Amendment 3

Financial Services Bill - Report (1st Day) – in the House of Lords at 4:30 pm on 24th March 2021.

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Lord Oates:

Moved by Lord Oates

3: After Clause 5, insert the following new Clause—“Review of capital adequacy requirements risk weights(1) Within six months of the day on which this Act is passed the Prudential Regulation Authority must complete a review of the risk weighting applied to investments in—(a) existing fossil fuel exploitation and production, and(b) new fossil fuel exploration, exploitation and production.(2) In conducting this review, the Prudential Regulation Authority must have regard to—(a) the need to prevent the misallocation of investment to global warming accelerating activities as a result of artificially low risk weights; (b) the full implications of climate change for the risk of investments including physical climate risks, transitional climate risks and climate liability risks;(c) the likelihood of assets becoming wholly or partially stranded before the end of their normal exploitation cycle;(d) the impact of global warming accelerating activities on financial stability, in particular as a result of climate change related disruption of the economy; and(e) the advice of the Climate Change Committee.(3) The Treasury must lay before Parliament the outcome of this review within one month of the completion of the review.”Member’s explanatory statementThe purpose of this amendment is to place a requirement on the PRA to review the adequacy of risk weights applied to fossil fuel exposures in capital requirements having regard to the implications of climate change.

Photo of Lord Oates Lord Oates Liberal Democrat Lords Spokesperson (Energy and Climate Change)

My Lords, I declare my interest as the chairman of the advisory committee of Weber Shandwick UK. Amendment 3 is in my name and the names of the noble Baronesses, Lady Hayman, Lady Jones of Whitchurch and Lady Altmann. I thank all the organisations who provided me with briefing, in particular Finance Watch for its helpful advice and recommendations.

Before I speak to Amendment 3, I also want to express support for other amendments in this group, particularly Amendments 22 and 23 in the name of the noble Baroness, Lady Hayman, which deal respectively with climate risk reporting and the appointment of a senior FCA manager responsible for climate change. I have been pleased to put my name to both.

In Committee we had an excellent and productive debate about the impact of climate risk on the financial system and the wider economy. I am grateful to the Minister for his careful consideration of the arguments, and to noble friends and colleagues across the House for the excellent cross-party co-operation we have achieved on these issues. I thank the Minister for listening to the arguments on the need for the FCA and PRA to have regard to the UK’s 2050 net zero obligations and for introducing government amendments to achieve this end. That is a great step forward.

If we are effectively to respond to the existential threat climate change poses to our financial system—indeed, to our whole human society—finance will be critical in allocating the huge amounts of capital required to decarbonise the global economy. Today, however, finance is the principal enabler of climate change by financing the global warming-accelerating activities of the fossil fuel industries at an artificially low cost as a result of the inadequate pricing of climate risk within the financial system.

As long as capital adequacy risk weights are inconsistently applied within the capital requirement rules so that fossil fuel activities are under-risked, capital will flow towards them because the equity that has to be held on the bank’s balance sheet will be less than it should be and the return on equity consequently better than it should be. As a result, capital which could be better employed in the new technologies we will need to counter climate change will continue to be misallocated to the old industries that drive it.

Amendment 3 attempts to address this problem by requiring the PRA to complete a review of capital adequacy risk weightings in relation to existing and new fossil fuel investments within six months of the Bill being passed. That review would aim to ensure that risk weights for fossil fuel investments adequately take into account the impact of global warming-accelerating activities on financial stability, in particular as a result of climate change-related disruption to the economy.

This amendment is an attempt to meet the concerns of the Minister over my more direct amendment in Committee, which called for specific risk weights to be applied to fossil fuel investments in line with the existing capital adequacy rules of the capital requirement regulations, or CRR. The amendment in Committee required the application of a 150% risk weight to existing fossil fuel investment, in line with Article 128 of the CRR. That requires such a risk weight to be applied to

“items associated with particular high risk”,

for example, hedge funds or investments in immovable property.

It is clearly hard to argue that fossil fuel investments are less risky than either immovable property or hedge funds investments, given the likelihood of fossil fuel assets becoming partially or wholly stranded. The logic of CRR is, therefore, that such investments must be included under Article 128. That they are not indicates that the regulatory system is struggling to respond to the complex and interrelated risks posed by climate change to the financial system.

The original amendment also proposed that, for new fossil exploration and production, the risk weight should be applied such that investment in these activities would have to be backed by 100% equity on the lender’s balance sheet. Such a risk weight is merited by the fact that new fossil fuel investments are likely to become entirely stranded and that exploitation of new fossil fuel investments would push us far beyond the level of two degrees of warming that the Intergovernmental Panel on Climate Change warns us would have enormous and unpredictable consequences for human society, not to mention the banks and the financial system as a whole. It is right in those circumstances that the resulting loss of capital should be effectively ring-fenced so that the problem is confined to the bank equity holders and not allowed to spread to depositors and the wider financial system—adding a financial crisis to a climate crisis.

It is fair to say that the Minister and a minority of other Peers were resistant to the direct approach to risk weights I proposed. The Minister was concerned, as was the noble Baroness, Lady Noakes, that we were seeking to use prudential regulation to achieve policy objectives that they felt were better pursued elsewhere. The noble Baroness stressed that the system of prudential regulation should be about the

“risk to the capital of the banks and the resilience of the financial system as whole.”—[GC 244.]">Official Report, 1/3/21; col. GC 244.]

To this, I can say only that I agree; that is the precise purpose of the amendments that my noble friends and colleagues across the House and I have been pursuing.

Last week, the deputy governor for prudential regulation and CEO of the PRA Sam Woods stated in a speech to the Association of British Insurers that

“it is a fundamental pillar of the prudential regime that it be risk-based: disregarding the risk in individual investments is a recipe for an under-capitalized financial system that would not be a robust or sustainable source of investment.”

I agree with the deputy governor, just as I agree with the Minister. My only difficulty is that the disregarding of risk in individual investments, which the deputy governor warns us against, is exactly what is happening in respect of fossil fuel investment because prudential regulation has not worked out how to adequately assess the impacts of climate change on the financial system.

The scale of the problem was highlighted by Mark Carney in his “Breaking the Tragedy of the Horizon” speech some years ago. He said:

“Take, for example, the IPCC’s estimate of a carbon budget that would likely limit global temperature rises to 2 degrees above pre-industrial levels. That budget amounts to between 1/5th and 1/3rd world’s proven reserves of oil, gas and coal. If that estimate is even approximately correct it would render the vast majority of reserves “stranded”—oil, gas and coal that will be literally unburnable without expensive carbon capture technology, which itself alters fossil fuel economics. The exposure of UK investors, including insurance companies, to these shifts is potentially huge.”

Is anyone seriously suggesting that these risks are currently being properly taken into account in the capital adequacy risk weights? If they were, it is inconceivable that existing fossil fuel investments would not be ranked under Article 128 of CRR as items associated with particular high risk. Of course, investments in new fossil fuel exploitation pose not only micro-prudential risks to banks arising from stranded assets, but the huge macro-prudential risks due to the acceleration of climate change which they will cause.

The Minister sought to assure us in the debate in Committee that the regulators have these matters under control. He prayed in aid, as did the noble Baroness, Lady Noakes, the climate scenario tests that the Bank will be conducting later in the year. These are no doubt worthwhile exercises and it is good to see that the Bank is setting the international pace. But these scenario tests will not fix the issue.

Although the Governor of the Bank implicitly recognises the role that capital adequacy requirements need to play in addressing climate-associated risks when he says that supervisory expectations will require firms to assess how climate risks could impact their businesses and to review whether additional capital needs to be held against this, he also states that, in relation to climate scenario tests, the Bank will not use them to size firms’ capital buffers. The reason the Bank is reluctant to do so is the difficulty of using such tests to measure hard-to-quantify future risk. So we have a dangerous scenario when regulators say that they cannot act until they can adequately measure risk, and on the other hand that the risk is too difficult to measure. The route through this is to apply the existing capital adequacy risk weights in an internally consistent manner, as proposed by the amendment that we put at Committee.

Although I stand by that position because I believe it is the only logically coherent and feasible way of dealing with risk in respect of fossil fuel activities, I have listened to the Minister’s arguments and those of the noble Baroness, and consequently I have put forward this revised amendment to require the PRA instead to conduct a review of the issue of risk weights and climate change and report back to the House. This will provide an opportunity to consider carefully the issues raised and also to inform the debate on risk weights at international level. I hope the Minister will see merit in this proposal.

