Financial Services Bill

Lord Oates Excerpts

2nd reading & 2nd reading (Hansard) & 2nd reading (Hansard): House of Lords
Thursday 28th January 2021 Lords Chamber

[Lord Oates (LD)]

My Lords, I congratulate the noble Lord, Lord Hammond of Runnymede, and the noble Baroness, Lady Shafik, on their excellent maiden speeches. I look forward to the important contributions they will both undoubtedly make to the House.

On Monday 9 November last, the Chancellor made a Statement to the House of Commons in which he set out the Government’s vision for financial services. He pledged, as the noble Baroness, Lady Hayman, reminded us, to put

“the full weight of private sector innovation … behind the critical global effort to tackle climate change and protect the environment.”—[Official Report, Commons, 9/11/20; col. 621.]

Just two hours later, his colleague, the Economic Secretary to the Treasury, John Glen, got to his feet to introduce the Second Reading of this Bill. In his opening speech, which lasted over 25 minutes, he did not refer to the climate and ecological emergency once. He made no mention of green finance, climate risk disclosure or the critical role the financial services industry will have to play if we are seriously to tackle climate change.

The omission of any reference to climate change, replicated by the Minister this afternoon, was not the result of an oversight on the Economic Secretary’s part. Far from it; it was simply a logical consequence of the fact that the Bill does absolutely nothing to address the climate emergency we face. The Economic Secretary had a number of answers for this failure when he got around to the matter in Committee. First, he argued that these issues were not relevant for discussion, as they were not directly related to the Bill—a strange and circular argument, as their absence from the Bill was precisely the complaint he was addressing. Secondly, he argued that the regulators were making progress on climate-related issues and we should let them get on with it. Finally, he said:

“The Bill grants the Treasury a power to specify further matters in the accountability framework at a later date, which could be used to add a requirement to explicitly have regard to green issues in the prudential framework, if appropriate … I can assure the Committee that the Treasury will carefully consider a green ‘have regard’ in the future.”—[Official Report, Commons, 24/11/20; col. 157.]


Essentially, he was telling Parliament, “It’s not for you to worry your little heads about these things, and to ensure that you don’t have to, the Bill will take the powers away from Parliament in this regard and vest them in the Treasury and the regulators, who know best.”

We on the Liberal Democrat Benches do not think that they know best. History does not cause us to put much faith in the willingness of the Treasury, or of unaccountable regulators, to act. Nor does it give us any faith in their ability to determine the appropriateness, or otherwise, of action on such critical matters for our planet. We agree with the Chancellor that financial services have a key role to play in tackling climate change, but we believe that it is for Parliament to determine that role. Accordingly, we will bring amendments forward in Committee to ensure that the Bill does exactly that. They will do this, first, by requiring the Prudential Regulation Authority to have regard to climate-related financial risk when setting capital adequacy requirements and, secondly, by ensuring that credit-rating agencies have to take climate risk into account in setting credit ratings. Thirdly, they would bring forward the date when the recommendations of the task force on climate-related disclosure will be mandatory from 2025 to 2023.

We will also seek amendments to ensure that, in setting general rules, the FCA has regard to the climate-related financial risks to which FCA investment firms are exposed and that the FCA, in setting Part 9C rules, and the PRA, in setting capital requirement regulation rules, have regard to the UK’s domestic and international climate obligations. I look forward to working on these issues with the noble Baroness, Lady Hayman, and other members of Peers for the Planet, the excellent organisation which she chairs.

I welcome the lead that the Government have taken in setting the net-zero target. I applaud the Treasury for moving on the TCFD recommendations, so far as they have gone, and for their positive words on green finance. However, the awful truth is that action in every respect of our response to the climate emergency is glacially and catastrophically slow. We are way off line to meet the Climate Change Act’s original 80% reduction target, let alone the revised net-zero one. There is a time when the talk of distant targets for which none of us will be held accountable has to end and the activity and action to meet them has to start. That time is now. The climate crisis is not something that might happen in some distant future if we do not get our act together. It is happening right now. Just ask those on the front line of the crisis; ask the people of the small island states who live with the prospect of being literally wiped off the map. Ask the farmers facing ever more erratic weather patterns and deteriorating soil conditions in Africa or South Asia. Ask householders in the UK who are becoming ever more susceptible to flood risk; ask the firefighters in California or New South Wales.

