Legal briefing | 18 Oct 2024 |

Travers Smith's Sustainability Insights: The role of government in transition finance

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A regular briefing for the alternative asset management industry.

Perhaps October will be the month when the new UK government hits its stride. After the missteps of the summer, the Prime Minister's team will certainly hope so, and – having pinned so much on growth – a lot will depend on the response of the business community to the significant policy announcements that are now coming thick and fast.

The budget on 30 October is the biggest set piece, of course, but this week's "International Investment Summit" was also a crucial opportunity for the government to set out its stall to domestic and international investors. Boosted by a letter from investors published on Monday headlined "Britain is ready for investment", the government announced that it had secured £63 billion of new investment as a result of its commitment to "serious, stable government".

Central to the government's side of this bargain is a commitment to streamline regulation. The Prime Minister was emphatic: "We will rip out the bureaucracy that blocks investment; we will march through the institutions; and we will make sure that every regulator in this country – especially our economic and competition regulators – takes growth as seriously as this room does."

This commitment builds on the announcement of a new Regulation Innovation Office, initially supporting the growth of four fast-growing areas of technology. Ministers are also reported to be preparing a letter to the FCA, pushing it to focus on the growth of the financial services industry.

Along similar lines, the Department for Environment, Food & Rural Affairs has announced a review into how its own role and the regulatory landscape it oversees can facilitate growth. There is of course a tension here: decarbonisation should not come at the expense of the natural environment, itself key to Net Zero – but DEFRA is sometimes seen as a blocker to growth.

But regulatory reform is not enough on its own. This week also saw a consultation on a new Industrial Strategy, with the public sector playing a "strategic and coordinating role" in supporting eight identified sectors.

Among the initiatives designed to unlock private capital are the re-branding and repurposing of the UK Infrastructure Bank as the National Wealth Fund, with £5.8 billion added to the £22 billion already allocated to it. Alongside that, a new "Business Growth Partnership" within the British Business Bank will aim to boost investment by pension funds into innovative companies, an announcement warmly welcomed by the BVCA.

One of the Industrial Strategy's eight targets for investment is clean energy, with the UK's Net Zero targets featuring heavily in the overall objectives of the initiative. It was timely, then, that the UK's Transition Finance Market Review (TFMR), set up by the previous government, also published its recommendations this week. If adopted, these could increase the attractiveness of transition investments for private capital firms.

One thing is clear: if Europe is to meet its decarbonisation targets, huge investment is needed. The European Commission has acknowledged the scale of the challenge, and Britain's renewed momentum is very welcome.

        
    
"…. there is also a recognition in the Review's recommendations that public money is needed to make some innovations investible, and government must be willing to partner with the private sector"

In fact, there have already been a few quick wins: for example, the UK is ending its effective embargo on new onshore wind projects, and ran a successful auction for clean energy subsides last month. But addressing other barriers to scaling established technologies – such as reforms to planning regulation and overhauling the grid – will take longer. This week's excellent Review endorses those policies but focuses its attention on access to finance for less established climate solutions, to support "an economy-wide transition to net zero".

The Review makes many important recommendations that will support access to finance and counter greenwashing. For example, a "Transition Finance Classification Scheme" is proposed, together with principles-based guidelines for transition finance frameworks. The Review is lukewarm about inclusion of transition activities in a taxonomy: while taxonomies are a very helpful point of reference, the approach to transition finance needs to be flexible and dynamic, rather than hard-wired.

Crucially, the Review notes that a focus on disclosure, financed emissions, and individual companies' net zero targets can also have unhelpful consequences, in some cases hindering the decarbonisation of activities that generate the most significant emissions. There was, however, strong support for mandatory, detailed, company-level transition plans, among other supporting measures, which is consistent with existing government policy – but more ambitious.

Clear policy signals are also key. As we discuss in our recent podcast, when the public sector is driving the train in the right direction, the private sector will jump on board. The Review is critical of the UK's "lack of clear sectoral decarbonisation pathways and whole-of-economy national transition planning" and makes suggestions for future government action.

But there is also a recognition in the Review's recommendations that public money is needed to make some innovations investible, and government must be willing to partner with the private sector to provide blended finance solutions. Much of the innovation that is needed will come from disruptors not incumbents, but the market will not deliver finance at the scale required without some risk-sharing by the public sector. Effective solutions will no doubt include some subsidies, tax incentives and carbon pricing, but well-designed blended finance models will de-risk investments and encourage profit-seeking investors to increase their allocations.

In this regard, it is especially important that the role of the private markets is recognised: the significant existing investment in low carbon energy assets by alternative asset managers demonstrates the importance of infrastructure, private equity and private credit funds to the transition. These funds are often ideally placed to take advantage of investible opportunities, large and small, and can move quickly to plug funding gaps if the risk / return profile fits.

With the right partnership between government and investors, the transition to a low carbon economy creates significant opportunities. No one initiative will make the difference needed, and the multi-layered approach adopted by the new UK government is hitting the right notes – even if the huge demands on the public purse will continue to drive scepticism that enough can be done to make the difference that is needed.