I made it clear in Committee, and I stress again on Report, that neither my amendment then, nor the revised version before your Lordships today, is driven by any animus against the fossil fuel industries—quite the contrary. I have a huge respect for the people working in those industries and a huge determination that there should be a just transition for those employees as we decarbonise our economy. We will be able to achieve that much more easily if the financial system shepherds an orderly transition away from fossil fuel industries through the appropriate application of risk in the system.

I understand the reluctance of the Government to intervene in prudential regulation, but Ministers cannot abdicate responsibility. They must not cling to the idea that the technicians have got this under control, because it is an illusion—and it is an illusion that will have disastrous consequences if it is not corrected. When the system of prudential regulation is so evidently failing in its primary task of managing and controlling risk in the financial system, at least in respect of climate risks, there is an obligation to act. So I am hopeful that, having listened to the arguments during the debate, the Minister will accept the case for the review and provide sufficient assurance that this will be taken forward in a timely manner. However, if he is not able to do so, I give notice of my intention to test the opinion of the House. I beg to move.

Photo of Baroness Hayman Baroness Hayman Crossbench

My Lords, I remind the House of my interests as co-chair of Peers for the Planet. I have Amendments 22 and 23 in this group and will speak also to the government amendments and Amendment 44, from the noble Baroness, Lady Bennett. I have added my name to Amendment 3, to which the noble Lord, Lord Oates, has just spoken so powerfully.

Before I speak to any of the amendments, I will thank colleagues, the noble Lord, Lord Oates, and the noble Baronesses, Lady Jones, Lady Altmann and Lady Bennett, who have added their names to my amendments. I thank very particularly the Minister and his team for their very approachable actions in relation to discussions since Committee. They have been engaged in a sensitive and constructive way, and the noble Earl, as we have come to expect, has always been extremely courteous, endlessly patient and generous with his time. I think we have made real progress because of that.

Amendment 3 was very clearly and, as I say, forcefully introduced by the noble Lord, Lord Oates, on the review of capital adequacy risk weighting. The recent report of the climate change committee’s advisory group on finance, The Road to Net-Zero Finance, made clear the need to,

“shift the mindset from managing climate risks to aligning finance with net-zero” and

“make real economy policies investable to attract capital”.

One key way to achieve this would be to address the issue of capital risk weightings by recognising the extremely high risk of investments in new and existing fossil fuel extraction becoming stranded. We do not currently recognise this in the system in the way we attach capital risk weightings and, as a result, financial institutions continue to invest trillions in fossil fuels: $2.7 trillion since the Paris agreement. This amendment asks that a review of fossil fuel risk weightings be carried out in order to consider the full implications of climate change and how it could affect the overall stability of the financial system.

The noble Lord, Lord Oates, has made changes to the amendment, taking into account, as he said, the criticisms and arguments made in Committee. The situation is urgent. I fear that we do not have the time to allow the market to adjust by itself without government action. Only last week the Met Office announced that CO2 levels had exceeded 417 parts per million—more than 50% above pre-industrial levels. This is due mainly to fossil fuel burning. So I hope that the Minister will indicate the Government’s recognition of the importance of this issue, and their commitment to looking very carefully at what is a fundamental underpinning that is necessary to the transition to a sustainable financial and economic future.

On the government amendments, I repeat my gratitude for the Minister’s approach, and very much welcome the amendments that he has tabled. These measures will ensure that the regulators must have regard to climate change targets when making new regulations. I would be grateful if the Minister could confirm that the provisions will be in place in time for the important changes relating to the Basel 3.1 standards. I hope, too, that the Minister will be able to respond positively to Amendment 44, tabled by the noble Baroness, Lady Bennett, which would add UK biodiversity commitments to the have-regard provisions. I recognise that there are difficulties with metrics in this area, but it is an extremely important issue, so I wonder whether the Minister could comment on whether nature-related financial risks could be added to these TCFD obligations.

These are very significant amendments which will ensure that the Bill is no longer, as it was when it came from another place, silent on climate change. But there is a great deal more to be done to ensure that climate change is embedded across discussions and decision-making at a systemic level within our financial services industry.

That is what my Amendment 22 attempts to do—to make sure that we have systemic reporting on climate change and proper scrutiny of that reporting, and that climate change is taken properly into account when consulting on changes to prudential regimes. It would provide a scrutiny and reporting framework to ensure that the FCA reports regularly on how it has evaluated systemic exposure to climate-related financial risks, and that that is scrutinised by Parliament. As the noble Lord, Lord Oates, said, the Bank of England’s climate stress test exercise for some key institutions is valuable, but we really need further, and systemic, reporting to be planned for the future.

The European Central Bank is undertaking an economic stress test to gauge the impact of climate change on 4 million companies and 2,000 banks over 30 years. The preliminary results have identified climate change as

“a major source of systemic risk, particularly for banks with portfolios concentrated in certain economic sectors”.

The vice-president of the ECB also commented:

“These results underline the crucial and urgent need to transition to a greener economy … to limit the long-run disruption to our economies, businesses and livelihoods”.

The UK regulators have a key role to play in ensuring that a long-term systemic approach to assessing the reporting on climate risk is adopted. That is why my amendment calls for a review of the regulators’ objectives, with a view to including consideration of net zero targets within their remit.

The Budget Statement indicated that the Financial Stability Committee and the MPC would take those risks into account within their remit, and I hope that that will be extended, both to the FCA and the PRA. It would be helpful if the Minister could tell us when the next PRA/FCA remit letters will be published. However, they alone, even if changed, will not be sufficient to address the challenges of climate change, so will the Minister commit to setting out the strategy and road map for how the sector will achieve that?

Mark Carney recently said that climate change will be

“the equivalent of a coronavirus crisis every year from the middle of this century, and every year, not just a one-off event. So it is an issue that needs to be addressed now.”

The amendment sets out ways in which the direction of travel for regulators to drive the systemic change we need could be achieved. I hope that the Minister will be able to respond positively to it.

Finally, my Amendment 23 mirrors the other in almost every detail—although again, I listened to the noble Baroness, Lady Noakes, and made some changes in it as regards board level appointments. It deals with the important point that would help to drive the shift in mindset that we need. Financial regulators require financial institutions, under the senior managers regime, to appoint a senior manager responsible for identifying and managing financial risk from climate change, and reporting on it.

In discussion with the Minister, I suggested that even if we did not include this in the Bill, it would be helpful for the regulators themselves to take that step. So I was pleased when, in the letters that were referred to earlier, the chief executive of the FCA set out his recruitment of an executive sponsor for climate-related risks. That is extremely welcome news, and in the context of the other comment that was made on the previous amendment—that it should go wider than climate—I recognise that the FCA remit would include all the ESG standards. That too is welcome, and I thank the Minister and the FCA for all their work in this area.

Throughout the passage of the Bill and in many other fora, the Government have made it clear in their rhetoric that they understand the overwhelming importance of climate risk. These amendments would lay the foundation of turning those words into action, and I hope that the Minister will be able to respond positively to them.

Photo of Baroness Bennett of Manor Castle Baroness Bennett of Manor Castle Green 4:45 pm, 24th March 2021

My Lords, it is a great pleasure to follow the noble Baroness, Lady Hayman, who is taking such a brilliant lead on these issues in your Lordships’ House. I thank her for her concentration on the biodiversity crisis as well as the climate emergency. Reflecting on her comments, I too hope that this is the last time it will be up to this House to add the missing element of climate to a financial Bill. Maybe for biodiversity we can proceed even faster. I too welcome the news about the FCA appointments—although putting that into the Bill, as Amendment 23 would do, would be better, because it would provide a statutory guarantee that such an appointment would continue.

I shall speak to Amendments 3, 22, 23 and 44. Amendment 44 is in my name, and Amendment 3 is in the name of the noble Lord, Lord Oates, and others. Amendments 22 and 23, to which I have attached my name, are in the name of the noble Baroness, Lady Hayman. I shall speak to Amendments 3, 22 and 23 together.

I had cause this morning to reflect back on the work of your Lordships’ house, by a similarly small and dedicated band, on the Medicines and Medical Devices Bill. At that team’s heart was the noble Baroness, Lady Cumberlege, author of the recent review often referred to by her name, but actually entitled First Do No Harm. Would that we could see the financial sector adopting that principle. Instead, it continues to pump funds into destroying the planet at breakneck speed.