As we speak, the world is on course for three degrees of warming. The devastation that would cause is beyond contemplation. We know the threat that we face, and what we have to do to mitigate it, but that does not guarantee that we will do it. A global pandemic was number one on the Cabinet Office’s risk register. We knew it would happen one day, yet it seemed so far off that, when it suddenly arrived, we met it almost completely unprepared. We cannot afford to do the same with climate change. So I urge the Government to use this Bill to start, however modestly, to match their fine rhetoric with action and to ensure that the financial services industry is able to play its full part in combating climate change.

Financial Services Bill

Lord Oates Excerpts

Committee stage & Committee: 2nd sitting (Hansard) & Committee: 2nd sitting (Hansard): House of Lords
Wednesday 24th February 2021 Grand Committee

Moved by

[Lord Oates]

11: Schedule 2, page 62, line 9, at end insert—
“(ca) the climate-related financial risks to which FCA investment firms are exposed,”Member’s explanatory statement
The purpose of this amendment is to require the FCA, in exercising its power to make general rules, to have specific regard to the climate related financial risks to which FCA investment firms are exposed.

[Lord Oates (LD)]

My Lords, I declare my interests as chair of the advisory committee of Weber Shandwick UK, as set out in the register. In moving Amendment 11 in my name and the names of my noble friend Lady Kramer and the noble Baroness, Lady Hayman, I will also speak to the other amendments in this group. Before doing so, I put on record my thanks to a number of organisations for their briefing and patient answers to the many and often ignorant questions that I have posed to them in preparing for the Bill, particularly Finance Watch, Positive Money and Carbon Tracker.

I am also grateful to the City Corporation and the APPG for Financial Markets and Services for the helpful information they provided, and, of course, to the noble Earl, Lord Howe, and his ministerial colleagues for meeting to discuss the Bill and, if not immediately signing up to all our climate amendments, at least recognising the seriousness of the issues that they raise. I hope that over the course of Committee we will be able to convince the noble Earl and his colleagues of the urgency of acting through this legislation.

There are essentially three categories of amendment in this group. The first addresses the rule-making powers of the regulators, requiring them when making the rules to take account of the climate-related financial risks to which the entities they regulate are exposed. This issue is dealt with in Amendments 11 and 12.

The second category requires regulators when making rules to have regard to the UK’s national and international climate change objectives and obligations. Amendments 13, 14, 15, 16, 17, 23, 34, 35, 36 and 37 address this issue in a number of different ways.

Finally, Amendments 48, 75, 76, 89 and 98 fall into a third category, which tackles disclosure and governance issues as they relate to climate change.

Turning to the first category, the objective of Amendments 11 and 12 is simply to ensure that the prudential regulation of FCA investment firms under Schedule 2 is fit for purpose; that is, that it properly takes account of and seeks to manage and control the risk exposure of the firms it regulates. It is hard to understand on any accepted definition of prudential regulation how it can be regarded as such if it fails to take account of exposure to climate risks, given the potential threat they pose, not only to individual firms but to the financial system as a whole.

There are those who argue that it is premature to take this approach, because the sector is in the process of working out how to measure climate risk, which is undoubtedly a complex matter, given the myriad interrelationships that exist and the fact that there is no precedent for measuring such dynamic risks. While I acknowledge that we do not have a perfect understanding of climate risk, we cannot wait for a perfect solution. We cannot accept that a potentially enormous risk exists for FCA investment firms, but, because it is difficult to measure its exact scale, we are going to act as if it does not exist at all. That is not prudential regulation; it is wantonly reckless negligence.

I hope that the Government will look at this matter very carefully and that the Minister will be able to give us some comfort that, if they will not accept our amendments, they will at least bring forward proposals to ensure that prudential regulation of FCA investment firms does not continue to ignore what is likely to be the most significant risk to which they are exposed over the coming decades.

The second set of amendments seek in different ways to ensure that the FCA and the PRA must have regard in rule-making to our net-zero target and our wider international obligations on climate change and biodiversity. Amendment 23 in my name, with the support of my noble friend Lady Kramer and the noble Baronesses, Lady Hayman and Lady Bennett of Manor Castle, would prevent the Treasury from using its power under Clause 3 to evoke capital requirement regulations unless the effect of the new regulation was compliant with the UK’s net-zero target.

