Shepherd and Wedderburn: Ethical finance poised to unleash the green recovery
Peter Alderdice, senior associate in Shepherd and Wedderburn’s banking and finance team and Daniel Boynton, a solicitor in the firm’s pensions team, detail how ethical finance can kickstart the green recovery of Scotland’s economy after COVID-19.
The COVID-19 pandemic has made one thing abundantly clear: when disaster strikes, major societal change is possible overnight.
The measures taken around the world to save lives and protect public health systems – such as shuttering non-essential businesses, furloughing almost 10 million workers in the UK and putting children’s education on hold – had been the preserve of dystopian fiction until earlier this year.
As governments start developing policies to rebuild our economy after this time of unprecedented disruption, we should not lose sight of the lesson that fundamental transformation is not only possible within a short period; sometimes it is essential.
That lesson and, in particular, the need for a green recovery, is of critical importance for achieving the targets set by the Scottish and UK governments of reaching net-zero greenhouse gas emissions by 2045 and 2050, respectively.
The challenge posed by those targets is enormous – not least in the midst of the biggest public health and economic emergency in recent times. However, the coronavirus pandemic has demonstrated that society can adapt to major change when it has to. As the saying goes, “needs must when the devil drives”.
If we are to succeed in achieving net-zero by the target dates, then the economic recovery from COVID-19 must be green. A key challenge in achieving this will be finding the investment required to turn ambitious targets into reality.
The transition to a decarbonised economic system will require unprecedented levels of investment; estimates from the Committee on Climate Change suggest that investment in the UK’s power sector alone needs to rise from around £10 billion to £20 billion annually to achieve this goal.
However, green investment is required not only in the energy sector, but across all areas of the economy if we are to tackle the impact of COVID-19 and climate change at the same time.
While some investment will come from government funds, measures to tackle the immediate impact of coronavirus have left the Exchequer’s coffers depleted. The scale of the net-zero challenge means the private sector has an essential role to play.
Many businesses may be contemplating restructuring to take advantage of the opportunities that the green recovery presents and need to be confident that investors are with them for the long-term in supporting the radical steps required to make the green recovery a reality.
Pension funds – whether in the traditional defined benefit sector, or up-and-coming master trusts in the defined contribution space – are uniquely placed to help meet the challenge of delivering ethical finance to support the green recovery:
- They have the capital. Thanks to automatic enrolment, more people than ever are actively saving for retirement and already by 2018 the value of UK pension wealth stood at more than £6 trillion. A green recovery offers many new sustainable investment opportunities for pension fund trustees and managers, such as green bonds.
- Members are demanding change. New disclosure requirements mean those running pension funds now need to explain how environmental, social and governance (ESG) factors are used in investment decisions. Recent high-profile campaigns have resulted in investment changes at the largest pension funds, and the pressure is set to build with greater public awareness of impact investing and fossil fuel divestment strategies.
- It’s good for business. A growing body of evidence indicates businesses that prioritise ESG factors perform better in the long-term. Being environmentally sustainable, socially responsible and well governed reduces business risk and ultimately improves the bottom line. At a time when historically low interest rates and gilt yields make returns harder for pension funds to find, harnessing the green recovery promises better outcomes for their members.
While these factors present pension funds with a great opportunity, more needs to be done to make sure that opportunity is seized:
- Pension scheme trustees can work with their advisers to develop better reporting tools to help them understand the ESG impact of investments.
- Automatic enrolment providers can offer default funds taking account of environmental factors and ensure that pension savers have the right information on those ESG points available to them.
- The UK Government and the Pensions Regulator can support pension schemes in their green recovery journey, recognising the importance of this issue to members.
As well as the patient capital offered by pension funds, the green recovery will also depend on businesses having access to working capital and shorter-term finance from sources such as banks.
The global financial crisis that befell us in 2008 led to systemic reform of the banking sector to rein in unethical behaviour and excessive risk-taking and to improve corporate culture and individual accountability in financial institutions. The increased regulatory scrutiny since then on responsible and sustainable conduct means the banking sector is now better placed than ever to meet the financing needs of the green recovery in an ethical way.
The deployment by banks of tools such as ESG ratings, more commonly seen in the asset management industry, to inform lending decisions is still in its early stages, but initiatives are already underway to help banks proactively accelerate the transition to a green post-COVID economy.
The Loan Market Association, a trade body for the syndicated loan market, has developed Green Loan Principles to promote the development and integrity of the green loan product.
On the international stage, the United Nations Environment Programme Finance Initiative (UNEP IF) is working with signatories to the Principles for Responsible Banking to increase lending that supports socially and environmentally sustainable economic activities.
The root-and-branch reform of our economic system required to achieve net-zero targets is daunting, but policy-makers should not be timid when it comes to proposals for the post-COVID recovery. Change is the only constant in life, as they say, and ethical finance stands poised to unleash the green recovery.