The UK could suffer around 500,000 job losses and be forced to spend more than £600bn of taxpayer cash to rescue the financial services sector, unless it prepares for the value of fossil fuels to collapse as a result of climate crisis regulation and legislation.
That was the stark warning made in a recent report from a collective of climate activism groups known as the One for One campaign, which suggested that the energy transition could result in bigger financial repercussions than the 2008 credit crunch, which forced the UK Government to bail out the Royal Bank of Scotland and Lloyds Banking Group to the tune of around £450bn.
The research makes comparisons between the credit exposure to subprime mortgages in that crisis and the forecasted global credit exposure to carbon-intensive industries in the future, factoring in the current levels of capital held against fossil fuel exposures by banks, insurers and asset managers.
It illustrates the risks that are likely to emerge if these institutions fail to hold enough to cover the potential losses they are likely to face as a result of the new rules necessary to achieve net zero emissions targets over the coming years.
These are predicted to make it significantly harder for companies to sell oil and gas, so they will instead be forced to buy greener sources of energy, therefore reducing the value of carbon-heavy assets - including shares or loans for fossil fuel projects or related businesses - which will in turn harm the institutional investors that hold them.
Globally, the report estimates that banks would probably need a total of $4.9trn in international bailouts if fossil fuel assets collapsed in 2030, putting 13.6 million jobs at risk worldwide.
Taking this as a worst case scenario point at one end, Insider spoke to a variety of stakeholders to find what’s being done to change course, how bad things could get and how the Scottish financial sector will be affected.
Lukasz Krebel, an economic researcher focussing on monetary and fiscal policy at the New Economics Foundation - which is part of the One for One campaign - started by pointing out that if the world is to have at least 50% chance of keeping global warming to 1.5C goal of the Paris Agreement, some 90% of known reserves of coal and 60% of oil and natural gas must remain un-extracted, and as the International Energy Agency stressed, no new fossil fuel projects beyond those already in development in 2021 are compatible with such a transition.
This means they are at a high risk of becoming ‘stranded assets’, given value on balance sheets, but increasingly diminished due to the rising pressure against extracting them.
"As the near blow-up of UK pension funds following last autumn’s ‘mini budget’ highlighted, financial markets remain very sensitive to any disturbances and risks of fast-spiralling contagion are high,” stated Krebel.
“So while the timing and exact dynamics of a potential ‘climate Minsky moment’ of fossil-related assets rapidly losing market value are uncertain, that is the very reason for regulators to apply a precautionary approach now towards assets most highly exposed to such transition risks."
Sandy Begbie, chief executive of Scottish Financial Enterprise, argued that the sector is a long way away from any stranded assets situation, noting that a lot of recent market volatility stems from Russia’s invasion of Ukraine - which has highlighted the reliance on fossil fuels, albeit with a gradual transition to renewable sources.
“What we must avoid is investors simply dumping fossil fuel stocks, as that’s not in anyone’s interests, because globally it will ultimately flow down to those who can least afford it and we run the risk of compounding the problem”
Begbie explained that within this conversation there are essentially three categories of businesses: those set up in order to take advantage of the transition - for which capital needs to be provided - then those which have business models focused on areas that in the future will no longer be acceptable - which need help updating their plans - and then those which don’t have a plan - for example car manufacturers that have no intention to move to electric or hybrid power.
In terms of investment, it would only generally be that third group that would suffer from money pulled out by fund groups.
“We’re calling for a carefully thought through transition, with proper government policy and a direction of travel that is far clearer,” he stated, pointing out that it can take up to a decade for planning permission to come through for renewable projects, which is roughly the same timescale as a decade ago.
“The supply of capital is not the challenge, it’s about how you develop a pipeline of investable projects - also in areas like housing, local and national authorities need to step up with options.
The recent Edinburgh Reforms, part of the Financial Services Markets Bill, should free up finance, particularly pension schemes - which have more than £3.4trn of assets - significant chunks of which are looking for new long-term capital projects.
“We have one of the most cautiously invested pension sectors in the world, because having been a trustee, it’s all been about de-risking,” Begbie said.
Changes to the Solvency II rules are also being considered by the EU, which could help activate the capital that’s sat redundant on balance sheets.
Alongside pensions, the insurance industry is similarly looking for low-risk, long-term investments to match liabilities.
The Association of British Insurers (ABI) welcomed recent proposals to reduce the risk margin by 65% for life insurers and 30% for non-life insurers, agreeing with the Prudential Regulation Authority that the level was too high and sensitive to interest rates.
ABI director general Hannah Gurga commented: “We strongly welcome these changes to the Solvency II regime which will allow the UK insurance and long-term savings sector to play an even greater role in supporting the levelling up agenda and the transition to net zero.