Amendment 13 to Schedule 2 and Amendment 34 to Schedule 3 require the FCA and PRA, when making rules, to have regard to the

“the likely effect of the rules on the relative standing of the United Kingdom as an international leader in combatting climate change”.

Amendments 16 and 37 to Schedules 2 and 3 respectively require that, in considering that likely effect on the UK’s standing, the FCA and PRA have regard to our commitments under the Paris Agreement. This includes our nationally determined contribution of a 68% reduction in emissions from 1990 levels by 2030 and the UK’s net-zero target under the Climate Change Act 2008, as amended in 2019. Amendment 17 in the name of the noble Baroness, Lady Bennett of Manor Castle, adds the United Nations Convention on Biological Diversity to that list of “have regards”.

In these amendments, I have deliberately replicated existing language in the Bill’s rule-making clauses, which require the FCA and PRA to have regard to

“the likely effect of the rules on the relative standing of the United Kingdom as a place for internationally active investment firms to be based”.

That is an undoubtedly an important consideration, but it needs to be specifically supplemented by a requirement that takes into account the UK’s standing as a leader on climate change. This will force the regulators to raise their sights and ensure that we have the rules in place to cement the UK’s position as the leading financial centre in tackling climate change and providing green finance.

On an earlier group on Monday, my noble friend Lord Sharkey quoted the Barclays CEO Jes Staley, who said when asked which amendment he would like to burn now we had left the EU:

“I wouldn’t burn one piece of regulation.”


He went on to say:

“I would continue pushing the climate agenda, trying to make London a centre of innovation around financing climate and transitioning to a net zero economy by 2050”.


That might be a pretty brilliant idea and we agree with him, but we need an adequate system in place to allow it to happen. In the last 15 years, Governments in which all the main parties have been represented have ensured that the UK has established and retained international standing as a leader on climate issues. We need to ensure that leadership is reflected not just in our politics and Government, but across industry and society as a whole. Nowhere will this be more important than in the most significant sector of our economy.

If our financial services industry and its regulators show leadership on climate, the industry will not only have the opportunity to gain a clear market advantage in the years ahead but will help to address the current climate emergency. If they do not, instead of playing a key role in averting climate catastrophe, that same industry will be a key contributor to it. That is what is at stake here.

Amendments 14 and 35 tabled by the noble Baroness, Lady Hayman, have a similar objective although I must admit that they are a little more concise than my version. They would require the FCA and PRA, in making rules, to have regard to

“the likely effect of the rules on the United Kingdom meeting its international and domestic commitments on tackling climate change”.

Amendments 15 and 36 in the name of the noble Baroness, Lady Jones of Whitchurch, have a similar objective again but focus specifically on the net-zero target under the Climate Change Act, as amended. I put my name to both these sets of amendments because the purpose of all our amendments is a common one: the essential task of ensuring that our regulators take account of the most significant threat that faces the financial services industry, and indeed every one of us on this planet—the climate emergency. The intent of these amendments has support across the Committee, so I hope that the Minister will recognise the need to act and the Government will either accept a version of these amendments or bring forward one of their own. If they are unwilling to do so, I think the spirit of the House will be to come together on a joint amendment on these matters on Report.

--- Later in debate ---

[Earl Howe (Con)]

My Lords, I failed to cover the Pension Schemes Act. I apologise to the noble Baroness. The Act provides a power to bring forward regulations, placing various obligations on pension schemes relating to climate change risks. The provisions in the prudential package of the Financial Services Bill do something slightly different. They place a duty on the regulators to have regard to certain matters and to explain how they have been considered, given that the Bill imposes duties on the regulators to make rules relating to Basel and the IFPR. I reassure the noble Baroness that my officials and I have considered these provisions carefully, as we have the other amendments discussed today.

As regards her main question, my point was simple. As yet, there is no international agreement on what the term “green” means. Therefore, we cannot say with certainty that greener means prudentially safer. I do not say that we will never be able to, but it is not possible at present.

[Lord Oates (LD)]

My Lords, I am grateful to all noble Lords for their thoughtful contributions to the debate. I thank and pay particular tribute to the noble Baroness, Lady Hayman, for her important leadership on these issues through Peers for the Planet which is recognised across the Committee. I also thank all noble Lords who signed or spoke in favour of amendments for their co-operative, cross-party approach.