An independent report by a coalition of NGOs, out this morning, shows that the world’s biggest 60 banks have provided $3.8 trillion-worth of financing for fossil fuel companies since the Paris climate deal in 2015. In our home sector, UK bank Barclays provides the most fossil fuel financing of all European banks—and the finance provided in 2020 was more than in 2016 or 2017.

The report notes that a commitment to be net zero by 2050 has been made by 17 of the 60 banks, but the report describes the pledges as “dangerously weak, half-baked, or vague”. It is clear that self-regulation—however much the Government may be wedded ideologically to the idea—has not worked. And we are in an emergency: we cannot wait.

Johan Frijns, at BankTrack, part of the coalition behind the report, says:

“there exists no pathway towards this laudable goal”— net zero—

“that does not require dealing with bank finance for the fossil fuel industry right here and now.”

These amendments do not go that far, but they least set us on the right track—a track to transparency that does not require little-funded NGOs to dig well-buried data out of dark corners.

None the less, as others have noted, we have made some progress since Committee stage, and I welcome the government amendments in this group, which reverse the Government’s claim, made to me in Committee, that we did not need a reference to the climate emergency in the Bill. This will be, I believe, after the Pension Schemes Act, the second financial Bill to start to acknowledge the truth of doughnut economics—that the economy, and all human life, has to live within planetary limits.

That brings me to my Amendment 44, which addresses biodiversity. It is an addition to the government amendment requiring the FCA to “have regard to” the carbon target for 2050 when making Part 9C rules. My amendment simply adds another “with regard to”—in this case to the UK commitments under the UN Convention on Biological Diversity.

I referred to planetary limits. We are not yet focused nearly enough on the fact that the atmospheric carbon dioxide levels, at 417 parts per million today, is only one way in which we are outside the doughnut of sustainability. There is also the collapse of the natural world, as the globe’s Governments have acknowledged with the Convention on Biological Diversity, to which the UK is of course a signatory.

At the moment I am not planning to push this amendment to a vote, despite the extreme urgency in this nation that is at the bottom of global biodiversity rankings, in a world in which none of the globally agreed targets on biodiversity is set to be delivered in 2030. The obvious point to do that would be after we have a UK target, and I am sure the Minister is well aware of the broadly backed NGO-driven push to include a 2030 nature target in the Environment Bill. That would provide an ideal element to include in financial regulation.

What is finance doing to biodiversity? That is not an area that has been well enough discussed. We do not have the kind of detailed reports of the type I referred to earlier on the climate emergency—at least, not that I am aware of. However, if we think about the level of destructive economic activity overall, it is not hard to think of examples, including the operation of industrial-scale agricultural monoculture, deforestation and trashing of soils and the production of destructive agrichemicals and fertilisers, which also have massive carbon implications.

Then there is the financing of fast fashion and the production of artificial fibres, plastics that will choke our seas and fill our rubbish systems. Giant factory ships are vacuuming up sea life and heavy trawlers are trashing the seabed, with massive carbon implications also. Financing any of these and many more economic activities is doing massive harm. As with climate, as the Government have acknowledged to at least a limited degree, regulation is essential.

We are slowly making progress, but the stress has to be on “slow”—it is not nearly fast enough. Amendment 3, proposed by the noble Lord, Lord Oates, would be a further step forward. It is needed to improve the immediate response. If it is pushed to the vote, I can promise the backing of the Green group, should the Minister not acknowledge the force of the noble Lord’s arguments.

Photo of Baroness McIntosh of Pickering Baroness McIntosh of Pickering Conservative 5:00 pm, 24th March 2021

My Lords, I am delighted to follow the noble Baroness and to contribute to this debate. I very much welcome the amendments in the name of the Minister, my noble friend Lord Howe, in this group, particularly Amendments 43, 46 and 47 onwards, requiring the FCA to have regard to the carbon target for 2050 when making part 9C rules, as set out.

I always listen to what the noble Lord, Lord Oates, says—we entered the House on the same day and are of the same vintage, so to speak—but I welcome the fact that the Government recognise the risks arising from climate change. The Minister addressed the issue of stranded assets, an issue on which I share his concern, and the transition plan out of them. I think that was addressed in Committee in so far as my noble friend said then that

“the point of the Bill is to support a flexible regulatory system that can respond to changing circumstances and developments as they arise.”— [OfficialReport, 1/3/21; col. 258GC.]

The noble Baroness, Lady Bennett, spoke about those technologies and forms of energy that can do harm. I am personally concerned that in Amendments 3, 22, 23 and 44, spoken to so eloquently by the noble Baronesses, Lady Hayman and Baroness Bennett, the focus is still very much on moving at the earliest possible opportunity and timetable away from fossil fuels. What worries me increasingly is our fixation on renewables, which on the face of it seem to be performing extremely well both onshore and offshore.

We on the EU Environment Sub-Committee have just completed our last piece of work, looking at the ecology of the North Sea. It is apparent from the evidence that we took that there is a lack of research on the impact of renewable energy offshore facilities on North Sea ecology, particularly marine life—dolphins, porpoises and whales—bird life and the whole sea biodiversity. A plea was made that the cumulative impact should be considered and that we should assess and value all the natural capital, not just the ability to create wind but what we are losing. In particular, it was put to us that we should consider the impact of these renewables, particularly offshore wind, on other users, such as, as in this case, fisheries and shipping.

Mention has also been made of the work going on in the Basel framework. I hope the Minister will give us an update on that. I am concerned that some of the amendments here, particularly Amendment 3, but others as well, may pre-empt and not have regard to the international work that will help us to understand how climate risk should be considered through the Basel framework and working with our international partners.

I pay very close regard to what those such as Mark Carney and the current deputy governor of the Bank of England say, but equally I was struck by the remarks of the noble Lord, Lord King of Lothbury, in the debate on the Budget Statement, where he expressed concern about the new remit requiring the Bank of England to

“reflect the importance of environmental sustainability and the transition to net zero”.—[Official Report,12/3/21; col 1914.]

In the context of the Financial Services Bill we are seeking, as I understand it, to have a flexible regulatory system, as my noble friend explained, that will be able to respond to circumstances as they develop. I imagine that it is the role of the Government rather than the regulators to set the policy, but I stand to be corrected by my noble friend.

I welcome the opportunity to have this debate. When it comes to net zero, climate change and environmental sustainability, obviously there will be a move away from fossil fuels, but no one has yet explained to me how we are going to attempt to fulfil all our energy requirements in what will be virtually all electricity supplied to the market.

With those few remarks, I look forward to the Minister bringing together all the themes of this debate.

Photo of Baroness Sheehan Baroness Sheehan Liberal Democrat Lords Spokesperson (International Development)

My Lords, it is a pleasure to follow the noble Baroness, Lady McIntosh. I thank the Minister for some movement on this issue. His courtesy throughout has been an example to all of us. I thank him for his correspondence on the issues that I raised in Committee, some of which I will return to later in my contribution.

I congratulate the noble Lords who moved amendments on climate risk in Committee, without which we would not be where we are today. The amendments were cogently argued and evidently persuasive, if only partially so, which is why a number of them have been brought back, albeit slightly amended, on Report.

I support Amendment 3 in the name of my noble friend Lord Oates and the noble Baronesses, Lady Altmann, Lady Hayman and Lady Jones of Whitchurch. It makes a strong case, with support from across your Lordships’ House, for a PRA review of the risk weighting applied to investments in existing and new fossil fuel exploration, exploitation and production. Amendment 22, in the name of the noble Baroness, Lady Hayman, seeks to embed evaluation of climate-related financial risks, and consideration of the impact of such risks on the stability of the UK financial system, in the modus operandi of the FCA and the PRA. Amendment 23, also in the name of the noble Baroness, Lady Hayman, provides for the appointment of a senior manager within the FCA with responsibility for climate change—and movement on this by the regulator, as she outlined in her earlier contribution, is welcome. Amendment 44, in the name of the noble Baroness, Lady Bennett, makes huge sense in the context of the recent Dasgupta review. I hope that the Minister will give it sympathetic consideration.

