Government must provide political certainty, a comprehensive strategy and targeted finance to attract private investment
The incumbent Conservative party and Labour, the main opposition predicted to win the July 4 UK general election, say they are committed to achieving net zero by 2050.
Yet how much the transition will cost and how the next government will pay for it remain largely open questions. Both parties say that attracting more private sector investment is crucial, but neither has offered a clear plan as to how they will win over investors.
Labour’s shadow secretary to the Treasury, Darren Jones, suggested last week that net zero will cost “hundreds of billions” of pounds, insisting he was mostly talking about private investment.
In 2021, the Office for Budget Responsibility calculated that reaching net zero by 2050 would cost £1.4tn, based on figures from the Climate Change Committee, the government’s independent advisory body. The OBR assumed that public spending would account for about a quarter of that total.
The CCC said in its sixth carbon budget, published in December 2020, that hitting the UK’s net zero target would require investment levels to increase throughout the 2020s, reaching around £50bn a year between 2030 and 2050. This investment programme, it said, should be “led by government, but largely funded and delivered by private companies and individuals”.
There isn’t a clear blueprint for how the government can attract such investment from the private sector, however policy experts suggest there are a few key ingredients that could help, namely political certainty, a comprehensive strategy and targeted financial interventions.
Policy certainty
The political disruption of recent years, including multiple changes in prime minister and the watering down of certain climate policies — such as pushing back the phaseout date for internal combustion engine vehicles from 2030 to 2035 — has undermined investor confidence in the UK, experts told Sustainable Views.
Speaking at the Bloomberg Sustainable Finance Forum event, during London Climate Action Week in June, Huw van Steenis, vice chair at consultancy Oliver Wyman and adviser to Mark Carney when he was Bank of England governor, said the significant policy uncertainty of recent years had “upset a lot of international investors” and given the impression the UK is not a “reliable partner on long-term infrastructure”. He cited the government’s decision to downgrade its plans for the High Speed 2 railway as an example.
During the same panel discussion, Ingrid Holmes, executive director of the Green Finance Institute and chair of the UK’s Green Technical Advisory Group, said that the launch of a public consultation on the UK’s green taxonomy had been “hampered” by changes of economic secretary to the Treasury. She is hopeful work on it will progress under the next government.
According to recent research from think-tank the Institute for Public Policy Research, across all areas, private sector investment is lower in the UK than in any other G7 country for the third year in a row.
The IPPR’s number one suggestion for increasing levels of private investment is for the government to “[commit] to a long-term green industrial strategy, to create business and regulatory certainty”.
The Conservative party manifesto, with its focus on taking a “pragmatic” approach to net zero, in practice represents a scaling-back of ambition. Meanwhile, Labour is committing to a range of measures under its Green Prosperity Plan, but its downgrading of plans to invest £28bn annually to £4.7bn a year has dented its green image.
Smart use of capital
The US Inflation Reduction Act, with its almost $400bn in federal funding for clean energy, is an unprecedented fiscal intervention. Unable to compete directly with the IRA, the UK should deploy public funds strategically in areas where it will have the biggest impact, say policy experts.
“It’s a difficult time for the public purse, and most major parties are not committing to large increases in public spending,” says Heather McKay, a senior policy adviser at think-tank E3G. “We need to spend public money strategically, in the right sectors, to de-risk and to provide market confidence. Every pound of public money that is spent should be aligned with the UK’s net zero trajectory and targeted to critical industries.”
E3G says the new government needs to devise a net zero investment plan that includes detailed sector-specific road maps. It argues that previously published government strategy documents on net zero lacked details on “how the government will incentivise the requisite amount of private finance” to achieve its objectives. The think-tank also says detailed monitoring to track financial flows should be introduced, to help the government target its interventions most effectively.
“This document would provide clarity on the whole-of-economy transition — including sectoral transition pathways — and what support government is putting together in terms of policy, regulation and targeted public investment. And that would be supported by financial flow tracking to make sure the UK is able to make dynamic data-led policy, addressing market barriers early on,” says McKay.
The Labour manifesto includes positive suggestions, such as the creation of a national wealth fund to catalyse private sector investment, but they need to be part of a proper framework, she says, adding “we don’t just need funds [to be] set up, we need them to be part of a matrix of targeted public support”.
This view is echoed by Emma Harvey-Smith, chief of staff at the Green Finance Institute. “The UK government doesn’t have the balance sheet to provide extensive subsidies,” she says, insisting that schemes such as the IRA aren’t just about the funding, they are also “underpinned by a central strategy, which provides clarity for investors”.
“Having that central strategy, paired with a smaller blended finance offering would be enough to create an attractive investment landscape in the UK. It’s about drawing on the positive lessons from bigger schemes and working out how they can work within the UK context,” says Harvey-Smith.
Innovative financing structures
The exact financial mechanisms used to incentivise greater private investment would likely vary by sector. However, policy experts say in general, the government needs to adopt a more innovative approach, rather than using more traditional grant-based financing. Grant-based financing, says GFI’s Holmes, “tends to crowd out private investment, not crowd it in”.
More innovative financing interventions could be based on the contracts for difference scheme that has been in place since 2014 to incentivise investment in renewable energy, where generators are given an agreed ‘strike price’ for the energy they produce. Or it could take another form, such as the government agreeing to be a buyer of last resort, as it has proposed to support the nascent sustainable aviation fuels industry. Holmes says the GFI has been engaging with the Department of Transport on creating revenue certainty mechanisms to support growth in the sustainable aviation fuels sector, for instance.
The GFI has also been exploring the creation of blended financial structures, such as a battery investment facility. This would work via the creation of a battery sector fund based on cornerstone investment from public capital, with private capital providing additional funds. It suggests such structures could incorporate “credit enhancement guarantees for individual deals, financial loss against construction risk, or first loss mechanisms”.
Such blended finance structures could help to unlock funding for early-stage companies to enable them to cross the so-called “valley of death” in funding between initial capital and being large enough to access mainstream finance,” says the GFI. Harvey-Smith suggests that Labour’s proposed National Wealth Fund could operate in this way.
Unlocking institutional capital
Wider reforms to unlock institutional investor capacity outside of specific net zero interventions could also make a substantial impact, says Peter Bachmann, managing director of sustainable infrastructure at alternative asset manager Gresham House.
He suggests reforms proposed by the Conservative government to make it easier for pension funds to invest in the private markets — the so-called Mansion House reforms — should be continued by the next government. In addition, he suggests further changes to the Solvency II regulatory regime for insurers to make it easier for them to invest in private assets.
Enabling large institutional investors to increase their allocations into private assets would be highly impactful for the net zero agenda because many net zero priority areas, such as clean energy or carbon capture and storage, rely on nascent industries and technologies that are outside of the public markets and require private capital investment, says Bachmann.
He also argues in favour of a comprehensive carbon tax to help shift investment from polluting sectors to clean tech. Only the Green Party in its manifesto proposes a large-scale carbon tax.
Positive thinking
McKay believes the story government is telling also needs to change. While measures such as Labour’s proposal for an expanded windfall tax on the oil and gas sector are welcome, she says government should tell a more positive story focused on enabling private investors to take advantage of the opportunities of net zero. “What I hear from private sector partners is that they want the narrative to be reset from them paying more of the costs, to being about capturing the opportunity,” says McKay.
Bachmann also suggests the government should talk up the opportunities of net zero. “The most successful businesses are those who solve the biggest problems, and there’s no bigger problem than climate. Why doesn’t the government try to shift narrative to talk about the huge investment opportunity?” he asks.