In quoting the Government’s approach, the noble Baroness, Lady Hayman, paraphrased St Augustine: “Lord, make me greener, but not yet”. I thank the Minister for his comprehensive response and characteristic courtesy, but it felt a little complacent. One could also quote from St Paul—that it was about “the good that I would I do not”. There is no doubt about the Government’s intentions, ambitions and targets. We welcome and are impressed by them, but it is now reaching the point where we have to act.

Financial Services Bill

Lord Oates Excerpts

Committee stage
Monday 1st March 2021 Grand Committee

Moved by

[Lord Oates]

28: After Clause 5, insert the following new Clause—
“Considerations in setting capital adequacy requirements
In setting the capital adequacy requirements of a credit institution, the Prudential Regulation Authority shall have regard to—(a) the level of exposure of an institution to climate-related financial risk;(b) the level of compliance of the institution with the recommendations of the Task Force on Climate-Related Financial Disclosure; and(c) the objectives of the Climate Change Act 2008 as amended by the Climate Change Act 2008 (2050 Target Amendment) Order 2019 (S.I. 2019/1056).”Member’s explanatory statement
The purpose of this amendment is to place a requirement on the PRA in setting capital adequacy requirements of a credit institution to have regard to its exposure to climate-related financial risk.

--- Later in debate ---

[Lord Oates (LD)]

My Lords, I declare my interests as the chair of the advisory board of Weber Shandwick UK, as set out in the register. In moving Amendment 28 in my name and those of my noble friend Lady Kramer and the noble Baroness, Lady Bennett of Manor Castle, I will speak also to the other amendments in this group. I once again express my thanks, in particular to Finance Watch, Positive Money and Carbon Tracker for their helpful briefing, and indeed to all organisations that have taken the trouble to provide me with information on this subject.

The context of our discussion of these amendments is one in which, at current levels of carbon emissions, the world will have exhausted within 10 to 15 years the carbon budget it must stick to if we are to meet the Paris objective of keeping warming well below 2 degrees. This is not the alarmist prediction of some fringe organisation or, indeed, even of a Liberal Democrat politician; it is the sober warning of experts in the field, including the United Nations special envoy for climate action and finance and former Governor of the Bank of England, Mark Carney, who spoke in his Reith Lecture at the end of last year of the struggle between urgency and complacency in tackling climate change, highlighting the contrast between the

“urgency of carbon budgets that could be consumed within a decade and the complacency of continuing to add new committed carbon … The urgency to reorient the financial system for the massive investment needed to create a sustainable economy, yet the complacency of many in finance”.

Mr Carney went on to warn that the tensions that exist in our desire to tackle climate change reflect the common challenge of values, including human frailties and market failures. Nowhere could market failures be more evident than in the failure to price climate risk appropriately within the financial system. That is what the amendments we are debating are all about. In the previous group of amendments related to climate, which we discussed last week, we talked about the purpose of prudential regulation, which is surely to manage and control risk. We spoke also about the fact that our system of prudential regulation is clearly not performing that function in respect of the greatest risk facing the financial system and, indeed, the planet as a whole: climate change.

Amendment 28 seeks to take the first steps in addressing this issue. It requires the Prudential Regulation Authority, in setting capital adequacy regulations, to have regard to climate issues, including the level of exposure of an institution to climate-related financial risk and the level of compliance of that institution with the recommendations of the task force on climate-related disclosure and the net-zero objective of the Climate Change Act, as amended.

Amendment 42 requires the Treasury to amend the credit rating agencies regulations to require such ratings to explicitly take account of the level of exposure of an institution to climate-related financial risk.

Both amendments aim to act as a wake-up call to regulators and the City so that, when setting capital adequacy requirements and issuing credit ratings, they take account of and act on the risks that climate change poses to individual institutions and the financial system as a whole.

Amendments 31 and 32 in my name and those of my noble friend Lady Kramer and the noble Baroness, Lady Altmann, focus specifically on fossil fuel exploration, exploitation and production. I am particularly grateful to Finance Watch for its advice and recommendations in this regard. Amendment 31 sets out the risk weight the PRA must apply to the funding of existing fossil fuel production and exploitation; Amendment 32 does the same in respect of new fossil fuel exploration, production and exploitation. They both seek to do so within the existing framework of the Capital Requirements Regulation, which sets capital requirements on a risk-based approach.

