly after Governor Carney steps down from his current position in September 2018. This will help to protect the UK’s own financial system and the global markets in which UK-based companies and investors operate.
• The City of London has long been a hub for expertise in financial services and, more specifically, green finance-related issues. The Interim Report makes clear that “the EU is in an ideal position to take the international lead” in establishing sustainable financial centres. Leading up to, and following, the UK’s withdrawal from the European Union, the UK Government should make sure to protect the financial services and green finance expertise that London offers.

Enhanced disclosure of climate-related risks and opportunities

• As reflected in the Terms of Reference for the UK’s Green Finance Taskforce, proper adoption, implementation, and extension of the TCFD’s recommendations can ensure that capital markets are provided the information that they need to manage an orderly low-carbon transition.
• This is an important piece of the HLEG’s work, but it will be only one part among many. The UK’s Green Finance Taskforce should strive to maintain the issue of enhanced disclosure as central to its work, especially as the Companies Act (2006) remains a model for capital markets disclosure.
• We welcome the UK’s endorsement of the TCFD recommendations, but the recommendations also provide an opportunity for the UK the lead international efforts to harmonise climate-related disclosure regimes, such as those we are seeing emerge from France, Sweden and China. We would highlight two ways in which the UK might seize this opportunity.
• First, we believe that the roles of the Financial Conduct Authority and Financial Reporting Council should be clarified so as to make clear whose responsibility it is to turn into practice the Government’s endorsement of the TCFD recommendations. Our impression is of a fragmented regulatory structure where mandates and decision-making responsibilities are unclear. Both HM Treasury and the Bank of England, through their positions of oversight, can help to resolve this lack of clarity.
• Second, clarification of the Financial Conduct Authority’s responsibilities on this subject should enable it to become actively involved in on-going efforts within the International Organisation of Securities Commissions (IOSCO) to take forward the TCFD recommendations. The inter-jurisdictional consistency of emerging climate-related disclosure practices depends on leadership within IOSCO, a position that the UK should take given its track record on climate issues and expertise on financial risk.

3. How effective are the Task Force on Climate-related Financial Disclosures’ (TCFD) recommendations likely to be at moving investment into ‘clean’ sectors?

• The TCFD recommendations provide a simple framework with novel tools to highlight the extent to which organisations’ forward-looking strategies are misaligned to global climate change targets. If the recommendations are adequately implemented, adopted and built upon, this information should assist in stimulating and diverting capital into low-carbon activities. It should be noted that the issue is not only that of mobilising capital for “clean” growth, but also of curtailing capital to existing and new high-carbon activities.
• We believe that the most important component of the TCFD’s recommendations are those on scenario analysis as a tool to understand climate-related risks and seize opportunities. We will focus our comments on this.

Scenario analysis can be a tool to understand and manage future risks, but a reference scenario is required

• Carbon Tracker’s work has highlighted the trillions of investors’ dollars at risk if fossil fuel companies continue to plan for business-as-usual while the rest of the world heads in the opposite direction.[8]
• Resolutions from both UK- and US-based shareholders over the last three years have made clear that investors want to know the extent to which the business plans of individual companies diverge from international climate change obligations.
• This desire is well-grounded. Despite the presence of group-think among companies that is explicitly sceptical of both governments’ ability to achieve the goals of the Paris Agreement and the significance of alternative technological development, many companies profess to conduct scenario analysis and a subset of these suggest it has and continues to impact planning. This is effectively an acknowledgment that such analysis is material to corporate investment decisions.
• Forward-looking scenario analysis can provide insight into the quantum of climate-related financial risk at macro- and firm-levels, thereby rebalancing the risk equation between fossil and low-carbon fuels.
• However, as the TCFD recommendations note, for this disclosure to be made decision-useful the outputs need to be consistent and comparable. Comparability is necessary because investors need to understand the relative risks facing companies. Only then can they model how these risks can and should be priced.
• This can be delivered but it requires use of a reference scenario.[9] A reference scenario, in turn, likely requires a regulatory structure that sets such a scenario.
• Further disclosure (for example, through existing forward-looking disclosure requirements found in the Strategic Report), could then supplement the reference scenario with management’s views on alternative scenarios and management’s view of the reference case.
• A reference scenario not only aids the markets, it reduces costs to issuers by providing the building blocks for disclosure. The use of a reference scenario, built upon climate targets, would be the first of its kind for capital markets disclosure, setting the UK out as a leader in the field, whilst minimizing the costs of listing on the UK’s exchanges.
• As the UK works to implement the TCFD recommendations domestically, we encourage the Government to explore the utility of using a reference scenario within the most relevant sectors, at a minimum.

