Financing the green transition

As support grows for the race to net-zero, so too do the fundamental questions about how we deliver it. How will we pay for the changes we need to make? What practical steps must we prepare to take? And is society ready for these changes?

If we are going to successfully decarbonise, whether it’s transforming our buildings to be more energy efficient, making travel electric, or reducing the carbon footprint of the goods we make, finance will have a key role in the transition.

The financial services industry is certainly rallying to the cause. For example, more than 160 financial institutions have been brought together to help build a consensus on how the sector can enable the green transition, in an initiative known as the Glasgow Financial Alliance for Net Zero.

Financing the green transition

Fortunately, private finance can already meet much of the demand for funding the more established technologies and ‘green’ projects, such as wind and solar farms.

However, when it comes to the practical application of finance to support the wider transition, real consideration needs to be given to how we encourage private finance to fund other projects - the “greening” of carbon heavy industries and supporting nascent yet critical industries such as battery storage and vehicle recharging infrastructure. These projects are often complex, feature new technologies and can be relatively expensive.

The UK has a number of success stories in these sectors already, such as Zenobe Energy, a company that has been developing battery solutions to support both the transition away from fossil fuels to renewable energy generation and the electrification of transport. But more can be done to ensure that these nascent sectors are able to access the finance they need.

Companies often say that cost and a lack of clear alternatives make it difficult to transition their business to net zero. To address these challenges, business should:

• First look at upskilling employees and seeking professional advice from industry experts on what can be done to start their transition.
• Consider the steps they can take – i.e addressing the business’s energy use in its day-to-day activities and manufacturing processes, greening its transport or investing in its property to generate clean energy from renewables such as solar panels.
• Engage early with funders and involve a bank that truly understands green finance when planning significant investments in capital intensive projects with long payback periods.

As the economy moves towards net zero, businesses will find that utilising finance to support their green transition can future proof business models and attract and retain talent, clients & capital. As such, transitioning to net zero is not just an imperative for climate change but a sound strategy for the longevity of any business.

Crowding in finance

The decarbonisation targets the UK has set for itself are demanding, and rightly so, but they can be delivered with the right support and by government working closely with business.

The UK’s ambition is to increase its offshore wind capacity to 40GW through unlocking £20 billion of private investment by 2030, as well as encouraging private finance to support innovation in carbon capture, hydrogen, transport and battery storage technologies.

Many of these technologies are relatively new or have untested business models, making it harder for lenders to have a clear view of the risks associated with these projects. This lack of data can pose a real challenge for these projects to find traditional sources of finance.

Businesses stand to benefit from the role that the government can have in directing private finance to support their transition. One way in which the government can do this is by guaranteeing price floors on wholesale energy or the residual value of green assets - providing a level surety for lenders. This need not pose a substantial financial risk to the state - new renewable energy projects are viable at a cost significantly lower than the average wholesale energy price, meaning that government can provide guarantees on new energy projects and there is a good chance it would not need to pay out unless energy became significantly cheaper. There is a clear role here for the newly established UK Infrastructure Bank to take the lead in crowding in private finance to these projects by capitalising on its remit to support the UK’s green transition.

Incentivising green lending

Alongside the government providing financial backing to encourage private finance, there is also a role for financial services sector regulators in creating the right environment to enable the green transition.

The Prudential Regulatory Authority’s (PRA) and Financial Conduct Authority’s (FCA) focus on climate change so far has been through the lens of their primary objectives – firm and system safety and soundness for the PRA, emphasising the financial risks from climate change; and investor protection for the FCA, focussing on climate-related disclosures from companies.

But going forward, they may have to also consider how they can incentivise the transition to net-zero. One idea, is to adopt a Green Supporting Factor which would require banks to hold less capital against green lending and therefore direct finance towards projects that support the green transition. Whilst efforts to incentivise green lending are positive, a policy along these lines should not lead to barriers that make it more difficult for lenders to support carbon heavy businesses that are transitioning. Another option that could be explored is initiating a central banking liquidity scheme like the successful Term Funding Scheme for SMEs that allows lenders to borrow cheaply from the central bank to lend to particular sectors. This could be targeted at lending to industries critical to the transition, such as battery storage and electric vehicle development.

Achieving net-zero

The challenge of achieving net-zero is significant but the UK has the innovation and high technology capabilities to meet its ambitious targets. We all have a significant part to play. In order to successfully direct finance towards projects that enable the transition we will need to see a public-private cooperation on a scale equal to the task ahead of us. Government, regulators and the financial services industry must come together to agree policies that will crowd in finance and allocate it to where it will be serve the UK’s net-zero aims.

Crucially, adopting these policies in the run up to COP26 would enable the UK to take the lead in advocating for the role that finance has in supporting the global Race to Zero and positively influence the progress to net-zero around the world.

If you’re interested in hearing more, join Tony Prestedge, Deputy CEO of Santander UK on June 14^th at the CBI conference: Road to Net Zero.