Greening public finance

The UK's public finance ecosystem and the net zero transition

Achieving the UK’s goal of reaching net zero’ emissions by 2050 will require far-reaching changes to transform the UK economy and put it on a more sustainable path. Greening the finance system is a key part of this transition. While aligning the private financial sector with the UK’s climate goals is an urgent priority, the scale and speed of the transition means that public finance must also lead by example.

In recent years the UK has established a range of new state-owned finance institutions (SOFIs) and significantly scaled up existing ones. These include the UK Infrastructure Bank (UKIB) and the British Business Bank (BBB), which operate domestically, and UK Export Finance (UKEF) and CDC Group, which operate internationally. Taken together, these institutions have significant financial firepower that could be effectively mobilised and scaled up to support the green transition. To date however, the UK’s public finance architecture has not been updated in light of the UK’s commitment to a net zero transition. If the UK is to achieve its net zero target and uphold its historic responsibility to deliver climate justice abroad, it is critical that its SOFIs are fully aligned with these goals. This requires a number of changes to their design and governance.

It is essential that the mandate of each institution is aligned with the UK’s climate objectives. We recommend that the mission and supporting objectives of each SOFI is updated to align with a just transition to net zero and set out specific reforms for reforming each institution’s mandate.

For the UKIB, we recommend that the Bank’s private sector lending arm aims to decarbonise existing infrastructure and scale up low-carbon alternatives by offering new concessional financial products and technical support. The UKIB will play a critical role in substituting the loss of the European Investment Bank (EIB) and its remit should be broadened to ensure the delivery of a just transition. We recommend that the UKIB’s local authority lending arm becomes a central coordinator for certain Just Transition initiatives across the country, engaging with local authorities to identify, design, and finance a pipeline of bankable projects that will accelerate a just transition to net zero.

We recommend that the BBB introduces a range of tailored concessional financial products to stimulate SME investment in the zero-carbon transition and announces that it will no longer work with private sector financial institutions that have not taken sufficient steps to align their business activities with the Paris Agreement. We also recommend that it should play a scaled-up green venture-capital role, providing highrisk, patient capital for innovators and startups that are contributing to the UK’s climate goals, including taking equity stakes where appropriate.

For UKEF, we recommend that additional steps are taken to green its export financing, including providing more generous financing terms for exporters of low-carbon goods and services; proactively assisting exporting firms with preparation for and adaptation to climate-related risks; prioritising the development of global renewable energy supply chains; and assessing the protection of biodiversity and nature in its financing decisions.

For the CDC, we recommend that it end the practice of making investments through private equity funds and align its climate-related investments with national development plans and industrial strategies. We also recommend that the CDC becomes the UK’s hub for a broader range of international climate assistance beyond finance, including technical support and technology transfers, to help drive a global just transition.

To succeed, it is crucial that each institution has sufficient financial firepower. Combined, these institutions on average finance over £7bn worth of projects every year. However, the proposals outlined in this report will enable the amount of finance these institutions provide to be significantly scaled up – making a considerable contribution to decarbonisation domestically and abroad. Instead of imposing arbitrary limits on how much SOFIs can borrow and lend, we recommend that the UK government commits to enabling each institution to raise the funding they need to meet their mandate, provided that their balance sheets are managed prudently within an agreed envelope of leverage and risk. We also recommend that the Bank of England finances SOFIs under certain conditions, for example if it believes the government is underusing its fiscal space.

The final area that requires reform is governance. Governance arrangements are particularly important for public financing institutions, as it is their distinct governance that enables them to play a fundamentally different role in the economy compared to that of private financial institutions. We recommend that the UK government establishes a new state holding company, UK Public Finance (UKPF), to exercise its oversight and control of the UKIB, the BBB, UKEF, and the CDC. Having a single governing entity oversee all four institutions will help to exploit synergies, promote strategic planning, establish a clear line of democratic accountability, and ensure a more cohesive public finance ecosystem. Chaired by the Chancellor of the Exchequer, UKPF Board members should include stakeholders from a wide range of backgrounds including finance, regional representatives, industry groups, and trade unions.

The UK has pledged to become a world leader in green finance. If structured and governed effectively, the UK’s state-owned finance institutions can make a significant contribution to achieving this goal – both at home and abroad.

Image: iStock

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