The two amendments apply different risk weights to the different activities addressed in each because the financial risks associated with the two activities are different: exploiting existing reserves runs a high risk that some fossil fuel assets will become stranded during their lifetime, whereas exploring and exploiting new reserves comes with a much higher risk—indeed, a near certainty—that they will become entirely stranded.

Amendment 31, dealing with the risk weighting for existing fossil fuel investment, is tailored around Article 128 of CRR as amended in CRR2. This deals with what it describes as:

“Items associated with particular high risk”.


Paragraph 1 of Article 128 states:

“Institutions shall assign a 150% risk weight to exposures … that are associated with particularly high risks”


and that for the purposes of the article, institutions should treat any of the following as exposures with particularly high risks:

“investments in venture capital firms, except where those investments are treated in accordance with Article 132 … investments in private equity, except where those investments are treated in accordance with Article 132 … speculative immovable property financing.”

Paragraph 3 of Article 128 goes on to state:

“When assessing whether an exposure … is associated with particularly high risks, institutions shall take into account the following risk characteristics: (a) there is a high risk of loss as a result of a default of the obligor; (b) it is impossible to assess adequately whether the exposure falls under point (a).”


As Finance Watch points out in its excellent report Breaking the Climate-Finance Doom Loop, paragraph 3 of Article 128 almost appears to have been written specifically to deal with stranded fossil fuel assets: first, because, if we manage to meet net-zero targets, a large proportion of existing reserves will have to remain in the ground, leading to the probability of default of the obligor, the issue addressed in Article 128(3)(a); and, secondly, because assessing the scale of the stranded asset risk is impossible given that it relates to a unique situation for which we have no historical precedent but in which we know that the future economic performance of the assets must be downward—the situation exactly envisaged and provided for in Article 128(3)(b).

Accordingly, Amendment 31 would apply an approach consistent with Article 128 of the CRR to make it explicit that the PRA must apply the 150% high risk weight in calculating capital requirements for existing fossil fuel funding. This risk weight is already applied to venture capital firms, private equity and speculative immovable property, and it is hard to understand how fossil fuel operations can be regarded as posing less risk. The fact is that the existing 100% risk weight is an incentive to the financial markets to continue to act as if nothing has changed. A 150% risk weight, by contrast, would provide a clear price signal reflecting the risk to assets but would not prevent the continued financing of existing fossil fuel operations, allowing an orderly and just transition for those industries and the communities that rely on them.

Amendment 32 addresses the much bigger threat to the climate and to the financial system that arises from new fossil fuel exploration, production and exploitation. It would require such investments to be funded entirely by capital by applying a 1,250% risk weight to this activity. This risk weight is calculated with reference to Article 92 of the CRR on own funds requirements, which obliges institutions to maintain at all times a total capital ratio of 8%. This provides the basis to determine the risk weighting to apply to ensure that new fossil fuel activities are funded entirely from equity.

The 8% total capital requirement is multiplied by the risk weight of 1,250% in accordance with the standardised approach, resulting in a 100% capital requirement for these activities. This risk weight is not some wild or punitive sanction; it is the considered application of the real risk such investments pose to the institutions themselves, to the financial system as a whole and to our ability to stabilise the temperature of the planet. It is also consistent with the existing risk weight applied under the capital requirements regulation for holding companies, as defined in Article 89.

Requiring any fossil fuel investment to be entirely equity funded is surely appropriate, given that these activities will either become non-viable because we have succeeded in stabilising the climate by reaching our net zero targets, or, if we have not, they will be fuelling runaway climate change which will threaten the viability of the whole financial system, not to mention our entire way of life.

The truth is that we have no chance of meeting the objective of the Paris Agreement to keep warming to well below 2 degrees, and ideally to 1.5 degrees, if we burn all the carbon in existing reserves, let alone exploit new ones. The regulatory system has to take account of that, and it has to adequately price risk for those institutions that wish to invest in activities which must become non-viable if we are to prevent catastrophic climate change. In doing so, it will help ensure an orderly and just transition away from fossil fuels.

I want to be very clear that these amendments are not driven by any animus against the fossil fuel industries, whose products have been critical to the development of human society, whether by keeping us warm or driving industry and prosperity. Indeed, my own title in this place is taken from Denby Grange colliery, where my uncles and my grandfather were miners, engaged in the critical but dangerous job of mining the fuel that provided heat and power for the nation.

