The financial sector and the UK’s net zero transition

We have heard that vast numbers of fossil fuel assets are at risk of devaluing before they are extracted due to changes in energy consumption and therefore becoming ‘stranded assets’. This is a particular risk in the City of London, as one of the top four financial centres where this concern is concentrated. This risk has also intensified due to Russia’s full-scale invasion of Ukraine leading to divestment from Russian- linked fossil fuel assets. While there have been some calls for the burden of this risk to sit with the companies which are driving the phase out of fossil fuel investment through individual policies, we have not identified a consensus on this matter.

We recommend that to mitigate against the risk of stranded assets from North Sea extraction, the North Sea Transition Authority should calculate what the impact to the UK taxpayer and 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.

We have heard during our inquiry that despite the pledges set out and agreed upon by global governments in the Paris Agreement, private banks have financed trillions of US dollars into fossil fuels. New UK fossil fuel Initial Public Offerings are still being approved, and the UK Government is pressing ahead with new fossil fuel investment opportunities. We have been told that, 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. While there are examples of financial institutions moving away quickly from fossil fuel investments, the engagement policies enacted by many organisations could be clearer about the extent to which they are still financing companies not aligned with the Paris Agreement.

We absolutely agree with the Minister for Energy Efficiency and Green Finance that energy security and net zero are two sides of the same coin. However, we are concerned that many believe that the Government is sending mixed signals to the market which in turn affects investment decisions in the energy transition. While business decisions are ultimately for those businesses to make, the Government should not underestimate its own influence.

We have previously concluded in our report ‘Accelerating the transition from fossil fuels and securing energy supplies’ that there is not a consensus on the speed of transition from fossil fuels as the Government endeavours to reach net zero by 2050. While the scientific consensus is clear that planned production of fossil fuels is already enough to exceed safe climate limits, with the IPCC’s recent Synthesis Report warning that “projected CO2 emissions from existing fossil fuel infrastructure without additional abatement would exceed the remaining carbon budget for 1.5°C”, there is a view from some financial institutions, recently endorsed by the UK Government, that new licences have a role to play in reducing reliance on imported fossil fuels. Energy security is sometimes used as justification to pursue new oil and gas exploration, but we have found that this approach may not The financial sector and the UK’s net ero transition 59 reflect climate goals effectively, as there is a risk that it may lead to either missing climate targets or ending up with stranded assets. Therefore when planning for net zero energy security and a just transition for the workforce, it is crucial that the Government considers the balance between the North Sea as a declining asset, and the UK’s capacity for renewable energy as the UK moves towards a net zero future.

We recommend that the Government publish quarterly reports to show how the UK is moving towards greater energy independence while staying on track to meet its 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. The notion of “energy security” should increasingly shift towards renewable energy, which can support greater energy independence and reduce reliance on fossil fuels.

We reiterate the recommendation of our earlier report that the Government set a clear date for ending new oil and gas licensing rounds in the North Sea: this date should fall well before 2050.

We welcome the Government’s intention to consult on requiring companies to disclose transition plans. However, the current “comply or explain” basis should be for an interim period only: a company can disclose by simply not having a transition plan, defeating the point of the policy.

We agree with the Government that the operating environment will become increasingly difficult for those firms that do not set out their plans for contributing to net zero. However, we do not think it is enough to leave the issue of transition planning to the market. The UK led the way globally with its introduction of mandatory reporting in relation to the Taskforce on Climate-related Financial Disclosures (TCFD), and now risks losing its leadership position in the green finance space by deferring its commitment to mandatory transition planning made at COP26. At the same time, we understand the risk of capital flight and the need to remain internationally competitive.

The Government’s consultation on requiring companies to disclose transition plans should include consideration of making it compulsory to have and to disclose a transition plan—not just if a company happens to have one—and the most suitable timetable for doing so. Beyond this consultation, mandatory reporting of transition plans should remain the Government’s ultimate aim.

