Financial Services and Markets Bill

Lord Lilley Excerpts

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—

[Baroness Sheehan (LD)]

I find the noble Lord’s contributions really very valuable. But on supply and demand, for him to label us people who just do not want fossil fuels is so incorrect. We need more energy, but it does not have to come from fossil fuels. The fossil fuel industry is supported to an extent.

[Lord Lilley (Con)]

By whom?

[Baroness Sheehan (LD)]

It has been supported by Governments, through subsidies, through tax breaks, through decommissioning tax reliefs—any number of routes for support exist. So I say to the noble Lord: please do not try to categorise the noble Baronesses who have spoken on this issue as people who do not like fossil fuels. What we do not want is for fossil fuels to be needlessly supported in the future when they are patently no longer able to support themselves.

[Lord Lilley (Con)]

I agree with the noble Baroness. I do not want to support fossil fuels. If she looked at the tax revenue levied on the production and consumption of fossil fuels, she would see that it is enormous. To describe that as a subsidy or support is very strange. But to the extent that there is anything that is a subsidy, I am with her: let us remove it, but that is not what these amendments do. They simply aim to make it more expensive to invest in fossil fuels. I do not know whether the noble Baroness, Lady Castle—whatever it is; bouncy castle—is upset at being described as being against fossil fuels. I would have thought that she would be positively flattered. I do not know whether the noble Baroness, Lady Drake, is offended at being told that she is trying to discourage the production of fossil fuels; I thought she was. I am simply saying let us stick to the CCC’s recommendations of phasing out demand and we can leave the supply side to look after itself. We should not pretend that we know better than the industry what is likely to prove excessive or insufficient.

[Baroness Sheehan (LD)]

Before the noble Lord sits down, perhaps I could say a little about stranded assets; I think we have had this exchange before. If stranded assets transpire—from where I am sitting, I think that is inevitable—what assurance can he give that the cost of those stranded assets will not be socialised?

[Lord Lilley (Con)]

Clearly, the Government ought to deal with that problem. These amendments do not deal with that problem. If there is a problem, if the noble Baroness thinks that BP or Shell will go bankrupt and be unable to pay for the liabilities it incurred, we should take steps to deal with that situation. I do not think it is likely but if she thinks it is that serious, she should table amendments that would deal with that, but these amendments do not. They simply make it more expensive to invest in things which we are going to continue consuming, according to the Government’s own plans and the CCC’s own projects and recommendations, in considerable quantities until 2050.

[Baroness Worthington (CB)]

I will interject on behalf on the amendment I drafted, as the noble Lord has completely mischaracterised what we are attempting to do here and has narrowed the debate into a very narrow conversation about oil and gas assets. We are talking here about climatic risk across the whole economy. It is not just oil and gas operators; it is anybody who has any money wound up in any of the sectors that will be affected by the physical risk, the risk of transition and the societal risk when we finally realise that science does not negotiate with oil and gas companies, financial regulators or anybody who pretends to be able to predict the future. We have poor modelling, we have terrible risk assessments, and the PRA and the Government need to issue better guidance so that we can understand the risks we are facing. Let us not reduce this to a narrow discussion about oil and gas interests.

[Lord Lilley (Con)]

I read the amendment in the name of the noble Baroness. Proposed new subsection (1) refers to

“group undertakings engaged in existing fossil fuel exploitation and production … group undertakings carrying out new fossil fuel exploration, exploitation and production”.

If this is not about fossil fuel exploration, that is not very clear from her amendment. I am dealing specifically—

[Baroness Worthington (CB)]

My Lords—

[Lord Lilley (Con)]

Hang on, I must have the right to reply to the previous intervention before I take the next. I am not dealing with things other than fossil fuels. I am talking just about fossil fuels. It seems to me that the noble Baroness’s amendment is about fossil fuels, in large measure. My arguments have not been responded to because they are fundamentally logical. They are the whole basis of government and CCC policy. But I give way to the noble Baroness now.

[Baroness Worthington (CB)]

The amendment lists certain sectors which are likely to be most affected. It does not in any way say it is limited to those sectors, and I think it is egregious to assume that this is a narrow amendment when it is, in fact, a very broad amendment.

[Lord Lilley (Con)]

My remarks are narrow. The noble Baroness’s amendment may be broad. Can we agree on that and deal with the aspect of fossil fuel investment?

[Baroness Worthington (CB)]

Yes.

[Lord Lilley (Con)]

We ought to allow the industry to invest as long as we are phasing out demand. If it invests too much, it is its problem. If it invests too little, it is our problem.

[Baroness Altmann (Con)]

My Lords, I declare my interests as set out in the register. I support many of the amendments in this group. My Amendment 241A is in this group. I have added my name to Amendments 201 and 237, which require FCA guidance about long-term returns for occupational pension investors. I think that is very important when considering climate change and is very relevant to the remarks of my noble friend Lord Lilley. I have also added my name to Amendment 235 as I think it is equally important for institutional investors in the UK to be equipped with some green taxonomy so that we have some standards by which we can measure the impact of climate investment.

As regards the issues raised by my noble friend, particularly, perhaps, in relation to Amendment 168, when I read that amendment it seems to me to be calling for a review. It calls for the FCA to review and perhaps guide pension schemes and insurance companies, which have very long-term liabilities, on assessing the long-term risks of investing in assets such as fossil fuels. There is a widespread opinion suggesting that over the long term, whether that is 20 years or 30 years —those timescales are relevant for Solvency II and the annuity books of insurers, for example—there is a significant danger in relying on the continued thriving of those large energy companies.