As we know, coal mining as a major industry in the UK came to an abrupt end in the 1990s. The way it did so, driven by political malice and with no transition planning at all, devastated the mining communities which had fuelled the country’s prosperity over a period of more than 200 years. Abandoned by government, these communities were beset by huge economic and social problems, many of which exist to this day. We cannot allow that to happen in the oil and gas industry.

--- Later in debate ---

[The Deputy Chairman of Committees (Lord Russell of Liverpool) (CB)]

Does the Minister wish to respond? No? In that case, I call the noble Lord, Lord Oates.

[Lord Oates (LD)]

I thank noble Lords from all sides of the Committee for their contributions. I am particularly grateful to those noble Lords who signed the amendments and spoke in the debate. I am grateful also to the Minister for his courteous response and for agreeing to continue to discuss these issues.

The noble Lord, Lord Sharpe, made the point that we are going to need fossil fuels for some time to come. That is precisely the point I covered in my opening remarks. That is why we need to risk existing fossil fuel operations properly and effectively so that they can continue as we transition.

The noble Lord, Lord Sharpe, and the noble Baroness, Lady Noakes, questioned which companies Amendments 31 and 32 might apply to. The intention was for them to apply to activities as opposed to specific companies, and specifically to fossil fuel activities to try to avoid capturing some companies’ non-fossil fuel activities. I am perfectly happy to accept that the amendments’ wording might be improved, but that was the intention. The issue we have to deal with is the threat of continued fossil fuel activities beyond what we have the carbon budgets for.

Overall, however, I was struck by the absolute complacency from the Government Benches—the lack of realisation of the issue that we are facing and of the urgency of dealing with it and of trying to use whatever tools we can to address it. The noble Baroness, Lady Noakes, appeared to question the very concept of using prudential regulation to achieve the objective of averting climate change. She said that the impacts of climate change were unlikely to find their way into credit risks in the short term. She also said, as the noble Baroness Lady Bennett, reminded us, that banks do not lend in situations where there is a high risk of default. History explicitly and categorically refutes that. The noble Baroness also informed us that credit agencies did not need any help in assessing credit risk—the same agencies which gave their highest ratings to complex securities associated with the subprime mortgage crisis.

Prudential regulation is a tool through which we can, necessarily and legitimately, regulate the sector and ensure its financial stability. My noble friend Lady Kramer quoted the current Bank governor’s rather extraordinary statement that we were not going to use the results of the stress tests of different climate scenarios to inform the size of firms’ capital buffers. But he did say that that does not mean firms should not be thinking about near-term capital requirements. He set out that firms must assess how climate risk could impact their business and review whether additional capital needed to be held against this. He expressly recognised the legitimacy of using capital requirements to tackle climate change.

The IPCC has warned us that if we do not act decisively to mitigate climate change, we are on a global warming path of between 3.8 and 4.8 degrees centigrade by the end of the century, with a range of median values between 2.5 and 7.8 degrees centigrade. That is the seriousness of the situation we face. Central bankers are clear about the huge risk that climate change poses to the financial system. But what is the reaction of the noble Baroness, Lady Noakes, and the noble Lord, Lord Sharpe? It is to say: “We don’t need to do anything now. Let’s wait and see.” We do not have time to wait and see.

We know the risks we face. If we do not act, we are culpable. Is our excuse to our children and grandchildren, nieces and nephews, and grand-nieces and grand-nephews going to be: “Oh, sorry, it was all too difficult. We were busy trying to measure everything and we thought the banks were quite good at predicting risk anyway, and they all let us down”? The noble Baroness, Lady Noakes, asked: why would we deny the City the opportunities of a relatively low-risk, profitable business? There is a simple answer to that: if those activities continue unabated, they will threaten the very future of human society. That is a reality. That is why we have to act.

In view of the Minister’s willingness to continue to discuss these issues, I beg leave to withdraw my amendment.

Amendment 28 withdrawn.

Financial Services Bill

Lord Oates Excerpts

Report stage
Wednesday 24th March 2021 Lords Chamber

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 statement
The 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.

[Lord Oates (LD)]

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.”—[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.

[Baroness Hayman (CB) [V]]

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.

--- Later in debate ---

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.

[Lord Oates (LD)]

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.