I need say no more about the content of these amendments, as I would only be repeating the excellent contributions of those who tabled them. Suffice to say that, if adopted, all three would send the right policy signals that the Government mean what they say when they speak of a climate emergency. Those signals are sorely needed because the signals presently being received by investors and, indeed, by all sectors of society, are confusing and misleading. We have a Government leading on ending the use of coal for power generation—the Powering Past Coal Alliance—who then toy with the idea of granting a licence to a new deep coal mine in Cumbria. The Government announced in December last year that they would end UK support for fossil-fuel projects overseas. Will the Minister say whether UK Export Finance’s support for the controversial east African crude oil pipeline—EACOP—which extends from Uganda to Tanzania, will be a done deal before the new March deadline just announced?

Just today, we have a garbled press release on supporting vulnerable communities in the north-east and Scotland, which will be affected by the transition away from fossil fuels. This is justified in the press release by an unexplained decrease in emissions by the oil and gas sector. These communities deserve better. In the same press release, we are told that this decrease in emissions will be achieved by a new regime to hand out new licences to explore for and exploit as yet undiscovered fields. I am confused. Can the Minister shed some light?

Is the Minister also able to shed any light on whether the Government will bring forward legislation to align the Oil and Gas Authority’s remit to our net-zero target, thus drawing a line under the current policy of maximising economic revenue, or MER? That might serve to remove some of the confusion. How can new licences be justified when extraction of the oil and gas in our existing fields will take us over our share of emissions under the Paris agreement? Surely the Government, in a climate emergency which they themselves declared, are not relying on reducing emissions via carbon capture, usage and storage, a technology which is unproven at scale?

Meanwhile, back in the real world, the NASA website tells us that 2020 was the hottest year since records began, while the World Meteorological Organization states that 2011-20 was the warmest decade on record. The warmest six years have all been since 2015—2016, 2019 and 2020 being the top three. The World Meteorological Organization’s secretary-general, Professor Taalas, said:

“It is remarkable that temperatures in 2020 were virtually on a par with 2016, when we saw one of the strongest El Niño warming events on record. This is a clear indication that the global signal from human-induced climate change is now as powerful as the force of nature.”

That is a chilling thought.

I will end with one last thought: temperature is just one of the indicators of climate change. The others are greenhouse gas concentrations, ocean heat content, ocean pH, global mean sea level, glacial mass, sea ice extent and extreme events. All are moving in the wrong direction. I hope that the Minister will be able to give a satisfactory commitment that climate risk in the financial sector will be satisfactorily legislated for. In the absence of such assurances, I will support amendments on the issue that are put to a Division.

Photo of Viscount Trenchard Viscount Trenchard Conservative 5:15 pm, 24th March 2021

My Lords, the noble Lord, Lord Oates, and the noble Baroness, Lady Hayman, eloquently introduced Amendment 3. There was much discussion on this matter in Committee but I still consider that such a review would place too heavy a burden, and a disproportionate one at that, on the PRA. I thank my noble friend the Minister for the diligent manner in which he has responded to noble Lords’ concerns about raising the importance of climate-change issues in the list of factors to which our regulators must have regard in making rules.

The Government’s credentials as global leaders in the movement away from reliance on fossil fuels are well established and will, I hope, be further enhanced by the G7 meetings and the COP 26 conference later this year. However, this should be kept in perspective and balanced against the need for economic recovery and the needs of industry. There is no point in pricing what remains of our steel industry out of the market if the result would be an increase in imports from countries which have not adopted energy policies as green as ours, especially if the impact on global emissions is negligible.

When I first read my noble friend Earl Howe’s amendments I was puzzled, because it seemed that he was giving with one hand and taking away with the other. I look forward to his clarification of how Amendments 43, 46, 47 and 49 net off against each other.

I am loath to saddle the regulators with increased obligations which go beyond the practices that they have already adopted. The letter from Sam Woods makes it clear that climate change is already an important consideration in the PRA’s supervision and regulation of banks and insurers, under its existing statutory objectives. Similarly, the letter from Nikhil Rathi makes it clear that the FCA is committed to helping market participants manage the risks in moving to a low-carbon economy and supports the commitment to match, at least, the ambition of the EU sustainable finance action plan in the UK. Since the FCA has already decided to recruit a director with specific responsibility for ESG matters, I do not think that Amendment 23, in the name of the noble Baroness, Lady Hayman, is necessary. The remit of the senior manager whom she suggests should be appointed would clash with that of the new director who is already in the process of being recruited.

Amendment 22, in the name of the noble Baroness, Lady Hayman, also goes too far and is too prescriptive. My noble friend the Minister was right when he said to the Committee, on 24 February, that

“it is important that we act carefully and rationally, consult appropriately with interested parties and therefore make progress in the right way.”

He was also right in stating that

“the changes the Bill enables serve to implement a number of vital reforms following the financial crisis. These reforms reinforce the safety and soundness of the UK financial system.”—[GC 224.]">Official Report, 24/2/21; col. GC 224.]

Surely we should not amend the Bill in any way that might prevent us giving effect to updated prudential rules. I also agree that there is no evidence that greener means prudentially safer, at least not yet. Therefore, it is not clear that a regulator, whose primary objective is the safety and soundness of financial institutions, should be burdened with disproportionate climate obligations now, especially at a time when it is essential to maintain and enhance the competitiveness and attractiveness of the UK’s financial markets. With regard to individual regulators’ objectives and rule-making powers on climate change-related risks, the ABI recommends the need for holistic debate across stakeholders before adding new objectives to the remit of regulators, given the need to balance the various priorities. I believe that my noble friend’s amendments strike the right balance, and I will support them.

While I agree with the noble Baroness, Lady Bennett of Manor Castle, that biodiversity is important, I believe she wants to go a step too far in her Amendment 44 in adding this to the FCA’s “have regard to.” There are countless other policies that could be added, but too many will muddy the waters and distract the FCA from its efficient operation in performing its core duties and objectives.

Photo of Lord Judd Lord Judd Labour

My Lords, these amendments, and this Bill, are crucial to the future of the United Kingdom. We have heard repeatedly in the arguments deployed of an interaction. There is the need for financial services to be successful and effective because they play such an important part in ensuring the well-being on which the rest of our society depends. That is beyond question. However, we know that they have implications, socially and beyond, for which they need regulation, and this has been well spelled out.

I shall focus on Amendments 3, 22, 23 and 44 in particular. Fossil fuels inevitably have considerable and extensive risks for the climate. There can be no argument about that. They have great implications in terms of climate change, and I am glad to see that Amendment 3 is grappling with this.

Amendment 22 deals with the point I have just made in that climate change poses risks to financial services. Therefore, it is essential to have the right arrangements in place to ensure that those risks are, if not eliminated, minimised.

Amendment 23 makes the point I have often felt strongly about in legislation: it is sometimes crucial to have a specific person carrying a specific responsibility for bringing together the various threads in the policy for which we are aiming and ensure their delivery. It is a good amendment.

I do not share the rather dismissive approach of the noble Viscount, Lord Trenchard, to Amendment 44. My view is that the noble Baroness, Lady Bennett of Manor Castle, deserves considerable commendation for having tabled this amendment. We have happily joined these UN conventions, and our diplomats have usually played a large part in bringing them about, but we sometimes lack the discipline to follow through with what they require of us. At this point in our consideration of the Bill, it is appropriate to talk about the convention and the undertakings we have thereby committed ourselves to on biodiversity. On that issue, I find myself dismayed by the position of the noble Viscount, Lord Trenchard, because we are surrounded by a major crisis. The biodiversity of the world is in danger of collapse, and the consequences have direct implications for the survival of humanity itself. There is urgency about this situation.

In conclusion, I simply make this point: I said that we wanted the financial services sector to be successful and effective, because we recognise its indispensability, but we also must recognise that on climate change, we are long past the age of rhetorical language and theoretical commitment. We have to demonstrate that we have the leverage and the arrangements in place to ensure delivery; if we do not ensure delivery on the measures we want to see to protect the climate, we will be party to a cruise towards catastrophe for the global community. It is vital to have these disciplines, and these amendments spell out how we can bring those disciplines to bear.

Photo of Baroness Noakes Baroness Noakes Conservative

My Lords, I shall speak mainly to Amendments 3 and 23 in this group.

On Amendment 3, I should say I am not generally in favour of littering legislation with reviews, though I confess to having tabled a few amendments of that nature myself in the past. More substantively, I think this particular amendment as drafted is a waste of time.

I can predict the outcome of the review if this amendment is passed. The PRA will find that banks do not hold any significant “investments”—the wording used in the amendment—in fossil fuel assets, whether linked to existing exploitation and production or to new exploration. So all the things mentioned in proposed subsection (2) of the amendment will be irrelevant.

