Almost 60 years after US Secretary of State Dean Acheson observed that Great Britain had lost an empire but not yet found a role, the City of London finds itself in a similar bind. In the wake of a trade agreement with the EU that, for financial services, is effectively “no deal”, the City is haemorrhaging jobs and business to rival financial centres in mainland Europe and beyond.

Could becoming a global centre for sustainable finance offer the City the new role it needs? London can point to decades of leadership and innovation in this area. The government’s flurry of policy pronouncements around net zero, and the UK’s hosting of the COP26 climate talks, offer a strong foundation for growth. However, London faces stiff competition from rivals around the world, and some note that mixed signals on climate policy risk undermining the UK’s pitch.

People make their way home through the drizzle in the City of London, the capital’s financial hub. (Photo by Tolga Akmen/AFP via Getty Images)

“London is a global financial centre and has aggregated a huge competence in terms of sustainable finance, responsible investment and climate bonds,” says Nick Robins, a sustainable finance professor at the London School of Economics. “That clustering effect is a huge advantage. But in terms of translating that into business, London’s position is far from unassailable.”

While the City may have been ignored in the government’s trade deal with the EU, the government acknowledges the opportunity presented by sustainable finance. “We will turn the UK into the world’s number one centre for green technology and finance,” announced Prime Minister Boris Johnson in last November’s ‘Ten Point Plan for a Green Industrial Revolution‘.

That document trumpeted the introduction of mandatory reporting in line with the Task Force on Climate-related Financial Disclosures (TCFD) across the economy by 2025, efforts to position the UK as a leader in global voluntary carbon markets, and the introduction of a UK green taxonomy. At the same time, Chancellor of the Exchequer Rishi Sunak set out plans to “extend global leadership in green finance”, including, alongside the UK taxonomy and TCFD disclosure, issuing the UK’s first sovereign green bond.

A global City?

The City of London Corporation, the governing body responsible for the City, is keen to tout the capital’s role as a centre of sustainable finance. In a recent report, entitled The Global City, it argued “the UK is the only global financial centre that is also a leading centre for sustainable finance”.

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Specifically, it underlined the relatively high proportion of UK-based investors signed up to the UN-backed ‘Principles for Responsible Investment’ (418 signatories compared with 519 US companies) and the larger volumes of green bonds listed in the UK ($53bn) compared with Germany ($49bn) and Singapore ($21bn). It also highlighted the green credentials of the London Stock Exchange and the deep pool of talent in sustainable finance.

However, other assessments are not as favourable. In the sixth edition of its Global Green Finance Index, think tank Z/Yen placed the UK fourth in terms of the depth of its green finance offering, behind Amsterdam, Zurich and Copenhagen. In its ‘green finance quality’ ranking, London had slipped two places compared with the 2019 index, dropping behind Zurich and Amsterdam.

The UK has “huge opportunities” in sustainable finance, says Michael Mainelli, executive chairman of Z/Yen. He points to the City’s history of innovation in the field, including pioneering work in emissions trading, responsible investment and green bonds. However, he suspects that part of the reason for London’s relative decline is its failure, so far at least, to integrate environmental considerations into its day-to-day business.

“It is improving, but people in the City don’t raise climate change with clients as much as they should,” he says. “Clients tend to raise climate change with financiers.”

Sustainable finance as BAU

Making sustainable finance the default option for savings and investment products is one of the recommendations of the Climate Change Committee, an independent body set up under the UK’s 2008 Climate Change Act to advise the government on how to meet its statutory emissions reduction goals. In December, it published The Road to Net-Zero Finance report, produced by an advisory group comprised of leading figures in sustainable finance.

The report was aimed at assessing the readiness of the financial sector to deliver the UK’s net-zero target. Its key finding was the critical role “smart policy” could play in dramatically reducing the cost of the capital needed to create a net-zero economy. It also called for a series of regulatory interventions to integrate climate risk and net-zero targets in the financial system, as well as recommending clearer policy from government on how each sector is expected to decarbonise, a strong carbon price, and ‘de-risking’ of low-carbon investments through government guarantees and tax breaks.

The City needs to be ahead of the real economy and be preparing itself for what the real economy will look like in the future. James Alexander, Sustainable Investment and Finance Association

De-risking measures are a key ask from the Green Finance Institute (GFI), a UK government-backed independent body established to address barriers to investment in the green economy. “We require systematic, sector-by-sector market innovation strategies,” says Rhian-Mari Thomas, its chief executive. These should be “supported by policy transition pathways, carbon pricing and financial de-risking mechanisms that increase the predictability of cash flows and promote the development of innovative financial solutions”.

