Has the Financial Services Bill done enough to tackle climate change?
Although not the industry most people think of in relation to climate change, financial services play a key role in the fight to stop global warning, from investment to insurance. As is the case with many other fields, financial firms have been struggling to align themselves to global climate targets.
In 2020, a financial advisory group to the Climate Change Committee, an organisation set up under law to advise the government on reducing emissions, warned that the financial system was far from being aligned with the Paris Agreement objectives to keep the global temperature 1.5°C to 2°C over pre-industrial levels.
The Financial Services Bill – a flagship bill that sets out the financial regulatory framework post-Brexit – presented the government with an opportunity to align the sector with the UK’s net-zero ambitions. However, although the government has introduced some measures that require two main financial regulators to consider the government’s 2050 net-zero target, many see the bill as a missed opportunity to reduce fossil fuel investment, and questions remain about how far the regulators would actually go to drive net zero-alignment.
When the bill was first introduced in October 2020, it contained no reference to climate change at all. In the Commons, the opposition sought to fix this by introducing amendments that would require the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) to consider the net-zero target when making prudential regulation. In essence, the regulators would have to consider the government’s objective to limit greenhouse emissions along with considerations such as other international standards and the UK’s competitiveness, when setting rules meant to keep financial institutions safe and sound. The regulators would also have to explain how they have done so.
There is concern among critics that it may be looked back on as a missed opportunity
These amendments were initially rejected by the government but following pressure in the Lords they were forced to compromise and introduced their own to the same effect. Also in response to amendments put forward by peers, the Chancellor announced net-zero mandates for the Bank of England and the FCA. The changes to the mandates and the new requirements in the Bill provide a significant opportunity for the regulators to drive net-zero alignment in the UK financial sector using their own tools, whilst also empowering them to act on climate change without worrying of overstepping their remit.
Yet several peers including Lord Oates, the Liberal Democrat Lords spokesperson for energy and climate change, backed by Baroness Kramer and Baroness Altmann, wanted to go further. Their proposals would have seen companies forced to set aside extra capital for any investments in fossil fuels. Funding production and exploitation of fossil fuels would have been treated as high risk investment and new production and exploration of fossil fuels would have been required to be funded entirely with the firm’s equity, in other words, not by taking any debt.
As Lord Oates pointed out, the effect of these rules would not only address the risk of devaluation of fossil-fuel-linked assets – the traditional view of looking at climate change in finance. It would also have the effect of slowing down climate change, as investment in new fossil fuels will push Britain over the Paris Agreement’s global warming limit. In response to the government’s criticism that the amendment was too prescriptive, Lord Oates revised his proposal to require the PRA to make its own assessment of capital requirements in light of climate change and report back to Parliament.
Adjusting the levels of capital that firms need to hold depending on their exposure to climate change risks, as Lord Oates proposed, is in line with the recommendations of the advisory group and is considered by experts as one of the most impactful way of driving net-zero alignment. However, the government opposed Lord Oates’ amendment, which was pressed to a vote and resulted in a tie, leaving the bill unchanged.
The significant support for Lord Oates’ proposal reflects concern about environmental campaigners that the government’s own amendments do not go far enough and urgent action is needed. The government did not provide further details or interpretation about how the new net-zero consideration could translate into policy. For instance, it did not encourage regulators to drive net-zero alignment by adjusting capital adequacy rules based on the level of emissions associated with their portfolio, which would make it more burdensome to hold carbon intensive assets. Instead, it merely required them to take the government’s objective into account.
As the Financial Services Bill reaches its final stages in Parliament, there is concern among critics that it may be looked back on as a missed opportunity to enforce critical fossil fuel deterrents, as well as failing to give regulators enough guidance to pressure the sector to align their investment flows and assets with net-zero.
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