Risk weighting applies to the assets that banks hold. Banks’ assets will largely be loans of various kinds. Banks do not normally invest in physical assets used by other companies, nor do they invest in shares in the companies that own the assets. Banking is fundamentally about lending and not investing.

The noble Lord, Lord Oates, cited the recent speech by the deputy governor talking about prudential regulation being risk-based, which indeed it is, but he failed to understand that he was talking to insurers at the time. They do have investments. This is a fundamental difference between banks and insurers—they have completely different balance sheets.

As I said in Committee, most borrowing by oil and gas companies will be generic—for example, by way of bond issuance or commercial paper—and by one of the companies in a group. It will not be hypothecated to individual assets or groups of assets. Money is fungible and cannot be linked to any specific use. Bank balance sheets might have some leasing arrangements that might be caught by this amendment, but my main point is that the amendment is fundamentally aimed at the wrong target and, therefore, amounts to not much more than virtue signalling.

There is a case for looking holistically at how climate-related financial risk should be reflected in banks’ capital requirements, as amendments in this group in the name of my noble friend the Minister may achieve in due course. The Bank of England and the PRA are already alert to this and have an extensive programme of work to explore the issues, including the exploratory stress test built around climate change, which will take place this year and which was referred to by the noble Lord, Lord Oates. I do not think that my noble friend the Minister’s amendments in this group are necessary, but they certainly do no harm in that context.

The noble Lords proposing Amendment 3 also need to understand that this is not an immediate issue for the prudential capital measurement of banks. Noble Lords might themselves see climate change as an emergency, but there is no emergency embedded in banks’ balance sheets. Corporate lending is short to medium-term in nature, and it would be very surprising if the Bank of England or other global regulators saw a need for significant near-term adjustments to capital. Even Mark Carney—the high priest in this area—has not suggested that.

The other amendment that I wish to speak to in this group is Amendment 23, which would require the FCA to appoint a senior manager with responsibility for climate change. This is certainly an improvement on the amendment that I criticised in Committee, which would have required a full member of the FCA’s board to be appointed, but I believe that the amendment is still imperfect because it refers to that person having “responsibility for climate change”. It is not at all clear that “responsibility for climate change” could have any meaning, as it is not related to any of the general duties or objectives of the FCA as set out in FiSMA.

In 2019, the PRA introduced a requirement for banks and insurers to allocate climate change responsibilities to one or more of the senior management functions, and that has to be included in their formal statements of responsibilities. The PRA framed that as responsibility for

“identifying and managing financial risks from climate change”.

This is a more understandable format than “responsibility for climate change”, but that kind of format clearly cannot be lifted and shifted directly into the FCA environment without further tailoring about what the FCA is actually expected to do.

It is a mystery to me why the proposers of the amendment have singled out the FCA, rather than the PRA, as requiring a senior manager to be appointed. While both are involved in the current work on the impact of climate change, the PRA has been more in the lead on this. It was the PRA, not the FCA, that specified the need for a senior manager to exist in the structures of regulated bodies. The PRA has already nominated one of its executive directors to oversee

“the Bank of England’s work enhancing the financial system’s resilience to climate change.”

The noble Baroness, Lady Hayman, noted that there is a new appointment at a slightly lower level at the FCA, although I think there is less clarity about what that person will actually be doing on climate change.

I am not convinced that anything is actually required in statute, given that both bodies have moved towards identifying individuals with responsibilities in this area, but if the proposers of the amendment wish to take it forward they should look much more carefully at how it is drafted.

Photo of Lord Holmes of Richmond Lord Holmes of Richmond Conservative 5:30 pm, 24th March 2021

My Lords, it is a pleasure to follow my noble friend Lady Noakes. In essence, since we are on Report on a Financial Services Bill, these amendments can, I hope, be rightly summed up as, “What point profit if no planet to spend it on?” But, as the term “global warming” clearly sets out, it is collectively a global issue, not a national one. In this context, I give more than a nod towards our involvement with the whole Basel process and the letter from Mr Sam Woods on this issue.

I support the amendments tabled by my noble friend the Minister. They strike the right balance on the need for transition—not in any sense slow or fast, but a transition—to get to where we need to get to across financial services and the wider economy. As noble Lords commented, there is no benefit—quite the opposite—in taking an approach to a particular industry in a particular region of United Kingdom only to have a more catastrophic climate impact by having to shore up resource from other parts of the globe.

In short, the PRA has a role to play, as do all elements in the financial services sector. More can probably be done on the use of new technologies and the measurement of how funds and various assets are performing in this sense. That is certainly in our grasp; it is not a matter for this group of amendments, but it could well provide much of the solution, and certainly the clarity and accountability that would come through in the course of business.

I fundamentally agree with my noble friend Lady Noakes’s commentary on how large corporates go about their funding—[Connection lost.]

Photo of Baroness McIntosh of Hudnall Baroness McIntosh of Hudnall Deputy Chairman of Committees, Deputy Speaker (Lords)

We appear to have lost contact with the noble Lord, Lord Holmes. Perhaps we should move on to the next contributor, the noble Baroness, Lady Altmann.

Photo of Baroness Altmann Baroness Altmann Conservative

My Lords, I have added my name to Amendment 3, moved so excellently by the noble Lord, Lord Oates. I congratulate him on his work on the issues relevant to this group of amendments.

I also commend my noble friend the Minister and his department for listening to the concerns expressed in Committee and for laying his own amendments to the Bill, which previously made no mention of climate change at all. I believe that the Government are committed to making a real difference on climate change and environmental issues, and have recognised the dangers that our precious planet faces due to climate change and biodiversity risks, as the noble Baroness, Lady Bennett, mentioned and as is in her amendment. I welcome the Government’s Amendments 43, 46, 47 and 49, and hope that the issue of climate risk will continue to move up the agenda in financial services.

I have enormous respect for my noble friend Lady Noakes and her experience in banking. She makes relevant distinctions between assets held by insurance companies, regulated by the FCA, which hold investments directly in fossil fuel or environmentally damaging firms and activities, whereas banks’ main assets are loans rather than more direct investments. Their balance sheets, as she noted, have some leasing, but, should the worst predictions of climate catastrophe materialise in a shorter timeframe than currently anticipated, there could be unexpected defaults on a number of the loans on the loan books, which also needs to be considered, I would hope, in terms of risk weightings.

In Committee, I supported the noble Lord, Lord Oates, in seeking to update the existing capital risk weightings to reflect climate change risk. Having listened carefully to the Committee’s arguments, he has taken care to adjust his amendment for Report. As we have all discussed in this group, climate change is now recognised widely as posing a significant risk to the entire global financial system and, in fact, to our expected and hoped-for way of life. Current central bank policy risks reinforcing a carbon lock-in through a systemic bias to fossil fuel investments—indeed, insurance arrangements and pension funds also have significant investments in this area. I believe we need a twin-track approach that both reports on and quantifies climate-related financial risks and, at the same time, amends prudential risk tools to reflect the risk of loss or stranding in relation to fossil fuel investments or, indeed, loan books.

Such an approach would reflect the urgency of the challenge we face and, as Andrew Bailey said in a speech last year:

“Investments that look safe on a backward look may be existentially risky given climate risks.”

The Minister’s response in Committee was that the proposed amendments would require the PRA to set punitively high risk weights against exposure to existing and new fossil fuel production and exploitation, and that these risk weights would, in effect, make it more expensive to finance such activities and thereby make them less attractive. Loans would be more expensive, potentially, to companies involved in this area. Is this not the very point that we should be seeking to achieve—to reflect the risks of carbon-intensive investments quantitatively, through higher risk weightings, and potentially through the issuing of loans to such companies?

Amendment 3 recognises the Government’s concerns and now proposes only that the PRA carry out a review of the current risk weightings applied to existing and new fossil fuel activities. In this regard, such a review may indeed confirm what my noble friend Lady Noakes suggested would be the outcome but, without such a review, I feel that we will not necessarily be taking this sufficiently seriously. I hope my noble friend can agree that this is a reasonable and prudent way to recognise the urgency of the climate change challenges we face, and that it would provide evidence to inform any necessary future changes to existing prudential rules around capital weightings, should that be found to be required.

In addition, two reports have just been published highlighting the systemic nature of climate risks. The LSE’s Grantham Research Institute report—I declare an interest as a visiting professor—Net-Zero Central Banking stated:

“Central banks and supervisors will need to take a systemic perspective, addressing both micro- and macroprudential risks over a much longer time horizon than they do now, and work to ensure that financial flows become aligned with net-zero.”