This analysis talks to one of the main criticisms of the City in recent decades: the gap between much of its trading activity and the financing needs of the real economy. Cementing its role as a centre of green finance will depend on closing this gap, says James Alexander, chief executive of the UK Sustainable Investment and Finance Association.

“The City needs to be ahead of the real economy and be preparing itself for what the real economy will look like in the future,” he says. For this to happen, the government must articulate how it plans to deliver on its net-zero targets and start making decisions on what technologies it plans to back to decarbonise the UK economy.

“There is a whole plethora of new low-carbon technologies… Until we know what the government is going to drive forward, the finance sector can’t start trying to figure out who the winners might be,” he says.

Decarbonising the world

While the Climate Change Committee report focused on ensuring the finance sector supports the UK’s net-zero goals, it also hinted at the role London could play in financing decarbonisation abroad – and generating overseas earnings for UK Plc.

“COP26 is an opportunity where the whole world will be looking at the UK,” says Jake Langmead-Jones, lead analyst at the committee. “It is an opportunity for the UK to put itself forward as the world leader in net-zero finance.” The benefits to the UK finance sector from this are likely to flow from relatively intangible ‘network effects’ – with financiers’ active participation likely to generate deal-flow down the line.

Similarly intangible, but equally important, is the UK “walking the walk” on policy when it comes to sustainable finance, says Mainelli. He is critical of the UK’s decision to leave the EU Emissions Trading System – a move that has led Intercontinental Exchange to shift its trading of carbon contracts, totalling around €1bn in volumes each day, from London to Amsterdam.

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Furthermore, the failure of the government to step in to prevent approval being given for a new coal mine in Cumbria, in the UK’s north-west, which would produce coking coal for steel furnaces, has damaged its climate credibility. The government’s COP26 president, Alok Sharma, is reportedly furious about the decision.

The UK government is, however, belatedly participating in the green bond market. When Sunak made his announcement in November 2020, 16 governments had already issued such bonds, whereby the revenues raised are directed at environmental (or social) projects. Nonetheless, Thomas at the GFI welcomed the move, arguing it will help catalyse a broader UK green bond market.

A Brexit dividend?

Looming over all this is Brexit. The City is still smarting from the ongoing failure of the UK government to secure ‘equivalence’ for its regulatory regime, which would allow UK-based financial services firms to continue selling products and services in the EU.

Brexiteers suggest the ability of the UK to diverge from the EU rulebook will create opportunities.

In green finance, a UK taxonomy is suggested as one such opportunity. The EU taxonomy is an attempt by the European Commission to identify economic activities aligned with environmental objectives and to require investment managers to disclose the proportion of their investments directed to taxonomy-aligned activities. The intent is to encourage investment to flow to companies involved in these activities.

The EU is a standard-setter. The UK can learn from the EU, but markets need to be closely aligned and there is very little appetite for major divergence. Nick Robins, London School of Economics

Drawing up the taxonomy has proved a fraught process, triggering disputes as to what is and is not green: a recent consultation exercise drew 50,000 comments.

Ben Caldecott, founding director of the Oxford Smith School’s sustainable finance programme, argues the EU taxonomy’s sustainability credentials have been undermined by lobbying. The UK has an opportunity to create a more rigorous home-grown alternative, he believes.

However, it is unclear how far the UK can usefully stray from the EU, says Robins. “The EU is a standard-setter,” he says. “The UK can learn from the EU, but markets need to be closely aligned and there is very little appetite for major divergence.” Another sustainable finance expert describes the move as a distraction that will end up simply replicating most of the work already done by the EU.

More replication is also needed to fill the hole left by the European Investment Bank, Europe’s lending arm, which is increasingly directing its funding towards climate action – and which was lending around £7bn each year to the UK before the 2016 Brexit vote.

Filling the gaps

The UK is planning to set up a National Infrastructure Bank (NIB). In its plans to establish a NIB, the government recognises that UK infrastructure needs will be very different to the past as it moves towards net-zero emissions, says Josie Murdoch, senior policy officer at the Aldersgate Group. It is important for a NIB to be independent of government, to be prepared to invest over long time horizons, and to focus on only providing finance where private sector investors are reluctant to do so, she says.

In creating its own development institution, Brexit does provide an opportunity, says Robins. “The NIB can become a real anchor institution in delivering sustainability goals in the UK… There’s huge innovation potential there.”

The combination of COP26, (mostly) positive climate policy signals, and an enthusiastic and entrepreneurial finance sector keen to build on its experience in sustainable finance means London has the potential to carve out a strong position. However, it will face fierce competition from other financial centres, and there is no escaping the damage Brexit has already wrought on the City. The UK government and the Square Mile’s financiers will have their work cut out to successfully exploit the opportunities ahead.