Government ministers love talking about green finance. Anything green is good and anything that points to a bright green future for the City after Brexit is even better.
Apart from highlighting the pivotal role green finance will play in the transition to a low carbon economy, the cheerleaders make two points: it is also a good business for the financial sector; and London is one of the world leaders in the field.
Unfortunately, neither of these claims is quite true. At least not yet.
Green finance is certainly growing fast. Just look at the statistics for the two main elements of green finance most people know about: green bonds and sustainable investment funds. Although they still represent a tiny proportion of the total bond market, issuance of green bonds has been rising rapidly (until the pandemic hit).
Green bonds substitute
But does this represent growth for the City? Not really, say bankers. Green bonds are essentially a substitute for conventional bonds. Nor are the fees any higher. “We don’t anticipate that green bonds will increase the overall size of debt capital or the wallet for the banks,” says the head of sustainable capital markets at a leading bank.
And what about the City’s leadership position? In terms of the depth of green finance centres, London comes in only sixth in the Z/Yen index though it takes the top spot for quality.
William Wright, founder of think tank New Financial, says that combining all green, social and sustainable bond issuance since 2015, the UK accounts for less than 5% of the European total, compared with just over a quarter for France and 17% for Germany. The UK has a much higher market share for sustainable investment funds. But similarly these will largely be substitutes for conventional funds.
Huw van Steenis, chair of sustainable finance at UBS, agrees that some elements of green finance and ESG investing involve substitution. “They may not grow the overall revenue pool, though they can give individual firms an advantage in the transition,” he says. But there are also likely to be new markets created, particularly around the trading for carbon offsets, he adds. And the City is well-placed to be a leader in these, reckons Wright.
Here, too, there are concerns, however. The biggest existing carbon market is the EU emissions trading scheme. Launched in 2005, this involves trading in permits to emit greenhouse gases allocated to 11,000 power stations and big energy users around the EU. Rather discredited when prices slumped after the 2008 financial crisis, the scheme is now seen as a key plank in the green strategy of the EU, which plans to extend it to many more big users in 2021.
But what about the UK? The government has still not confirmed that it will set up a UK version of the trading scheme at the end of the year. It wants a UK scheme to be linked to the EU’s and it is possible that if such a link is scuppered by the trade negotiations, the government might shelve the plan and go for a tax on big users instead.
This would be “a deeply regrettable step backwards” for the UK, says ICE, which owns Europe’s main emissions trading venue. It would hardly be helpful for the City’s ambitions to be a centre for other carbon trading markets.
Perhaps the most potentially exciting of these is the plan for a dramatically scaled-up market in voluntary carbon offsets, which represent investments in projects that remove CO2 from the atmosphere. For years, there has been a low-key, over-the-counter market in offsets. That market is currently worth about $600m annually.
Now a task force headed by former Bank of England governor Mark Carney and Standard Chartered boss Bill Winters is drawing up plans for a hugely expanded market that could do more than $100bn a year.
Christopher Blaufelder, one of the McKinsey team advising the task force, says a large, sophisticated market will be needed to satisfy the demand for offsets from the growing number of companies that are making net zero commitments, which they will not be able to meet solely by cutting their own emissions.
“If they want to live up to their commitments they will have to buy offsets one way or another, in addition to reducing their emissions. That gives the market formidable momentum.”
UK officials believe London could play a key role in the new market. But that market is likely to involve several competing platforms around the world, and London will face formidable competition from other centres in Europe and Asia. There might even be a challenge from New York and Chicago, with the US expected to become more active in climate change trading under a Joe Biden presidency.
If London really is going to be a leader in green finance, it can’t miss out on this. It will also test the claim that the City, released from its EU shackles, can quickly make up its losses from Brexit.
No pressure then.
David Wighton is a columnist at Private Equity News’ sister title Financial News.