Policy Exchange’s report Capital Shift recently stated:

“Whereas international banking codes require banks to include emerging risks such as cybersecurity in capital adequacy compliance … climate change barely features.”

It recommended:

“Central banks and supervisors should introduce higher capital charges for assets at greater risk from climate and nature-related financial risks.”

I hope my noble friend the Minister can provide assurances that an urgent review of this vital area is possible and will be considered.

I speak briefly in support of the aims of Amendment 22 in the name of the noble Baroness, Lady Hayman, on climate-related financial risk reporting. I commend her for her work in this area and declare a further interest as a member of the Peers for the Planet group, which she so ably leads. Amendment 22 would require adjustments to reflect the systemic risk in the whole financial system. I hope my noble friend will commit to a future consultation, at least, on the FCA and PRA objectives having regard to net zero targets.

Finally, I have added my name to Amendment 23, also in the name of the noble Baroness, Lady Hayman, whose work on environmental protection has been so powerful. I congratulate the new chief executive of the FCA, Nikhil Rathi, on the latest announcement that he is recruiting a senior role focused specifically on environmental and other ESG matters, so I suspect that this amendment may no longer be required.

Photo of Baroness McIntosh of Hudnall Baroness McIntosh of Hudnall Deputy Chairman of Committees, Deputy Speaker (Lords) 5:45 pm, 24th March 2021

My Lords, we have not as yet been able to restore contact with the noble Lord, Lord Holmes of Richmond. Should he reappear before the Minister speaks, I will try to call him, but for the time being he is not with us, so I call the noble Baroness, Lady Kramer.

Photo of Baroness Kramer Baroness Kramer Liberal Democrat Lords Spokesperson (Treasury and Economy)

My Lords, I will follow my practice of trying to be brief and selective on Report. We have had absolutely brilliant speeches and I do not intend to repeat them.

Perhaps I can start by being helpful to the noble Baroness, Lady Noakes, and I speak as a fairly weather-worn commercial banker who dealt extensively with loans and risk. She will understand, therefore, that the PRA, as the regulator, in dealing with capital adequacy issues, looks at the loans that sit as assets on the bank’s books, but of course it does not stop there. It looks through that to the operational activities—to the activities and investment of the company to which the loan is made. That is why the terminology “investment” pins exactly what this amendment is intended to do, which is to make sure that the PRA does that look-through to investment. I do not think that any member of the PRA would have the slightest difficulty in understanding what this amendment is guiding them to carry out. They would see that it has genuine precision in it. I do not have a problem with the wording; the wording says what it should, it says what it means and it says what the PRA would understand and follow through.

Very briefly, I thank the Minister for the two “have regard” amendments that he has embedded in this group. To “have regard” to the climate change target of 2050 is a step forward, but we have to recognise that it is very light-touch and will not scare the horses. The noble Baroness, Lady Noakes, captured that rather well when she said that the two “have regard” amendments will do no harm. I do not think they change the landscape, but they give a little hint of a change in direction and I welcome that change in direction.

Like others, I am very frustrated that we have a PRA that is going to do stress tests to test the sufficiency of banks’ capital buffers to deal with the financial instability caused by climate change, but then seems to have taken almost the equivalent of a vow of passivity and will not then follow through and implement the consequential adjustments to capital adequacy ratios that would come from that exploration and examination of the buffers. I really do not understand going through the process and then saying, “But we will not learn from or implement the consequences of that work”.

I sometimes think, as I listen to the speeches, that there is a sense that this requirement to look at capital adequacy ratios is somehow novel or revolutionary. I sit on the Economic Affairs Committee and last week, we were privileged to hear from the noble Lord, Lord Turner of Ecchinswell. I hope I have pronounced that correctly. We were looking at quantitative easing issues and therefore it was a discussion of central banks, but the issue of climate change came up. I thought what he said was quite helpful in understanding how normalised the approach of challenging this issue through capital adequacy ratios is now becoming. He said that any role of central banks in relation to climate change is very much secondary to the fiscal and regulatory authorities—the same issue that I think was raised with reference to quotes from the noble Lord, Lord King—but that is an important statement. It is secondary to the fiscal and regulatory authorities because, of course, the relevant regulatory authority is the PRA. He went on to give an illustration by referring to coal:

“If banks go on lending to coal companies, they may end up with stranded assets on which they will make a loss. That will be bad for their capital ratio. I think that it is reasonable for the PRA to set higher capital ratios for anybody who is still lending to coal.”

I do not want to suggest that he was willing to go further than coal, but he was using it as an illustration. I think most of this House would very happily accept that that language needs to be extended across the full range of fossil fuels, certainly in requiring the PRA to do a review. So, I wanted to underscore that this is a normalised approach; this is where we will go, and where we will end up. Given that we have described climate change, absolutely correctly, as an emergency, a delay in getting to that appropriate application of capital adequacy is really serious.

I wanted to pick up the point made by the noble Baroness, Lady Noakes—that most loans are short or medium term. They are, but they are supporting longer-term projects. Of course, the duration of financing the project itself—the project they enable, the project they empower, the project they drive—has a much longer-term application. So, the fact that the loan itself is short term does not mean that it can be set aside as though it had no longer-term implications. It is merely the first step in an ongoing process, and once the process is started it is almost impossible to stop. Loans might be short term because people think they might get better terms and conditions or pricing in the future. The short-term issue is not applicable here; the urgency issue is.

We know that we face an emergency and that how we act in the future will have to be more draconian and dramatic, and have far greater collateral damage, than if we act early. It is crucial that the issues raised in Amendment 3—getting in place the plan, pattern and process for using capital adequacy ratios to tackle the financial instability that will come from allowing climate change-related activities to continue and grow—be dealt with now, and rapidly. If the Government do not recognise what we have been describing here and commit to this review of the whole issue of capital adequacy and climate change, I very much hope that my noble friend Lord Oates will press his amendment. The message is absolutely critical.

Photo of Baroness Jones of Whitchurch Baroness Jones of Whitchurch Shadow Spokesperson (Environment, Food and Rural Affairs)

My Lords, I am grateful to the noble Lord, Lord Oates, for leading this debate this afternoon, and to all noble Lords who have spoken. We had a detailed debate in Committee on the need for the regulators to take a more systematic and urgent approach to their climate change obligations. I do not intend to repeat the general arguments, not least because the Minister accepted the need to embed our climate change goals in the financial services sector. The point of difference remained, how deep and how fast. Since that time, we have had a useful meeting with the Minister and we were pleased to hear that he had accepted our arguments concerning the need for the regulators to have regard to the Climate Change Act. The Government’s amendments, tabled today, reflect that concession and we consider this to be a considerable step forward. I thank him for his work in making that happen.

Since then, the Minister has also facilitated the sending of two letters from the PRA and FCA setting out their work on sustainable finance, to which a number of noble Lords have referred. It is useful to have their current commitments restated in this way and we are pleased that they have engaged with us on the subject. It is also helpful that they have set their work in an international context, as we know that we cannot solve this issue alone. However, I would say to the regulators, and indeed to the Treasury, that what is lacking in these letters is the urgency and reprioritisation that the climate change emergency demands. As we discussed in Committee, many individual financial institutions are already ahead of the game and are implementing dynamic green initiatives. We have heard great speeches from the Chancellor and others on the importance of the issue, but why are the regulators not being more ambitious, to ensure that everybody meets the standard of the best? As a result, today we have tabled further amendments to spell out in more detail how systemic finance-related climate risks should be embedded in the policy agenda going forward.

I have added my name to Amendment 3 in the name of the noble Lord, Lord Oates. It addresses the need for the PRA to review the risk weighting applied to investments in existing and new fossil fuel exploitation and production. The noble Lord has explained the case for that amendment extremely well today. We agree that the current regime does not adequately reflect the high-risk exposure of such investments. Clearly, institutions with over-exposure to carbon-intensive investments are not acting prudentially and their capital requirements should reflect this. As we discussed before, as the policy agenda moves rapidly away from fossil fuels and towards renewables, there is a considerable risk of the assets being stranded. The capital adequacy requirements need to reflect this risk more accurately.

