Innovation in Finance

I have had the privilege of coordinating the Innovation Working Group of the Bank of England / Financial Conduct Authority's Climate Financial Risk Forum, led by CEO Nigel Wilson with support from the fab team at L&G Group. The key messages from our innovation group are:

·????????This importance of the ‘financing green’ agenda - channelling finance to real economy outcomes - suggests that financial firms need to have a capital allocation framework as well as a climate risk management framework.

·????????Innovation on this issue is happening at pace, through the activities of multiple firms, public agencies, and non-profits, nationally and internationally. However, to meet national and international climate targets, this innovation needs to be both actionable and scalable.

·????????While there are many good innovations happening, few innovations exist which will scale sufficiently to transform whole economic sectors (buildings, land use, hard-to-abate sectors, energy) to meet the necessary ￡50Billion/year finance required (as per Climate Change Committee recommendations). Pension funds provide a critical opportunity in this space.

·????????This will require regulators to work closely with industry to ensure regulations (e.g., prudential regulation in insurance) take the macro-risks of not addressing climate change as seriously in practice as more traditional financial risk factors.

We offer 11 case studies to show innovation happening in finance, split into three groups: (a) mobilizing capital into areas of need (climate solutions and place-based investments; (b) financing ‘transition assets’ (those sectors which are not ‘green’ but need to transition to net zero over next couple of decades; (c) innovation in data and metrics. The case studies provided are not exhaustive, instead they seek to illustrate examples of leading-edge activities which are emblematic of innovation on levers of change in the financial system which could be scaled and replicated by others.

You can see video briefings on a number of our case studies here: https://group.legalandgeneral.com/en/inclusive-capitalism/tackling-the-climate-crisis/climate-financial-risk-forum/ and the commentary report on all 11 case studies here: https://www.fca.org.uk/publication/corporate/climate-financial-risk-forum-guide-2021-innovation.pdf

Our case studies of actions to expand financing into the real economy through increasing supply of finance and enabling actions on the demand side:

Approaches to redirect ￡’00s Billions to the real economy

(1)???Mobilizing ‘capital to need’ include ways of channelling finance into the real-world economy – typically private markets (or ‘alternative investments’). Examples include making use of the new Long Term Asset Funds to enable UK-authorised open-ended funds to invest in long-term private market assets, with potential to help UK pension funds direct half a trillion pounds of capital to net zero goals.

(2)???Redefining asset classes – for example in place-based investments – in which we want to see pension fund contributions directed. Kaisie Raynor explains the work of Royal London and IIGCC on changing asset allocation models to support and enable investment in the real economy at the scale required, requiring optimisation of investments for outcome, considering risk, return and impact. See: https://bit.ly/3nicnrM

Approaches to redirect ￡’00s Millions to climate solutions

(3)???Investing policyholder money into private market (venture capital) assets. Using a change in the insurance permitted link (the amount of funds invested into ‘illiquid’ assets) to enable @abrdn policyholders to benefit from private market assets (for example venture capital in green/ESG themes) through @PheonixGroup, directing potentially ￡’00Millions to climate solutions.

(4)???@Barclays is investing in scaling climate solutions by building pipelines of growth companies, providing an ecosystem finance model, led by equity growth capital, to help companies scale rapidly through its Sustainable Impact Capital Programme, directing ￡’00Millions to climate solutions.

Approaches to support net zero place-based investing

(5)???@Abundance has been at the forefront of developing local green / climate bond markets, opening bond markets and peer-lending to help direct retail and community investors to green projects, routed through local authorities to reduce delivery risk, with potential to raise ￡Billions across 400 local authorities. See Bruce Davies explaining their work: https://bit.ly/3nicnrM

(6)???Using public funding to leverage private finance into levelling up and net zero regional plans. The West Midlands Combined Authority provide a case study of developing the enabling environment (skills, capabilities), and new blended public-private financial models, to leverage private capital into ‘place-based investing’ to meet the demand for ￡’00sBillions investment in net zero places. Ed Cox explains their work: https://bit.ly/3nicnrM

Our case studies of actions to finance transition assets – delivering structural changes in sectors - include:

(7)???Mechanisms to scale up investment into building retrofit. The Green Finance Institute is coordinating the Coalition for the Energy Efficiency of Buildings (CEEB) to develop a suite of interventions to scale investment, from pump priming the green mortgage market, efforts to stimulate consumer demand, improved disclosures, phase-in of LENDERS recommendations on affordability calculations and property assessed financial instruments. Emma Harvey has more: https://bit.ly/3nicnrM

(8)??Mechanisms to support structural changes in the maritime sector. Citi is supporting the Poseidon Principles framework for assessing and disclosing the climate alignment of ship finance portfolios, using agreed common and consistent baselines, driving financial transactions to address climate alignment. Citi’s James Bardrick: https://bit.ly/3nicnrM

(9)??Mechanisms to support structural changes in agriculture sector. NatWest is working with the Sustainable Food Trust to develop The Global Farm Metric, to measure farm sustainability, enabling effective financing strategies for supporting net zero transition given the lack of homogenous unit of output for farming activities, and seeking to create an industry standard.

Our case studies of innovation actions to improve use of data and metrics:

(10)?Open Data Standards: transforming industry data: Icebreaker One is developing the open data standards to create marketplaces for commercial and open data (such as insurance), delivering interoperability to unlock metrics and reduce the burden of reporting, and help direct finance to deliver maximum impact. See Gavin Starks on: https://bit.ly/3nicnrM

(11)?Building portfolio alignment with climate goals. BlackRock shows how it is tackling – with Baringa - the need for investors to both quantify the current impact and vulnerability of their investment portfolios AND measure and demonstrate the benefit of changing their capital allocation decisions to align with goals.

We have focused on identifying and sharing actionable innovation opportunities to mobilise financial capital and steward an economy-wide transition to meet climate targets. All those in the finance industry need to step up to support the mobilisation of financial capital required to deliver the change we need to see.