Financial Services and Markets Bill

Baroness Drake Excerpts

Committee stage
Tuesday 7th March 2023 Grand Committee

[Baroness Meacher (CB)]

I apologise; I am completely confused.

The due diligence system reintroduced for companies under Schedule 17 to the Environment Act is world-leading in its intentions. However, we have to finish the job to end our financing of deforestation. The GRI Taskforce has been unequivocal in its advice that financial actors should conduct deforestation due diligence too for their own sake as well as for everyone else’s. In the meantime, as somebody mentioned last time, Britain’s financial institutions are contributing $16.6 billion to businesses implicated in deforestation.

This is a huge global issue. Experts say that we must end commodity-driven deforestation by 2025 if we are to limit global warming to 1.5 degrees centigrade. At present, as a result of those investments, climate-critical tropical forests are shrinking. This is absolutely appalling. The UN’s high-level climate champions have begun to refer to deforestation as the new coal in investors’ portfolios. There should be no investment in companies involved in deforestation. It is quite simple.

The amendment responds powerfully to the GRI Taskforce’s advice. It has significant cross-party backing in the House of Commons. The Government are inclined to go for a weaker policy against the advice of their own expert task force on deforestation. I hope that the Minister will do all she can to persuade her colleagues in the other place to support Amendment 199 before Report. Rishi Sunak has promised that the UK

“will be the world’s first net zero financial centre”.

His support for Amendment 199 is an obvious step on the way. I thank the WWF, Greenpeace, Global Witness and Mighty Earth for their excellent joint briefing. I call on all noble Lords to support Amendment 199.

[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—

Financial Services and Markets Bill

Baroness Drake Excerpts

Report stage
Tuesday 6th June 2023 Lords Chamber

This amendment is a logical next step to Schedule 17 to the Environment Act 2021, which, if secondary regulations are ever brought forward after over a year of delay, will ban the import of certain goods produced on illegally deforested land. This amendment would allow us to future-proof UK financial regulation so it delivers a liveable planet and a workable food system, with all the attendant benefits for global economic stability. Inaction allows these deforesting companies to continue turning a profit by undermining the basis for future prosperity. It goes absolutely in the face of everything in the Dasgupta review. I look forward to the Minister’s response, and will be testing the opinion of the House on this.

[Baroness Drake (Lab)]

My Lords, I declare my interests as trustee of DB and master trusts. I will speak to Amendment 93. Government Amendment 4 is welcome because it recognises the necessary direction of travel on disclosure requirements on sustainability, but the problem is that it is not sufficient. It gives the Treasury the power to issue a policy statement on SDRs and to require the regulators to report against this, but the FCA does not have the powers to actually implement SDRs. As Amendment 93 proposes, there is a need to give the FCA the power to publish guidance on how asset managers must consider the long-term consequences of any decision; consider the impact of climate, nature and society on their investments; consider the impact of their investments on climate and nature; and publicly report on their considerations.

It is interesting that the explanatory statement accompanying the published government amendment states that it supports

“the regulation of disclosure requirements relating to sustainability”

by requiring the FCA not only to have regard to Treasury policy but to inform a policy statement by the Treasury. It is difficult to see how the FCA could optimally inform Treasury policy if it does not set guidance on expected content and open reporting by asset managers on the impact of their investment decision-making.

Confusion among fiduciaries about the extent of their duty to consider such impacts is not limited to occupational pension schemes; it runs across the length of the investment chain. The FCA has broad powers to issue guidance under Section 139A of the Financial Services and Markets Act 2000, but there is still an ambiguity. Amendment 93 gives the FCA the explicit power to issue guidance on the disclosure of considerations of sustainability impacts as a core part of the investment managers’ duties. This is not inconsistent with the existing duty on trustees, in Regulation 2 of the occupational pensions investment regulations, to report on how they have complied with the Section 35 duties of the Pensions Act 1995.

