Financial Services Bill

Debate between Baroness Jones of Whitchurch and Earl Howe

Committee stage
Monday 1st March 2021 Grand Committee

[Baroness Jones of Whitchurch (Lab) [V]]

My Lords, I am grateful to the noble Lords, Lord Oates and Lord Holmes, for tabling these amendments and for their helpful contributions. They provided a welcome extra clarity as to how we can deliver the UK’s climate change obligations across the financial services sector.

In an earlier debate, we identified the important principles which should underpin the application of climate change principles by the regulators and how they should be reported. A number of noble Lords then made strong and compelling cases for changes to the regulatory regime in advance of the Government’s consultation and implementation of the Basel standards because of the urgency of the climate change threat that we all acknowledged in that debate.

These amendments go one step further. Amendment 28 would add a specific requirement on the PRA to take the level of exposure to climate-related financial risk into account in setting capital adequacy requirements. We believe this is right, given the increasing evidence that institutions with overexposure to carbon-intensive investments are not acting prudentially.

In the debate last week, the Minister said:

“There is no evidence that ‘greener’ means ‘prudentially safer’, at least not yet”.—[Official Report, 24/2/21; col. GC 224.]


Although we accept that evidence in this field is still being collected, we believe that there is already a sufficiently strong evidence base on which to act. This has been confirmed by the Bank of England, which is already planning to tighten the supervisory expectations on climate-related risk for banks and insurers. As the Governor of the Bank of England said—and we all seem to be quoting the governors or the bank in different guises in this debate, but all roads lead to the same conclusion—in a recent speech:

“Investments that look safe on a backward look may be existentially risky given climate change. And investments that might have looked speculative in the past could look much safer in the context of a transition to net zero.”


Therefore, let us face it: high-level thinking is changing fast, whether it is by the Chancellor or the Governor of the Bank of England or, indeed, in the quotes from BlackRock that we looked at in the previous debate. There are big changes and big thinking going on. We now need to turn that recognition by all those leadership characters into practical policies for the future, and that is what we are attempting to do. We identify the urgent need to revisit investment assumptions and near-term capital requirements, and that is what Amendment 28 is trying to do.

Amendments 31 and 32 focus on the specific risk weight of investment in fossil fuels, which remain a major contributor to carbon emissions and are inevitably high-risk. We welcome the debate on these amendments and the specific risk weights that are proposed. I listened carefully to what the noble Lord, Lord Oates, and other noble Lords, had to say on this. We feel that the noble Lord was making a very valid point. As other noble Lords have said, the wording of these amendments might not be perfect, but they are certainly worthy of further exploration. On that basis, I look forward to the Minister’s response.

[Earl Howe (Con)]

My Lords, I am grateful to the noble Lord, Lord Oates, for his clear and succinct introduction to these amendments, and to other noble Lords who have spoken in his support, as well as to those who have sounded a more critical note.

I have already spoken about some of the broader questions relating to climate change and financial services in a previous debate and, in response to the noble Baroness, Lady Ritchie, in particular, I set out last Wednesday the significant action the Government are taking in this area. I also indicated that I have heard and understand the well-argued concerns of noble Lords about the manifold risks arising from climate change. I stand ready to discuss those concerns in the context of this Bill as constructively as I can between now and Report.

To add one more assurance in reply to the noble Lord, Lord Oates, who spoke about the risk of stranded assets and asked specifically about a transition plan, the Government are committed to a managed transition that puts new jobs in the clean energy sector at the heart of our strategy. My right honourable friend the Prime Minister set out details of this in his 10-point plan; further detail will be included in the forthcoming net zero review.

If I may, I will focus my remarks more narrowly on the specific issues raised by these amendments. Noble Lords reflected in earlier debates on the importance of prudential regulation, which aims to ensure the safety and soundness of the financial system. Much of the UK’s existing prudential regulation was introduced as a result of the 2008 financial crisis, to protect our economy by ensuring that financial services firms are adequately capitalised and properly managed to limit the risk of failure and the impact that would have on the economy. We must therefore be careful when considering the use of prudential tools to deliver other policy objectives; my noble friend Lady Noakes was absolutely right to emphasise this.