We welcome the publication of the Transition Plan Taskforce’s disclosure framework for transition plans, and the steps taken to achieve international alignment of that framework. We believe that those who publish transition plans should follow a compulsory framework, to ensure comparability and to mitigate the risk of greenwashing. While investors have an important role to play in determining the credibility of transition plans, it is vital for measuring our progress towards net zero that ‘credibility’ is not subjective. We recommend that the Government should 60 The financial sector and the UK’s net ero transition introduce regulations, to be phased in and monitored over time, to ensure that companies developing and disclosing transition plans do so in accordance with the Transition Plan Taskforce’s guidance.

A plan is only effective if it delivers its contents. The Government should set out simple, consistent regulatory expectations for net zero transition plans and establish an independent mechanism for monitoring and evaluating and verifying organisations’ net zero transition plans, to ensure that they are aligned with Paris Agreement compliant pathways.

We welcome the Government’s commitment to just transition principles in its Green Finance Strategy and the inclusion of specific workstreams in the creation of the transition plan disclosure framework and implementation guidance. While the Transition Plan Taskforce acknowledges the inclusion of just transition principles within its working group and includes a definition within its guidance, we are concerned that it does not appear to include those principles explicitly within the transition framework itself, which may leave organisations with no further knowledge of how their transition plans should consider wider stakeholders.

We recommend that the Government publish further guidance to stakeholders to advise explicitly how just transition principles should be considered within the transition plan framework, to ensure that companies are able to provide better outcomes for all people, including workers and their communities.

We welcome the references to nature in the Transition Plan Taskforce’s framework; however, we consider that the framework could go further on nature. We recommend that the Government should take steps to incorporate into the framework the contribution by a company towards halting and reversing nature loss within the overall strategic ambition of its transition plan.

We welcome the Government’s intentions for Sustainability Disclosure Requirements (SDR). As part of that framework, we welcome the Government’s intention to incorporate International Sustainability Standards Board (ISSB) standards and make them mandatory, its consultation on reporting scope 3 greenhouse gas emissions, and its intention to adopt the Taskforce on Nature-related Financial Disclosures (TNFD) reporting. Having internationally-aligned standards such as the ISSB standards is vital for reducing the risks of greenwashing and carbon financing leakage.

To maintain the UK’s global leadership in green finance reporting, the Government must keep up the momentum. We recommend that Ministers set out an overarching implementation timetable for the SDR, including for TNFD reporting, and commit to making TNFD reporting mandatory, continuing the trail the UK blazed for TCFD. The Government should consult on TNFD definitions, and should phase in compulsory TNFD disclosures over the next three to five years, starting with the largest companies.

While we welcome the Government’s intention to introduce a UK green taxonomy, we are concerned to note the delays to its introduction. As with transition plan frameworks and disclosures, we support the principle of a mandatory taxonomy to ensure comparability.

We recommend that the Government seek to introduce the UK green taxonomy as soon as possible. That taxonomy should include a spectrum of definitions—‘fifty shades of green’, as one of our witnesses put it. During the period of voluntary reporting against the green taxonomy, the Government should monitor and report quarterly on progress, to optimise its implementation and ensure that it becomes mandatory no less than two years after the beginning of the voluntary period.

It is unfortunate that, due to the delays to the introduction of the green taxonomy, the remit of the Green Technical Advisory Group 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.

We welcome the Government’s progress in developing blended finance models for net zero projects, in particular the work of the UK Infrastructure Bank (UKIB) which, according to the evidence given to us by the Minister, has created around £4 of private capital for every £1 of public funding invested. Such models are valuable for de-risking and stimulating investments in emerging technologies that may help the UK achieve its net zero target. We therefore welcome the Government’s continued work with the Green Finance Institute in this area and its timely goal of drawing conclusions in advance of the next spending review.

The Government must keep to its ambition of setting out its future plans for net zero blended finance solutions by the next spending review, and should include nature recovery projects within this suite of solutions. The Government should set out in one document all its different blended finance models, cross-checking them against its various sector roadmaps both to ensure that solutions are targeted towards the investment gaps that need to be filled, and also to ensure that institutions such as UKIB are supporting the right projects with appropriate levels of investment.