The proposed FCA guidance is not legally binding: regulated firms would be free to diverge from it, but there is an expectation that they would need to explain why they have done so. There is a need to apply the guidance to contract-based personal pension schemes as well, to avoid the risk of regulatory arbitrage between a weaker FCA regime and a more robust TPR disclosure regime.

The concept of fiduciary duty borne by those responsible for the best interests of pension scheme members is evolving, and, as we heard, the Government’s updated green finance strategy of 2023 includes a commitment to review pension trustees’ fiduciary duties and stewardship activities. That trustees must act in the best interests of scheme members must not be a principle in doubt or, indeed, overridden. The key issue is what “acting in savers’ best interests” means in law for fiduciaries, and the extent to which it includes stewardship and ESG engagement. If fiduciaries ignore the impacts of investment strategies on society, climate and nature, or vice versa, those major externalities will eventually impact them at a later date.

In seeking more productive investment by the finance sector, the Government should acknowledge that pension funds are not the only decision-maker or the beginning and end of the problem; asset managers have an equally key role to play in managing impacts and considering the long-term consequences. Amending FCA regulation powers to guide open reporting on these matters will encourage investment away from environmentally and socially damaging activities, and towards supporting efficient transition to net zero, nature protection and healthy societies, in a way that is in the savers’ best interests and that supports the successful transition of the wider economy.

Guidance from regulators is required along the length of the investment chains as risks become more acute. Pension schemes contract with fund managers to manage assets. If schemes are expected to consider the sustainability of their investments, they need fund managers to support them by undertaking that activity too. Trustees’ ability to discharge their ESG and stewardship responsibilities to greatest effect has a dependency on how regulators expect asset managers to discharge their duties. Expectations placed on pension funds and asset managers are a complement to, not a substitute for, government policies on efficient transition to a sustainable economic future. Government regulations that perversely drive greenwashing or green asset bubble risk are equally unsustainable.

The Government want to see more productive investment by the financial sector, but mandating how citizens’ private assets are invested would displace trustee fiduciary duty with state control of private assets, inviting litigation and risking impacting public attitudes to private saving. But, in giving the FCA power to guide the content and require open reporting on sustainability, Amendment 93 can assist confidence in aligning members’ best interests with increasing productive investment. I commend it to the House.

[Lord Naseby (Con)]

My Lords, I welcome Amendment 4. Having listened to my noble friend on the Front Bench in Committee and subsequently, I know that she played a major role in this absolutely vital amendment coming forward.

The noble Baroness, Lady Wheatcroft, was quite right. Let us reflect on two key areas where we desperately need the SDR policy statement. First, in terms of the energy market, is the national grid. Today, all sorts of decisions have to be made by the energy market, whether on nuclear, solar or whatever else. People in that market want to know at what point the national grid will be in a position to be connected to them—that is absolutely key to sustainability.

Secondly, in my judgment, the public in general are confused and have no understanding of what they should do about making their contribution to net zero with the condition of their property. Some of us had a good briefing on that situation from the building society movement today. We must address this. But the principle is here, and I thank my noble friend on the Front Bench for how it has come forward.

I declare an interest as a trustee of the Parliamentary Contributory Pension Fund. Noble colleagues will not be members of it unless they have been in the other place or are ministerial colleagues. Nevertheless, I can assure anybody who knows anything about that particular area that, in my judgment, our fund—given the care and attention paid by its chairman and the members in terms of the time put in freely and the trouble that is taken to ensure that we listen to asset managers, question asset management and challenge the advisers we have—is aware of government policy, whatever it may be. Yes, we welcome guidance and particular in- depth information. But—and this is a very big “but” in capital letters—our primary duty is to the membership and the beneficiaries, and we must never forget that. We are not there to take risks, unless we really have to take them, and we debate these issues.

All I will say in relation to the forestry dimension is that I do not welcome that particular one more than any other. I want concrete material that is of benefit to those who are the beneficiaries. With that, I do not think that I need to say any more.