Indeed, one of the key advantages of the approach taken in the Bill is that it allows the UK’s prudential regulator, the PRA, to react where necessary to changing market conditions and to developments in international work and research on climate risk, particularly the development of a global consensus on what role the financial sector should play in tackling climate change. I believe this is a better solution than the amendments we are discussing here.

Amendment 28 would require the PRA to set capital adequacy requirements of a credit institution while having regard to its exposure to climate-related financial risk. As I have said, I appreciate all the concerns around climate change—there is no question of the Government being complacent about them—but I cannot see how this amendment would deliver more than the PRA’s existing obligations under the Financial Services and Markets Act, which by definition requires it to consider risks to the safety and soundness of financial institutions. I say to my noble friend Lady Altmann in particular that this includes climate risks in the same way as any other risks. The regulators are very alive to climate-related risks and are already acting to make sure they are understood and addressed in the financial system. To prove the point, the PRA will undertake climate-related stress tests in June to ensure that the financial system remains resilient to climate-related risks.

Amendments 31 and 32 would require the PRA to set punitively high risk weights against exposure to existing and new fossil fuel production and exploitation. These risk weights would, in effect, make it more expensive to finance such activities, and thereby make them less attractive. However, the point of the Bill is to support a flexible regulatory system that can respond to changing circumstances and developments as they arise. This framework puts financial stability at its heart through the PRA’s primary objective of safety and soundness. Other relevant public policy considerations are dealt with through the system of “have regard” set out in the Bill. None of these is prescriptive in the way that these amendments are, and they are, quite importantly, subordinate to the PRA’s primary objective. I maintain that this is the most effective way in which to ensure appropriate prudential treatment for all assets. Putting other public policy issues on a par with safety and soundness could lead to decisions being taken that are not sufficiently focused on the core purpose of prudential regulation.

Amendment 42 would require the Treasury to make regulations requiring credit rating agencies to give due consideration in their ratings to the level of exposure of a credit institution to climate-related financial risk. The credit rating agencies regulation sets out the UK’s regulatory regime for credit rating agencies, which are supervised by the FCA. A key principle of the regulation is that the agencies are independent, and the credit ratings they produce are independent, objective and of adequate quality. In producing these ratings, credit rating agencies are required to use methodologies that are rigorous, systematic, continuous and subject to validation based on historical experience. However, the credit rating agencies regulation does not stipulate factors that must be included within the methodologies used by credit rating agencies. In line with this principle of independence, the regulation prohibits interference of public authorities in the content of credit ratings or methodologies when performing their supervisory functions. This is an important principle designed to ensure that ratings have not been unduly influenced.

However, the regulation places requirements on credit rating agencies clearly to disclose their methodologies and the key elements underlying the credit rating or the rating outlook. That ensures that those using the ratings can make an informed choice as to whether a rating gives due regard to the impact of a type of risk on the creditworthiness of the institution in question, including climate-related financial risk. In addition, EU guidance published in 2019 provides that, when a credit rating agency changes a rating, it must disclose whether environment, social and governance factors played a part in that decision. The FCA has publicly communicated that it considers all guidance published by European authorities before 31 December 2020 to be relevant to UK firms and, therefore, UK agencies are expected to continue to apply this principle. More generally, 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.

On the topic of disclosures, Amendment 136A would require the Government to introduce an obligation on fund managers to report to the FCA on how their funds are satisfying environmental, social and governance requirements. I have already spoken about the Government’s commitment to implementing the requirements of the Task Force on Climate-Related Financial Disclosures—TCFD—in the UK. Becoming the first major economy to commit to fully mandatory and public climate disclosures is even more ambitious than the proposed amendment, which requires FCA-regulated fund managers only to make disclosures to the FCA. But fund managers do not yet have sufficient information on environmental factors from the wider economy in which they invest. The mandatory TCFD road map set out by the Government will apply to funds and the wider economy in a co-ordinated timeline.