We welcome the many net zero sector roadmaps that the Government has published and plans to publish, which should provide investors with the detail they require to help their investments align with the Government’s net zero target. We particularly welcome the fact that nature is included among these investment roadmaps, and urge the Government to publish the next round of roadmaps, promised this autumn, without delay. While we received limited calls for an economy-wide net zero investment roadmap, we did not receive enough evidence to arrive at a conclusion on whether this is needed. This makes tracking green financial flows across the economy all the more important.

Understanding levels of investment across the economy is vital for knowing whether the UK is on track to meet its climate and nature targets. That is why we welcome the work underway by the Government to explore methodologies for tracking both net zero-related financial flows and nature-related financial flows.

We recommend that the Government go further and turn this research into a formal tracking mechanism by a date no later than the end of the current Parliament. The Government should task either an existing independent body, or create a new 62 The financial sector and the UK’s net ero transition independent body, to track net zero and nature-related financial flows, as well as investment in high-carbon projects. Within a year of setting up this tracking mechanism, the Government should review financial flows against its investment roadmaps to determine whether those roadmaps provide sufficient coverage of the whole economy. It should also use this information to inform whether further incentives or regulation are required to shift financial flows towards the Government’s net zero and nature targets.

We applaud the UK Government and civil society for leading the way in building a global voluntary carbon market. We appreciate the difficulty of achieving a global price for carbon, but it is ultimately needed to prevent a race to the bottom where industries flock to headquarter in jurisdictions with the lowest penalties for polluting the planet and derailing the Paris Agreement to limit global warming to 1.5°C. A global price for carbon would also help to remove the perverse incentives in individual nations’ carbon pricing schemes such as the UK emissions trading scheme, where high-emitting industries may be inadvertently subsidised to prevent capital flight. We recommend that the Government launch its promised consultation on voluntary carbon markets without delay.

Having been a long-standing leader in climate finance, the UK now risks falling behind by failing to install mechanisms to mitigate carbon leakage. The EU has already launched its carbon border adjustment mechanism (CBAM). It is now over a year and a half since we called on the Government to begin work immediately to develop a UK CBAM. We welcome the Government’s consultation on addressing carbon leakage risk, but are concerned to note the Minister’s view that it is better to encourage other countries to develop their own carbon pricing than to introduce our own CBAM. As we have argued before, the UK should be doing both. The Government must get on with it and plug the leaks that the UK’s emissions trading scheme risks causing, by developing a carbon border adjustment mechanism.

The UK Government should be proud of its world-leading track record in supporting green finance initiatives. At the same time, it must neither be complacent nor lose momentum. The UK must continue to use its leadership position to bring other countries on board and create policy alignment across jurisdictions. For its influence to continue, the UK cannot be perceived to be watering down its own net zero policies.

Local authorities have a significant role to play in green finance, from delivering grants at the household level, to collaborating with financial institutions on local net zero projects, and crowding in private capital for large scale projects. However, they are hindered by a fragmented funding landscape and limits on technical capacity.

We welcome the 50% increase permitted for individual grants under the Boiler Upgrade Scheme, and we would wish to see the overall envelope of funding increased subject to sufficient uptake.

We welcome the work that the Government has done so far to provide a “one stop shop” of information on net zero grants to which local authorities can submit competitive bids. The Government appears to have streamlined the number of competitions for English local authorities somewhat, apparently taking the total from 22 to 18. However, this does not solve the problem of local authorities having to spend time and resource putting together applications that may fail, preventing them from having the visibility they need to plan for the long-term and develop investable projects. Furthermore, place-specific net zero measures have been shown to be more effective than place-agnostic measures. We recommend that the Government move away from competitive grants for net zero projects, and consider allocating some funds on a needs basis, and provide core funding for all councils to take forward climate action across their own services. We also recommend that the Government consider issuing funds for place-specific measures that are less constrained by the nationally set criteria of central-government issued grants.

We welcome the ongoing work to provide technical support and advice to local authorities, including through the Local Net Zero Hubs, UKIB, Net Zero Go, and the Local Net Zero Forum. We also welcome the Government’s intention to work with the Green Finance Institute to provide assistance to local authorities to develop commercially attractive net zero investments. We suggest that the Government conduct a mapping exercise to ensure that local authorities most in need of technical support receive it.