Speech for EY seminar: Covid-19 – what it means for sustainable finance

The following speech was given by Anjalika Bardalai, our Chief Economist and Head of Research, at the recent EY seminar on Covid-19 and its impact on sustainable finance.

In my role managing the economic research programme I’ve led our work on green finance, but I approach the issue of sustainability and sustainable finance from a very holistic perspective rather than as a specialist. So I’d like to share a few thoughts on mainstreaming sustainability and the role of financial services, to give some macro context.

When we talk about sustainability in the context of Covid-19, I think two things stand out for me:

  • First is that although in recent years sustainable finance was more or less synonymous with green finance, now it’s obvious that it’s linked much more to wider ESG concerns.
  • Second is this idea that that issues of sustainability have become more prominent in some ways during the pandemic, not less. This is something that’s come as a bit of a happy surprise to me, although it’s an idea I want to come back to in a few minutes.

As far as financial services is concerned, I think we can probably agree that sustainability can’t yet be considered to have been mainstreamed within financial products and services. The very fact that we talk about whether ESG indices under-perform over over-perform relative to benchmarks is evidence of that. And I think that the very fundamental issues around definitions and taxonomies are still a critical barrier to mainstreaming within the industry.

For example, in the green finance research we’ve undertaken with the Centre for Climate Finance & Investment at Imperial College Business School, our first report was a sort of primer on green finance and included a section on definitions. We acknowledged that there was no standardised definition; we put forward our own synthesised definition, noted that a good definition needed to strike a balance between coverage and integrity, and also emphasised that definitions of green would inevitably be evolving works in progress.

But that was already three years ago and I’d argue that the challenge is still there. Our most recent report looked at green infrastructure in particular. The fact that there is no widely-accepted definition of low-carbon infrastructure means there is no predefined benchmark to measure performance. In that context, we wrote that:

“the lack of a clear benchmark for measuring investment performance is…one of the main disincentives to investors increasing their exposure to low-carbon infrastructure. This fragmentation of results can manifest itself in various different ways…”

For example, lack of distinctiveness of infrastructure projects, and inconsistent – and therefore non-comparable - data.

In our analysis, we found that this lack of standardisation isn’t presenting a huge barrier to green infrastructure investment in the short-term because each investing institution ends up assessing projects based on its own definition, and will take investment decisions based on internal metrics. But that means that only the most obviously viable projects are likely to be financed – this is basically why in the UK, green infrastructure investment tends to be skewed towards offshore wind projects, because they are often extremely investible – so much so that they can often be funded with or without a ‘green’ or ‘low-carbon’ label. But in the longer term, investment at scale and the funding of less obviously investable projects is probably going to require a common definition of what constitutes ‘green’ infrastructure, as well as some kind of taxonomy of financial frameworks. A standardised definition would also facilitate comparable credit ratings and the enhanced transparency that you need for risk assessment and due diligence.

So, the challenge is there even for green. My concern at the moment is that in areas that are even more difficult to quantify clearly, like societal well-being, the challenge will be even greater.

So coming on to the role of financial services. The financial services sector very obviously has a direct role to play in terms of financing sustainable projects, and, conversely, the extent to which it continues to finance non-sustainable projects (in the aggregate, how the industry finances the Transition). This is the standard stuff like green infrastructure investment, or underwriting of green and social bonds. TheCityUK is currently undertaking research on an Ecosystem Recovery Plan, which is going to look at the economic and policy implications of the pandemic and then the financial and related professional services industry’s role in contributing to the rebuilding of the economy. For example, we’ll consider how the industry can work with government to support areas that will make a positive contribution.

I’ll give you one example. Technology is obviously going to be central to green growth generally and to achieving the net-zero target specifically. But broadly speaking, it’s difficult for banks to finance projects that rely on technology that might be new, or projects that may be innovative but that by virtue of that very innovation, have uncertain or unproven business models. 

Government subsidies or incentive schemes may well have an important role to play; the consensus was that financing the transition was going to require a combination of private-sector and public-sector money even before the pandemic. But now, that balance will be even more important given the huge impact of the pandemic on the public finances, and the additional constraints that is going to have on government spending in the years ahead. I’m sure everyone saw the data published last week showing that the debt/GDP ratio is now more than 100%, and the OBR estimates that the total cost of government interventions related to Covid-19 will be £133bn just in 2020/21.

So maybe there is a role for the industry in terms of coming up with some possibly creative approaches to addressing this funding challenge to potentially facilitate private-sector financing and reduce the need for government subsidies and incentives.

I think the industry also has an indirect role to play in terms of addressing its own sustainability credentials. Compared to something like the carbon footprint of the transport sector, obviously the room for improvement is relatively small. But as an industry that accounts for around 10% of GDP and includes some of the most prominent names in the entire corporate sector, there is perhaps a point here around example-setting.

I’ve covered the mainstreaming of sustainability in financial services, and how financial services can play its part in promoting a more sustainable economy, and I want to make a point about the mainstreaming of sustainability in the real economy more widely. In other words, to address the question of how we integrate green and sustainable principles in post-pandemic economic rebuilding plans.

As I said, in financial services, one of the major obstacles to mainstreaming remains the lack of standardised definitions and benchmarks. But in the wider economy one of the big hurdles is a lack of technical expertise in various industries, and lack of resources. I’ve actually just published a post for my economics blog that details this idea and uses the example of green buildings to demonstrate some of the challenges with greening that part of the economy – very happy to share that work if it’s of interest. One point that I think comes out of that work is that because incentive structures are often not sufficient to promote sustainable business choices over non-sustainable ones, government regulation is going to be a major driver on this front for the foreseeable future.

Another point I want to touch on here is the importance of supporting small businesses if we’re going to have any hope of really integrating sustainability into the real economy.

Attaining the additional knowledge and skills required for more sustainable approaches - all the while continuing ‘business as usual’! - will require a lot of investment of time and, therefore, money. But leaving aside the firms specialising in sustainability issues, small businesses tend to have less expertise and fewer financial resources to deploy in this area than large firms do. I think this was implicitly recognised in the UK when, for example, smaller firms were exempted from the gender pay gap reporting requirement. And again, in the Covid-19 era, the resource challenge is even more acute since so many businesses will be focused on pure survival. But I think we should remember that SMEs make up 99.6% of all UK businesses and account for just under 50% of turnover. In that context, I think true mainstreaming of sustainability will be impossible unless all firms, regardless of their size, have the incentives and the support structures in place to make these issues central to their businesses.

In economics terms, that’s the producer side of the economy. But on the consumer side as well, coming back to the point about sustainability issues having become more, rather than less prominent during the pandemic. I think what we’ve seen so far is very encouraging, but I still think there’s a risk that as economic conditions get even tougher over the next several months, public attention will again focus more narrowly on jobs and GDP growth. Public-opinion research that TheCityUK commissioned shows that overall, the public is more concerned about a recovery than a sustainable recovery per se. So our challenge will be to demonstrate that sustainable growth is not an either/or, zero-sum game; and, that longer-term issues around sustainability shouldn’t be sidelined in favour of addressing short-term challenges.