The United Kingdom: Global Hub, Local Dynamics - Mapping the transition to a sustainable financial system

United Nations Environment Programme (UNEP) (2016)

The UK’s transition towards a sustainable financial system is shaped by a dynamic between domestic green economy priorities and its role as a global financial centre. With financial assets worth eight times annual GDP, the UK financial system is disproportionately large when compared to the underlying domestic economy. The City of London is not only home to some of the world’s largest financial markets, but also to a range of sustainable finance initiatives that are setting the agenda both domestically and internationally. Historically, it was the key location in the initial rise of carbon markets and a leader in the integration of environmental, social and governance factors into institutional investment. It is now a pioneer in confronting climate risk. The UK has also become a global centre for Islamic Finance, a striking example of how the public and private sectors have cooperated to develop a strategic competence in a growing area of values-based finance. The crisis that followed the 2008 credit crunch had enormous costs for the UK economy, and profoundly impacted the structure and governance of UK financial markets. The continued prevalence of market abuse and high-profile scandals in the aftermath of the crisis has inspired a renewed vigour by regulators and legislators, with recent efforts to restore trust and public confidence focusing on market integrity and professional conduct. Importantly, the focus on stability risk has also changed the ways in which sustainability is being considered by firms and regulators – notably by shifting attention from the institutional to the systemic level. Over the past 15 years, four “waves” of sustainable finance innovation have taken place in the UK, starting with ethical investment, moving to mainstreaming environmental factors into institutional investment, the surge of post-crisis reform and the current focus on climate and carbon risk. Across these, a UK model of innovation emerges – one starting with social entrepreneurs and civil society organizations raising expectations for financial institutions, practitioners competing to capitalize on new market expectations and finally regulation being introduced to universalize good practice. Currently, there are six priority areas for sustainable finance in the UK: 1. Social innovation: aligning finance with individual values and social purpose – for example, from leading work on ‘unburnable’ carbon and stranded assets to new thinking about the overall purpose of the financial system. 2. Institutional stewardship: placing sustainability factors at the heart of mainstream financial sectors, most notably investment management – for example, the Law Commission’s review of fiduciary duty. 3. Capital market mobilization: incorporating sustainability into equity and debt market disclosure, analysis and capital raising – for example, mandatory reporting of greenhouse gases on the London Stock Exchange. Green bonds are also critical growth area: the UK was the third largest green bond market in 2015. 4. Housing finance: improving the environmental and energy performance of the UK’s housing stock through new ways to mobilize financing – for example, finding a practical successor to the Green Deal mechanism. 5. Prudential governance: embedding sustainability into the safety and soundness of key sectors and the system as a whole – for example, the Bank of England’s review of insurance and climate change. 6. Public balance sheet: mobilizing fiscal and other resources to facilitate the transition to a low-carbon, green economy – for example, the launch of the world’s first Green Investment Bank. The UK’s leadership in many areas is clear. But sustainability could perhaps be classified as a ‘sleeping giant’ of the financial system. Initial innovation is sometimes developed in the UK, but then deepened by fast followers in other markets. Many of the promising initiatives are also relatively new and will need careful nurturing to flourish. Heading into 2016, the global momentum is likely to intensify, not least through China’s decision to make green finance a core theme of its G20 Presidency, launching a new study group co-chaired by China and the UK, for which UNEP will act as secretariat. Domestically, the dialogues that contributed to this country report revealed significant enthusiasm for the development of a clear roadmap for sustainable finance in the UK. This would seek to build on existing innovations, overcome key bottlenecks and identify shared priorities for future action. A number of countries are introducing national roadmaps – notably China and Indonesia – and based on the findings of this report, a UK Sustainable Finance Strategy could take forward the following priorities: - Deepen sustainability disclosure and analytics: Disclosure on UK capital markets is improving, but could be deepened on climate, food and water. - Confirm the sustainability dimensions of stewardship, fiduciary duty and investment structure: Improving sustainability performance in the investment chain is not just a question of rules, but also developing pension funds with the scale and capacity to deliver. - Establish a Green Bond Hub: A UK Green Bond Market Development Committee would help to consolidate existing market innovation and provide a platform for future growth. - Empower individual investors with the right information: Innovative use of communications technology could bring information on the sustainability of investment funds to the consumer, strengthening financial literacy. - Build on the track record of the Green Investment Bank: The Green Investment Bank has considerable potential to facilitate capital deployment as it moves into its next phase, addressing market failures that remain pressing issues. - Enhance financing for the greening of the UK’s homes: Breakthrough ideas are needed to develop ways of financing home retrofits that are attractive and compelling for the consumer. - Take a system-wide view on environmental risk: The Bank of England’s prudential review of insurance is world-leading, and the lessons could be applied to other sectors and parts of the system, such as banking and pension funds. - Explore the green potential of alternative finance: The UK is Europe’s leader in alternative finance – such as peer-to-peer – and this could be leveraged for the green economy. - Embed sustainability into financial culture: Following the crisis, considerable attention has been placed on improving financial culture. The sustainability dimension could now be incorporated as an additional motivational driver for improved conduct over the long-term.