The Minister will know that the Basel Committee conducted a survey of regulators in April of last year to stocktake their supervisory initiatives on climate change financial risk. This seems to run counter to the point that the noble Baroness, Lady Noakes, was making—I listened carefully to what she was saying about the comparative responsibilities of regulators and banks—because the Bank of England and the PRA were both respondents to the survey. In fact, only six out of the 27 replies factored the mitigation of climate-related risk in to their prudential capital requirements so far, but there was some criticism in the conclusions of the survey as a result of that. So, were the UK regulators in the good minority or the bad majority in the outcome of that survey, and are their responses to it in the public domain? Does he also accept that, without the necessary adjustments made in Amendment 3, investments will continue to focus disproportionately on outdated oil and gas activities that run counter not only to investments but to the interests of the UK economy as a whole? This point was well illustrated by the noble Baroness, Lady Sheehan. This is why we would particularly welcome the involvement of the Climate Change Committee, in order to provide the wider perspective of the longer-term UK interests, rather than the narrow short-term interests on which investment decisions are too often made. I therefore hope that the Minister will be able to give us the assurances we seek in this regard.

I have also added my name to Amendment 22, in the name of the noble Baroness, Lady Hayman, for which she made a very powerful case. We believe it essential that the Government set out how they will actively ensure that climate change considerations are reflected in the regulators’ statutory objectives. This amendment would provide a framework for systematically assessing and reporting on climate change financial risk. It would ensure that all government guidance is linked in order to provide a coherent and entire picture on managing climate change—an improvement on the current piecemeal reporting structure. I therefore hope that the Minister will be able to give us the assurances we seek on this issue. It would also be helpful if he could spell out what future formal reporting mechanisms would be put in place to achieve this.

Moving on to Amendment 23, at Committee and again today, the noble Baroness, Lady Hayman, has made a compelling case that the FCA needs a senior executive to oversee and deliver the climate change agenda. Like her, we were pleased to see in the FCA’s letter that a dedicated director of environmental and social governance standards is being recruited to lead on this work. We welcome this appointment and believe it represents a real step forward.

With Amendment 44, the noble Baroness, Lady Bennett, has once again made the important point that action on climate change and biodiversity need to go hand in hand. As my noble friend Lord Judd said, we all too easily join UN international conventions on issues such as these, but we lack the discipline to follow them through at a UK level. It often feels that biodiversity is the poor relation of climate change, but we know that urgent action on both issues is essential if we are to have a thriving, sustainable planet in the longer term. I agree with the noble Baroness, Lady McIntosh, that we should aspire to a future in which all natural capital is valued in its proper place. This is an issue that we will continue to pursue.

We very much welcome the inclusion of government Amendments 43, 47 and 49 in this Bill. While this was the right thing to do, I do not doubt that the Minister had to do some persuading with his Treasury colleagues and we thank him for that. These amendments represent another step in creating a cross-departmental approach to tackling climate change and, in due course, meeting our net-zero targets. I look forward to the Minister’s response to our amendments today and to hearing the specific reassurances we seek in order to move forward more fully with a credible package of actions to deliver our climate change obligations.

Photo of Baroness Henig Baroness Henig Deputy Chairman of Committees, Deputy Speaker (Lords) 6:00 pm, 24th March 2021

I understand we now have the noble Lord, Lord Holmes of Richmond, back to finish his speech, so I call him at this point.

Photo of Lord Holmes of Richmond Lord Holmes of Richmond Conservative

My Lords, I shall not detain the House for long at this stage. I fear I got cut off just as I was extolling the virtues of how new technologies could help in this endeavour. I support the amendments in the name of my noble friend the Minister and look forward to his explanation of them.

Photo of Earl Howe Earl Howe Deputy Leader of the House of Lords

My Lords, let me begin by saying that I have listened carefully to the debate today, as well as the important contributions made in earlier debates on this Bill. As a result of those earlier debates and subsequent discussions held with a number of your Lordships, the Government have tabled the four amendments included in this group, which I shall speak to in a moment. Before I do, I want to leave the House in no doubt as to the context in which we are now operating.

In November, my right honourable friend the Chancellor set out a vision for the financial services sector to put the full weight of private sector innovation, expertise and capital behind the critical global effort to tackle climate change and protect the environment. That is why the Government are taking a number of actions, such as making climate-related financial disclosures mandatory across the economy by 2025, with a significant portion of mandatory requirements in place by 2023, and issuing our first-ever green gilt later this year. At Budget this month, we augmented the Government’s economic objectives and the remit of the Monetary Policy Committee and Financial Policy Committee to support environmental sustainability and the transition to net zero. We also established the UK infrastructure bank with a mandate that includes tackling climate change. The Government have ambitious plans to ensure that the financial services sector as a whole plays its role in supporting our climate change commitments. However, we heard loud and clear the strong views from members of this House that they wanted to see that ambition reflected in this Bill.

Amendments 43 and 47 in my name will require the PRA and the FCA to consider the 2050 carbon target in relation to the Climate Change Act 2008 when making prudential rules under the accountability framework set out in this Bill. The Government are showing, very publicly, how the financial services sector and our regulators can take a lead role in delivering on our climate commitments. They are also showing the rest of the world that the UK is taking a cross-sector approach. I have greatly welcomed the way in which noble Lords have engaged with me on this issue. We have picked the 2050 carbon target, as it benefits from being both legally defined and substantively focused. This makes it clear to both regulators exactly what they must have regard to in making their rules and how they can be held to account.

As I explained in earlier debates, the Government and the regulators are committed to implementing the first wave of Basel reforms and the initial introduction of the investment firms prudential regime on 1 January 2022. These reforms are important for our international standing as a country that upholds its international commitments, for financial stability, and for our competitiveness relative to the EU. As I said in Committee, there is a great deal of work happening at the moment at the international standard-setting level to determine exactly how climate change should be factored into prudential policy globally. This is why Amendments 46 and 49 delay the application of mandatory climate change considerations to 1 January 2022. This will ensure there is sufficient time for this work to progress, and that there is no unnecessary and impractical delay in implementing these vital regimes. Otherwise, we would be in the unfortunate position where the regulators would have to reopen or restart their consultations.

When and how will the amendments bite, if not on the first wave of Basel and the IFPR? I can assure noble Lords, particularly the noble Baroness, Lady Hayman, that the PRA will still need to make rules to implement substantive reforms contained in Basel 3.1, which will be implemented in 2023. These rules will be within the scope of the amendments in my name. I fully expect the regulators to use the powers again in future to update their rules—for example, to take account of new international standards or developments in the market. I hope the House will agree that these amendments strike the right balance between acting quickly on climate change and taking swift action to reform our prudential regimes which aims to prevent a future crisis. I therefore see this as a significant action which very visibly demonstrates the Government’s commitment to furthering this important agenda.

The Government are also acting to ensure that the regulators take account of our climate commitments more broadly. At Budget, the Treasury published remit letters for the Monetary Policy Committee and the Financial Policy Committee, requiring both these committees to consider the Government’s commitments on climate change. Today, I can confirm that the Chancellor has set new remits for the FCA and the PRA that will also require them to consider these commitments across the whole of their remit. As has been mentioned in this debate, the CEOs of the PRA and the FCA have both written to me to set out the significant amount of work they have under way. I will provide some further details on this in a moment. They have also demonstrated their clear commitment to acting to address climate change. I have placed copies of their letters in the Library and in the Royal Gallery.

Lastly, and importantly, there is the future regulatory framework review. This is the means by which the Government are exploring how the regulators focus more broadly on important public policy issues, such as climate. I hope this meets one of the concerns expressed by the noble Baroness, Lady Hayman. I can add to it because, as part of that review, the Government recently consulted on a proposal to allow Parliament and Ministers to specify new regulatory principles for specific areas of activity—for example, setting out how the regulators must consider sustainability or green issues when making rules. The Government are considering the responses to the consultation ahead of a second consultation later this year, and recognise the need to address this crucial issue across the whole regulatory framework. I hope I have shown that the Government understand the issue, that we are taking the appropriate actions and that the regulators are ready and willing to support such actions.

I now turn to the other amendments in this group, though not in numerical order. I begin with Amendment 44, which would amend one of my own amendments. Amendment 44 would require the FCA also to take into consideration the UK’s commitments under the UN convention on biodiversity when making rules to implement the investment firms prudential regime.

