Financial Services and Markets Bill

Debate between Lord Lilley and Baroness Drake

Committee stage
Tuesday 7th March 2023 Grand Committee

[Baroness Drake (Lab)]

My Lords, I rise to speak to Amendments 168 and 201. I refer to my interests as a trustee of defined benefit and master trust pension schemes.

The loss of financial stability can occur quickly. History shows us that risks that crystallised and caused that instability were often insufficiently captured by regulators and that actions to mitigate their impact were not taken in good time. It would be extraordinary for any Government to believe that financial regulators could deliver the objectives of competitiveness and sustainable growth without embedding in that delivery the finance sector’s response to climate risk.

Climate change brings immense risk, but it is not specifically factored into either the regulatory capital risk requirement for banks or the solvency requirements for insurers. We already see the weaknesses: banks and insurers still retain exposure to fossil fuel investments and a significant number of the largest UK banks do not have interim targets to cut funded emissions. I could quote many other statistics to confirm that weakness.

As the Bank of England stated in the executive summary of the Results of the 2021 Climate Biennial Exploratory Scenario, its assessment is that UK banks and insurers still need to do much more to understand and manage their exposure to climate risks. The Bank admits that there is a lack not only of managing that exposure but of understanding it. That makes Amendment 168 important in calling for a PRA review of capital adequacy and solvency capital requirements, having regard to the full implications of climate change physical, transitional and liability risks and for financial stability.

Failing effectively to factor climate risks into regulatory requirements tolerates the failure of firms that make unwise bets on the continuation of “business as usual”. Inevitably, it necessitates government intervention, socialising of losses and consequences for taxpayers. When a similar amendment was sought previously, the Government argued that the CBES work that I have just referred to would assess the implications of climate change risks for investment, stranded assets and financial stability. However, we have heard from speakers in this debate, including my noble friend Lady Worthington, and read from informed commentators worrying concerns with the work, reinforcing the need for the PRA to review its risk assessment approach and modelling. In a Policy Exchange publication, the former chief economist of ING Group put those concerns succinctly when he concluded that

“central bank scenarios have been based on assumptions and models which ignore or downplay crucial elements of climate risk and critical triggers, tipping points and interdependencies between climate, economy, politics, finance and technology”.

As has just been referred to, the Prime Minister, Rishi Sunak, promised that the UK would create the world’s first net-zero financial centre. However, London recently lost its position as Europe’s most valuable stock market to Paris. The London market is more heavily exposed to unpredictable sectors such as mining and oils and we now see the issue of listings emerging as a problem.

Achieving a net-zero financial sector requires regulators having the necessary mandate and accountability. The finance sector’s practices, as a major investor in companies and as an insurance underwriter, have a vital role to play in the transition towards zero carbon. In an area with which I am familiar, the closure of private defined benefit pension schemes has been followed by an accelerating trend for trustees to enter buy-out financial agreements with insurance companies, paying premiums in return for individual annuity policies covering members, with assets and liabilities transferring to insurers.

Buy-in is also occurring, such as the record-breaking £6.5 billion buy-in recently by the RSA pension scheme. That market saw a £30 billion transfer in 2022 of pension liability to insurers. It could exceed £40 billion in 2023. There were many billions that preceded 2022 and the trend means that there will be many more in 2024. Auto-enrolment means that billions of pounds of defined contributions are being invested each year. The market is consolidating into fewer master trusts, some set up by vertically integrated finance companies that also manage the assets in those trusts, and individual pensioners. Tomorrow’s pensioners will be much more dependent on insurer stability. That clearly reinforces the need for the PRA review and for raising the bar on the investment duties of asset managers, as Amendment 201 seeks, by requiring the FCA to publish guidance on the consideration by investment managers of the long-term consequences of decisions, the societal and environmental impact of investments, standards of conduct in governance and transparency of reporting.

The UK Sustainable Investment and Finance Association reports that it continues to see a common lack of understanding within financial services on the extent to which ESG factors form a core component of investors’ fiduciary duties. The Principles for Responsible Investment Association similarly identified that lack of understanding and recommended further regulator guidance. As a jobbing trustee, for want of a better phrase, there is a part of me that wonders to what extent there is such a lack of understanding, rather than a reluctance to understand, but there is a problem. The investment association found that only 14% of members incorporated ESG across their entire portfolio in 2019, while 44% said that it accounted for less than 25% of their portfolio.

The Government want to see more productive investment by the financial sector. For government to direct how citizens’ private assets are invested would displace fiduciary duties which rest with trustees, providers and asset managers and raise issues of state liability, political expediency trumping best interest and litigation. Amendment 201 could assist regulators, providers and asset managers in considering decisions on productive investment consistent with fiduciary duties and identifying the barriers to aligning these. We can perhaps address some of those barriers on another amendment later in the Bill.

However, the ability of trustees to discharge their ESG and climate risk duties to greatest effect has a clear dependency on how regulators expect asset managers to discharge their duties. We cannot do ours well unless asset managers do theirs well, too. It also depends on central bank scenarios and the regulation of the finance sector’s response to climate risk, because it will influence attitudes and the value of different assets. The whole eco- system needs improvement in both transparency and due diligence. The two amendments that I speak to, on the PRA reviewing its whole approach to modelling, regulating and embedding climate risk, and the contribution that asset managers are required to make to mitigating climate risk, both have merit and are badly needed.

[Lord Lilley (Con)]

My Lords, I will address the amendments just addressed by the noble Baroness, Lady Drake, and others, which are intended to discourage investment in fossil fuels. There are two routes to net zero: one is to phase out demand, which is the route that we have adopted in this country. My noble friend Lord Deben, who is not here today, provides guidance and forecasts to the Government on how to phase out that demand to meet net zero by 2050. That is the sensible way of doing it. The alternative is to try to phase out supply. If fossil fuel producers invest in more production capacity for those fuels than is needed for declining demand, they will lose money. They may even be left with oilfields that have not been fully depleted —it could not happen to a nicer bunch of people.

I am really touched that so many green noble Lords and noble Baronesses are determined to protect the oil industry from losing money. That is not their real intent, of course; that is to discourage investment and reduce it as fast as possible, if need be by reducing the supply of fossil fuels faster than we reduce demand for them. If they achieve that, we will have a shortage of fossil fuels. We will have rising prices with those shortages and will have done to ourselves exactly what Putin has done at the moment. Is that what they want?

Noble Lords pretend on the first argument that they want to save the banks and the industry from being left with stranded assets. As I say, it is touching that they should be so concerned about them, but why do they think they are better at forecasting the future demand and supply balance for fossil fuels than the oil companies and others whose business it is, or others in the City whose business it is to try to work out whether it is worth investing? I used to be an energy analyst in the City; it was my job to try to forecast these things. In some years, I was the most highly rated analyst in the City on these matters, presumably because I was making long-term forecasts and no one could tell that they would prove wrong. But the idea that the PRC knows better than people in the City—