11 March 2021

SUERF: Greening the UK financial system – a fit for purpose approach

The transition to a low-carbon economy consistent with the 2015 Paris Agreement represents the greatest challenge of our time...re-aligning our financial sector. The deregulated and market-oriented approach to greening finance taken by the current UK government will not go far enough.

A fit for purpose Green Finance Strategy is needed to address the market failures and systemic financial risks posed by climate change and the transition to a low-carbon economy. This entails getting the UK’s institutional architecture right by developing a green and dirty public taxonomy, making climate-related disclosures mandatory based on such a public taxonomy, and setting up a Green Finance Action Taskforce composed of state actors to oversee the greening of the financial system. It further entails greening monetary policy and banking regulation, by decarbonising corporate bond purchases and the Bank of England’s collateral framework, and aligning risk-weighted capital adequacy rules with the greenness/dirtiness of the assets that banks hold. It would finally entail the decarbonisation of shadow banking and market based-finance. This can be achieved by establishing green-supporting/dirty-penalising haircuts and margins, and implementing a dirty penalising factor for Global Systemically Important Banks (G-SIBs). Fiscal, industrial and environmental regulation policies have a stronger and more substantial role to play in achieving the low-carbon transition quickly. But the urgency of the climate crisis requires that all policy tools are used for the purpose of avoiding a climate breakdown. Our proposals ensure that the UK financial system will support climate economic policies, instead of undermining them.

1. Introduction

The UK economy needs to be decarbonised rapidly. This decarbonisation requires the use of a wide range of policies, including green fiscal policies, green industrial policies and environmental regulation policies. However, decarbonisation might not be rapid enough without the green transformation of the UK financial system. The Green Finance Strategy announced by the UK government in July 2019, and further elaborated in November 2020, does not go far enough: it offers a deregulated decarbonisation approach that prioritises the development of green asset classes to increase the competitiveness of the UK financial sector, lacks penalties for dirty activities and is over-reliant on transparency and disclosures.1 A rapid low-carbon transition will not take place via such a market-oriented approach because of a series of market failures that include incompatible time horizons between private finance and the climate crisis, corporate market power that opposes fundamental changes in climate finance and subjective private classifications of green assets that are susceptible to greenwashing.

Figure 1: A fit for purpose Green Finance Strategy: outline of recommendations

Source: Constructed by the authors

A fit for purpose Green Finance Strategy should be more ambitious and should address these market failures using a holistic and more interventionist approach. Such a strategy needs to include (i) the development of a climate-aligned institutional architecture that relies on a public taxonomy of green and dirty activities, (ii) the greening of monetary policy and commercial banks’ balance sheets and (iii) the decarbonisation of shadow banking and market based-finance (see Figure 1).2 We first explain the reasons why the UK financial system should be decarbonised and we then analyse the components of our proposed fit for purpose Green Finance Strategy....

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