It makes sense. We have been taken by surprise too many times in the financial world by supposedly very small long-term risks which materialise in a cliff-edge event that people had not been prepared for. Whether or not the review concludes that there should be any change, it is appropriate that this review should be carried out, so I support the amendment, but I understand the points made by my noble friend. Perhaps, on a shorter-term timescale, given the need for fossil fuels and the work that is being done by those large companies to try to transition to more green energy, that is an issue that needs to be carefully weighed up by any investor who is considering the potential returns from their investment.

In the interests of time, I will now speak to my Amendment 241A. I hope that my noble friend will be interested in this amendment and, indeed, that other Members of the Committee might consider that there is merit in this proposal. It is a relatively modest reform. It would be deregulatory. It supports the transition to net zero and nature preservation and it would encourage innovation. I hope it would garner more of our domestic institutional asset base to be used for the kinds of investments that all of us who are concerned about the long-term impact of human activity on the climate and nature would want to see happen.

I thank the Public Bill Office and Susannah Street, as well as Peers for the Planet, for their assistance in trying to ensure that the amendment is in scope of the Bill, which was quite a feat. It is a probing amendment; I am not wedded to the wording, but the principle of the proposal would make it easier for funded occupational pension schemes to join together to establish fund managers under a lighter-touch regime that already exists in order to invest in and support climate and nature protection. We all know that there is a growing need to find the funding to rebuild, repurpose or have new infrastructure for low-carbon and nature-friendly projects. Indeed, nature’s impact on and interaction with climate change and net zero is increasingly recognised. These issues feature in the other amendments I have attached my name to, so I hope that the scientific and political consensus that we need urgent action might help my noble friend and the Committee recognise that this could be a win-win for pension funds to get better long-term returns, for pensions to be perhaps better than they otherwise might be, and for the economy.

Much of the investment needed to reach net zero will be in very large long-term projects. It is not always easy to find the money. Normally, perhaps, with a Government who were in a much stronger fiscal position than most western Governments now are, we might look to the majority of this being funded by government, but that is less likely at the moment. Yet we have in this country this enormous pool of long-term assets that is currently being encouraged to invest in assets with a much lower expected return or so-called safe assets—gilts and corporate bonds, for example—shunning long-term growth with equities and projects such as the one I have in mind for this type of approach. Only 100 schemes or so have more than £5 billion worth of assets. Even with the kind of forecast consolidation, it is unlikely that we will have very many of the £5 billion-type scale that is normally suggested to be required to put forward a prudent, risk-diversified portfolio of such infrastructure and other protective investments.

My amendment would facilitate asset pooling for the smaller pension funds as well, so they can all join together in FCA-authorised investment managers specifically for pools of pension assets to benefit from and contribute to the benefits for green growth and sustainable long-term returns for the specific purposes set out in proposed new subsection (3) of my amendment. The Local Government Pension Scheme is already starting to do this, but private schemes would have to use commercial fund managers, which often either deters such investing or incurs much higher costs, whereas big schemes such as USS and NEST are already looking to invest or have the expertise to do so, but they are not joined with the smaller schemes.

I hope that the currently existing lighter-touch regime that the FCA offers in its occupational pension scheme firm rules, which currently apply only to fund management firms that are wholly owned by one pension fund, could be applied to a combination of pension funds that are investing for their own purposes in the various schemes that belong to it. It is not commercially available or available to other members of the public, but it is for long-term pension investing.

I would be grateful if my noble friend considered this modest reform, or, if she feels that there is some flaw in the wording of the amendment that could be changed and still facilitate this, I would be happy if she, or indeed any other noble Lords, wanted to meet to discuss it. As I said, it is deregulatory, it supports the aims of net zero and nature preservation, it would encourage innovation and it should provide better diversification and therefore long-term risk reduction for a number of occupational pension schemes which otherwise could not take advantage of it.

[Lord Davies of Brixton (Lab)]

My Lords, I support the objectives behind all these amendments. I was going to direct my remarks specifically to Amendment 237, but I want to make a narrow but important point of qualification. I support the principle, but I cannot stop myself responding to the discussion we had earlier, led by the noble Lord, Lord Lilley, about fossil fuels. The important point about fossil fuels is that there are massive externalities—external costs—which are not caught in the market, and, unless we do something now, our children, and their children, will pay the price. It is not just a question of moving the market now; we need to stop using this stuff, which is poisoning the planet.

[Lord Lilley (Con)]

I was not disputing that; I was saying that we accept that we have to find the route to net zero, but the question is: should we phase out demand for fossil fuels, as the noble Lord’s last sentence indicated, or should we phase out supply? Which does he prefer?

[Lord Davies of Brixton (Lab)]

Both. I am not really being given that choice but, as I said, it was just a narrow point.

My question on Amendment 237 is: would you take investment advice or guidance from the Secretary of State? Is the Secretary of State even authorised to provide investment guidance or advice? I am troubled by the involvement of the Secretary of State, and I hope that we could perhaps consider a different wording if we wish to raise this on Report. If the Government want something to happen—net zero—as a matter of public policy, they have to accept the risk themselves and not pass it on to private individuals. I am talking about pension schemes, and the underlying point is that the money in a person’s pension scheme is their money, provided to them to be used in accordance with their wishes to provide them with a retirement income. Part of that retirement income depends on solving climate change—that is clear. I do not doubt the importance of taking these issues into account; I simply question the relevance and role of the Secretary of State in that process.

Over many years’ involvement with pension funds, I have seen that, when people see the massive amount of money involved, as highlighted by the noble Baroness, Lady Altmann, they see that the economic power is there, but it is there on behalf of the members’ interests and not, in principle, as a means of implementing government policies—however worthy. They might be in alignment, but the leading factor should be the members’ interests.