To create a sustainable economy we will need a $1 trillion‑a-year investment worldwide. Is the City up to leading the way?

By Nick Robins and David Pitt-Watson

Making the transition to a low-carbon, green economy will require an unprecedented reallocation of capital in the world’s US$300tn financial system. As home to some of the world’s largest fin­ancial markets, London has the opportunity to take the lead.

Already, across the world, there are moves to incorporate environmental and social factors into the rules governing financial decisions. An international network of (so far) 1380 investors, with US$59tn of assets under management, have signed up to the United Nations Environment Programme’s (UNEP’s) Principles for Respons­ible Investment initiative – six principles of sustainability to be considered when making investment decisions, covering environmental, social and governance issues.

Twenty-seven of the leading stock exchanges now include sustainability factors in their requirements when listing companies. And new principles and standards for bonds targeted at clean energy and clean water – so-called green bonds – are emerging in the world’s US$100tn debt capital markets. In 2014, the value of green bonds issued tripled to $36bn over the previous year.

London has been at the heart of these innovations, creating many of the initiatives that are setting the agenda both domestically and internationally. ⁹ Carbon Tracker is a good example: the former City analysts who make up this new financial think-tank were the first to reveal that the majority of global fossil fuel reserves (oil, coal and gas) cannot be commercialised if the world is to meet its climate change targets. Their conclusions have prompted a growing will to act, as investors have become concerned that they could be left with stranded assets as the world shifts onto a low-carbon pathway.

A number of factors explain London’s innovative potential. The UK has a vibrant culture of social entrepreneurs and civil society organisations working on financial innovation. Ethical finance has strong roots in the UK: the first UK retail ethical funds came to market in the 1980s and London is now the home to the Social Stock Exchange, which provides a platform for investors to seek out listed companies delivering financial, social and environmental returns.

The UK’s pension funds and asset management industry has often been ahead of the curve in looking for sustainability in its investments. According to one estimate, in 2003, 69% of European assets in socially-responsible investment among institutional investors were held in the UK. ¹⁰

London is the location for many of the world’s leading players in sustainability reporting, not least the Climate Disclosure Standards Board and the International Integrated Reporting Council. The network effects that encourage the clustering of activity in the City are now working for green finance. Importantly, the leadership of the City reflects wider activity in the UK financial services sector – with Bristol and Edinburgh, for example, both having a growing green finance market.

The Bank of England has recently joined the fray. The Prudential Regulatory Authority, part of the Bank, published the first ever assessment of the implications of climate change for the insurance industry in September 2015. Speaking recently in London, the Bank’s Governor, Mark Carney, emphasised that ‘green finance cannot conceivably remain a niche interest over the medium term’.

Following the financial crisis, the UK was in the vanguard of eff­orts to ensure investors intensified their oversight of the companies they own through the Stewardship Code. London-based insurance group, Aviva, has set out a roadmap for sustainable capital markets, with CEO Mark Wilson arguing that ‘the financial sector as a whole has a generational opportunity to build sustainable capital markets’. London’s debt and equity capital markets have often been at the cutting edge: the world’s first equity research team focused on sustainability was established at HSBC in London. All in all, as Parliament’s Environment Audit Committee concluded in 2014: ‘The UK, with London at its heart, is a world leader in finance, and there are great opportunities to lead on low-carbon investment’. ¹¹

For all this, sustainability is perhaps still the ‘sleeping giant’ of London’s financial markets. Initial innovation is often developed in the UK but then deepened by fast followers in other markets. For example, by 2014, the value of assets managed according to a variety of sustainability strategies in the UK had risen to EUR1.9tn, but its share of the European total had declined from previous highs to less than 20% (though this may arguably be a more normal level). ¹²

As of May 2015, the UK had actually fallen behind France in terms of socially responsible investment funds under management, according to the latest Extel survey. ¹³ Many of the promising initiatives are also relatively new, with as yet unrealised potential.

What has been missing so far, and what we need now, is a clear strategy setting out how London and the UK more broadly could be a financial hub for the global green economy.

Such a strategy would build on London’s vibrant culture of social and market innovation but would also create the policy architecture to allow for the scaling up of promising trends. In practice, this might mean further strengthening the work of the London Stock Exchange in promoting sustainability disclosure among the companies listed on its markets: the LSE has risen from 11th out of 45 stock exchanges in terms of sustainability transparency in 2013 to 5th in 2015. ¹⁴

The strategy could also leverage the UK’s leadership in global capital markets. London has many of the ingredients to become a centre for the raising of finance for the green economy worldwide. Currently, the UK is the third largest market for issuing ‘green bonds’ after China and the USA and could play a significant role in raising international capital for green investment in emerging markets.

In addition, the UK’s leadership in the fast-growing crowd and peer-to-peer finance segment could also be deployed for the green economy. According to a recent survey, the UK has about 80% of this fast-growing ‘alternative finance’ market in Europe, with some players, such as Abundance, specifically focused on green finance. ¹⁵ Finally, a strategic vision would also identify the critical role that public financial institutions such as the UK’s Green Investment Bank – another world first – could play not just in crowding in private capital but, more importantly, in helping to create the new markets that green finance will require.

A race is starting amongst the world’s financial centres to see which will best serve the green transition. Switzerland has identified sustainability as a key dimension for the future competitiveness of its financial sector. ¹⁶ China has incorporated green finance into its next five-year plan and has identified the need to raise US$400bn per annum in green investment through to 2020. ¹⁷ London has many powerful attributes – but these are by no means exclusive or permanent. The time to develop a green finance strategy for the City has arrived.