This Government are committed to being the first to leave the natural environment in a better state than they found it, with our long-term agenda laid out in the 25-year environment plan. As the Dasgupta review highlights, and as the noble Baroness recognises, the global financial system will play a critical role in enhancing our stock of natural assets and encourage sustainable consumption and production activities. We will reflect on the conclusions and recommendations of the Dasgupta review and consider the most appropriate way to take them forward. However, unlike the 2050 carbon target in the Climate Change Act 2008, which my own amendment targets, the commitments under the UN convention are extensive, varied and more challenging to deliver through financial services regulation. Work on how the financial sector can support our transition towards net zero is more developed than work on how the sector can support biodiversity goals.

However, work to develop our understanding is under way. For example, just last year we saw the launch of the Task Force on Nature-related Financial Disclosures. This task force will provide a framework for businesses to assess, manage and report on their dependencies and impacts on nature. This will support the appraisal of nature-related risk and will continue to realign incentives which support our biodiversity goals.

The Convention on Biological DiversityCOP 15—will also be an important milestone for international action on biodiversity. We will work with countries to agree long-term, realistic, measurable and fit-for-purpose targets to set nature on the path to recovery. Nature will also feature as one of five policy themes for COP 26, which has been agreed by the Prime Minister. The nature campaign is focused on catalysing action to protect and restore the natural habitats and ecosystems on which our climate, air, water and way of life depend, which includes increasing the volume of finance for nature-based solutions. I listened with interest to the remarks of the noble Lord, Lord Judd, in that context.

Amendment 3 would place a legal obligation on the PRA to review the risk weights applied to certain fossil fuel exposures and thereby the amount of capital held against them. The purpose of risk weighting is to preserve the safety and soundness of our financial system and to prevent banks failing as a result of not covering themselves appropriately against the risks they are taking. I was grateful for the remarks of my noble friend Lady Noakes on these issues.

In its letter to me, the PRA recognises the threat posed by climate change to the UK economy and the financial system and sets out the steps it is taking to mitigate this threat. This includes setting out specific and detailed supervisory expectations for both banks and insurers on their approach to managing financial risks from climate change. The PRA has also written to firms setting out its expectations that firms should have fully embedded their approaches to managing climate-related financial risks by the end of 2021.

The noble Lord, Lord Oates, questioned why a lower risk rating should be applied to fossil fuel funding than some other asset classes. As I am sure he is aware, the risk weighting of assets is decided internationally through a set of agreed standards set by the Basel Committee on Banking Supervision, and this is based on analysis of how risk is transmitted and how it can be quantified. These post-crisis reforms have also been endorsed by the G20 and ensure that risk weights are applied consistently across the globe. The flexible approach taken in the Bill ensures that, where considerations around the risk weighting of assets change, the PRA can respond to developing circumstances as they arise.

We must not act with undue haste, but rather with appropriate speed. In 2020, the Network for Greening the Financial System, a group of central banks and supervisors, found insufficient evidence of a measurable difference in the risk posed by brown and green asset classes, so further work is needed. The Basel committee task force on climate-related financial risks is seeking to understand how climate risk is transmitted, measured and assessed. This task force plans to complete this fundamental research by the middle of this year. Building on this analytical work, and to address a question asked by the noble Baroness, Lady Hayman, the task force will consider the extent to which climate-related financial risks are incorporated into the existing Basel framework and identify effective supervisory practices to mitigate such risks.

So the review that noble Lords wish to see is already under way, and we will see more on this in the autumn. I hope the noble Lord, Lord Oates, will agree that this review demonstrates that the Basel committee, of which the PRA is a member, is already considering climate risks in the financial system, and that this will persuade him not to press his amendment.

In this context, perhaps I could quickly respond to the noble Baroness, Lady Sheehan, who made a number of points relating to the funding of overseas projects by UK Export Finance. I should be happy to write to her on this, further to our previous correspondence on the subject.

Amendment 22 is broader, as it would require the regulators regularly to review the exposure to climate-related financial risks and the impact on financial stability. The PRA’s existing obligations under the Financial Services and Markets Act already require it to consider risks to the safety and soundness of financial institutions, and this includes climate risks in the same way as any other risks. The PRA will be undertaking further climate-related stress tests in June, to ensure that the financial system remains resilient to those risks. I shall answer as best I can the question of the noble Baroness, Lady Kramer, on those stress tests, on which I do not have up-to-date details—I am sorry.

Our green finance strategy commits the Government to improving the understanding throughout the financial system of climate risk and environmental impact. I have already said that the Government have committed to implementing the requirements of the task force on climate-related financial disclosures in the UK, with a significant portion of mandatory requirements in place by 2023, and all relevant firms reporting in line with the requirements by 2025. This requires firms to investigate, report and manage the climate risks that they face. The UK is the first country to take such a step and, incidentally, we are a long way ahead of the EU in doing so. The Bank of England reported publicly on its own climate risk exposure in June 2020. The Government’s approach in this area can be seen as systemic, to pick up the word used by the noble Baroness, Lady Hayman.

Amendment 22 would also require Her Majesty’s Treasury to review how the FCA and the PRA’s objectives “have regard” to the Climate Change Act 2008. My amendments ensure that the regulators will consider this when implementing their prudential regimes, and the remit letters set by the Chancellor also require this.

I turn now to Amendment 23, which aims to require the FCA to appoint a senior manager with responsibility for climate change. I am happy to confirm that, in his letter to me, the CEO of the FCA has committed to recruiting a dedicated director of environment, social and governance standards. The director will report directly to the CEO of the FCA and will have responsibility for its ambitious work programme in this area. So I am happy to confirm that it is not necessary to set out this requirement in legislation.

I hope that what I have said has demonstrated that the Government have listened to the arguments and, through the amendments tabled in my name, have responded tangibly to them, and are also substantively on the same page, as are those the noble Lords who rightly feel passionately about these issues. Therefore, against that background, I commend my amendments to the House and in turn ask noble Lords not to press theirs.

Photo of Lord Oates Lord Oates Liberal Democrat Lords Spokesperson (Energy and Climate Change) 6:15 pm, 24th March 2021

My Lords, I thank all noble Lords who have taken part in this interesting and engaging debate and I give particular thanks to the noble Baronesses, Lady Hayman, Lady Jones of Whitchurch, and Lady Altmann, for signing Amendment 3, and to my noble friend Lady Kramer, as well as to the noble Baroness, Lady Bennett. I am also grateful to the Minister for his engagement at all times.

I am sorry if the wording of the amendment caused any confusion to the noble Baroness, Lady Noakes, but I hope that the clear explanation made by my noble friend Lady Kramer has lifted it. I do not have anything to add to that, except to say that I have no doubt that the PRA will understand very clearly what it is being asked to do. The noble Viscount, Lord Trenchard, said that he felt that a review would be disproportionate. I am not sure what he is measuring the proportions against but, if anything, the amendment seems to be a disproportionately modest response to a desperately urgent issue that will impact on us all.

I am pleased that the Minister and the FCA have reacted to a number of the amendments, in particular Amendment 23 tabled by the noble Baroness, Lady Hayman, on the senior manager of the FCA, and obviously I welcome the movement on the Government’s “have-regard” amendments.

I reiterate my thanks to the Minister for his engagement during this process, although I am disappointed that he has not been able to provide the reassurance I had hoped for that risk weights would be properly addressed. He said that we had to move not with undue haste but with due speed—but I am not sure that we are doing either.

I am afraid that I do not accept that the issues are covered sufficiently by the existing work that he has taken the trouble to set out, not least because the approach being followed does not take into account sufficiently the specific issues set out for the review in my amendment, in particular the climate-related disruption of the economy. It is very important that this review should take place and that the PRA can use it to look properly into these issues. As I said in my opening speech, it should feed into discussions at international level. It is very important that it is looked at in terms of the remit of my amendment. So, on that basis, I would like to test the opinion of the House.

Ayes 276, Noes 276.

Division number 2 Financial Services Bill - Report (1st Day) — Amendment 3

Aye: 276 Members of the House of Lords

No: 276 Members of the House of Lords

Ayes: A-Z by last name

Nos: A-Z by last name

Division conducted remotely on Amendment 3

Photo of Baroness Henig Baroness Henig Deputy Chairman of Committees, Deputy Speaker (Lords) 6:37 pm, 24th March 2021

My Lords, there being an equality of votes, in accordance with Standing Order 55, I declare the amendment disagreed to.

Amendment 3 disagreed.

Photo of Baroness Henig Baroness Henig Deputy Chairman of Committees, Deputy Speaker (Lords)

We now come to the group beginning with Amendment 4. Anyone wishing to press this or anything else in this group to a Division must make that clear in debate.