4. The Government has said it will ‘encourage’ publicly-listed companies to adopt the TFCD’s recommendations on climate risk disclosure. How could it do this? Is a voluntary approach sufficient?

• At the recent One Planet Summit in Paris, Governor Mark Carney and Bloomberg CEO Mike Bloomberg reaffirmed the growing support among corporate firms and financial institutions for the TCFD recommendations.[10] The UK Government’s endorsement of the recommendations is a positive first step, but it now needs to move from high-level government support to specific support and active involvement from financial regulators, such as the FCA.
• Within this context, we believe it important to understand both why decision-useful disclosure does not currently appear in registered reports and further why such disclosure is needed.
• We, and others, have pointed out that for some companies, compliance with the Strategic Report component of the Companies Act 2006, which requires disclosure of principal risks and uncertainties, should result in the identification of climate change or the energy transition as a material risk.[11] Indeed, many companies have made precisely this general disclosure, which suggests broad agreement as to its materiality.[12]
• The problem is that the risk registry requires risk identification but not risk assessment, as the regulations are not designed to elicit that information. For well-known macro trends like the energy transition, risk identification alone is of little utility.
• Companies could discuss implications of the energy transition through the Strategic Report’s requirement to discuss “the main trends and factors likely to affect the future development, performance and position of the company’s business”.[13] In practice, however, companies have been afforded wide latitude to make these determinations and chosen not to disclose.
• It is a sound first principle for management to determine what it believes to be material. But for such future trends where there is wide global agreement on the direction of travel, the response from the markets is that investors need a better understanding of the implications.
• The risk here is not of too much information being in the market, but of investors having to make decisions about these risks with blunter instruments. We are already seeing pension funds facing increasing pressure to demonstrate tangible progress on addressing these risks within their portfolios. Further, the response outside the UK, from Norway to New York, has been to consider whole cloth divestment from the energy sector. Better disclosure that allows differentiation between companies is essential to ensure that these risks are priced against the most exposed companies and not the sector as a whole.
• Can this happen with voluntary disclosure alone? We believe that to be unlikely. Too much latitude in how these disclosures are structured will encourage companies to select those metrics and assumptions that will set the business in the most favourable light and therefore fail to produce outputs that are comparable across sector competitors. Lack of utility will reduce investor interest in the disclosures and encourage the “laggards” to disclose nothing at all. Furthermore, voluntary regimes will not be assured, and potentially not assurable, further weakening the credibility of the disclosures made.
• Thus, while we recognize the value in initially affording organisations some flexibility to become familiar with subjects and tools that may be novel, we believe strongly that to deliver consistent, comparable and decision-useful disclosure, the UK should consider steps to making at least elements of the TCFD recommendations mandatory. We would be happy to elaborate upon these elements in greater detail.

[1] For analysis of recent value destruction across European utilities, see https://carbontransfer.wpengine.com/reports/eu_utilities/.

[2] For analysis of the rapid decline of the US coal-power sector, see https://carbontransfer.wpengine.com/reports/the-us-coal-crash/.

[3] https://www.gov.uk/government/speeches/amber-rudds-speech-on-a-new-direction-for-uk-energy-policy

[4] https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/660041/powering-past-coal-alliance.pdf

[5] https://carbontransfer.wpengine.com/reports/lignite-living-dead/

[6] https://carbontransfer.wpengine.com/reports/expect-the-unexpected-the-disruptive-power-of-low-carbon-technology/

[7] https://ec.europa.eu/info/sites/info/files/170713-sustainable-finance-report_en.pdf

[8] See https://carbontransfer.wpengine.com/reports/2-degrees-of-separation-transition-risk-for-oil-and-gas-in-a-low-carbon-world-2/ for analysis of the oil and gas sector.

[9] For further detail on how a reference scenario can be simply used, see https://carbontransfer.wpengine.com/time-machine-climate-risk-bringing-future-forward-2%CB%9Ac-scenario-analysis/ and https://carbontransfer.wpengine.com/wp-content/uploads/2017/02/TCFD-Phase-II-CTI-Response-FINAL.pdf.

[10] https://www.fsb-tcfd.org/wp-content/uploads/2017/12/TCFD-Press-Release-One-Planet-Summit-12-Dec-2017_FINAL.pdf

[11] https://carbontransfer.wpengine.com/wp-content/uploads/2017/08/Joint-Letter-to-FRC-Final-2.pdf

[12] https://carbontransfer.wpengine.com/reports/no-rhyme-or-reason-eia-energy-outlook-coal-companies-risk-disclosure/

[13] S414C(7)(a) CA 2006.