“Meaningful reform of the rules creates the potential for the industry to invest over £100bn in the next 10 years in productive finance, such as UK social infrastructure and green energy supply, while ensuring very high levels of protection for policyholders remain in place.”
Andy Briggs, chair of the ABI’s Climate Change Committee and chief executive at Phoenix Group, said: “The long-term savings and insurance sector is committed to playing a central part in the race to net zero – but we need to take the handbrake off.
“There is no time to spare in making the changes needed which can unlock the once-in-a-lifetime opportunity to drive investment which can cut emissions and deliver growth across the country.
“Meaningful reform to investment frameworks and the regulatory regime, including Solvency II, is essential if our sector is to turbocharge investment in the green infrastructure that we urgently need.
“If we can get those structures in place - supported by better planning systems, transparent data, and clearer climate change policies - we can put our foot even harder on the throttle.”
In terms of asset managers, many have specific funds dedicated to investing in companies which score highly in terms of environmental, social and governance (ESG) factors, while others operate a broader due diligence policy across all their portfolios.
Roshni Bandesha, head of ESG and sustainability at SME-specific investor the Business Growth Fund (BGF), said that the issue of stranded assets was a priority for her, although she agreed with Begbie that the timeline is actually longer than many suspect - at around 20 years.
“This means that the incentivisation strategy changes and the conversation is how to make it a priority now, given how far away the potential consequences are; how do we make this real for the CEOs?
“It’s important not to forget the benefits of oil and gas sector for instance, so the question is how do we look at the decarbonisation journey - whether its wells or customers - and make them part of the solution, as excluding the sector just leaves a lot of value on the table.”
Bandesha revealed that the executives she has talked to in the oil and gas sector are often afraid of the “ESG people”, so BGF tries to take a more empathetic approach.
“Across our portfolios we have a baseline scoring system and with those that score lower, we have conversations to help identify where they must focus first.
“Often the recommendation to investors and investees is to think about the really committed people within your business and give them the right platform to take action, which can help take the pressure off the c-suite team, because ultimately this is a people problem.”
As for the One for One report’s warnings of banks haemorrhaging money and jobs, Bandesha suggested most will be at the lower end of the economy - “not the oil field engineers, but the people in the communities, those daily wage workers will be facing the pinch”.
To help smooth this transition, she argued that the best thing would be to focus on how ESG actions impact salaries.
“You have to make it about people’s daily actions - how does it hit your bonus - so let’s change the incentive structure, make it more valuable to make the right decision.
“And give some abilities to the local communities, offering those affected a more cohesive voice, so that government needs to listen.”
Charlie Kronick, senior programme advisor at Greenpeace UK, who leads the charity’s climate finance campaigning work, said that while many in financial services think they’ll be able get out just before the music stops, what's increasingly clear is that fossil fuel demand has peaked.
“Ukraine has clearly caused a disturbance in the market, but overall the trend is downwards - BP themselves stated recently that they need to invest in energy efficiency and renewables, not oil and gas.
“We and others want some action on the statements made at COP26 around making the UK a net zero financial centre, but that will require regulation on lenders and asset managers to align assets under management or credit portfolios with the Paris Agreement goals.
“The rules have to change, as this has to be a sector-wide shift, with a really strong indication around the direction of travel.”
However, Kronick raised concern that instead deregulation has been the trend recently.
“If you don’t make this a fundamental part of each department’s mandate, it will fall down the pecking order - right now, if you’re an asset manager or lender, all the government is prioritising is competitiveness.
“And the longer we wait, the more expensive this gets - if we don’t move rapidly away, there will be significant amounts of stranded assets and a real risk of bail-outs, like in 2008.”
Krebel agreed that - despite the opposite direction of travel within the Scottish National Party in Holyrood - the current Westminster government appears committed to plans for fossil fuel expansion.
“However, the Labour Party has indicated it will look to end further investment in new North Sea oil and gas if elected in the next general election - and while this may not result in outright cancellation of new projects already underway, it would send a clear market signal that such assets have little future in the clean energy system.
“Importantly, global shifts towards clean energy - including the US and the EU engaging in a green transition race ignited by president President Biden’s Inflation Reduction Act - increase the likelihood of new fossil assets stranding as international markets move away from oil and gas."
Begbie concluded that coming out of COP26, the Glasgow Financial Alliance for Net Zero was a positive step in the right direction, but the key is about pace and scale.
“There’s a recognition among politicians that this is a long time horizon, usually beyond that of MP’s tenures, or even CEO’s tenures.
“Our industry needs to articulate this change better and work with smaller businesses, because we’ll only be as good as the majority of our economy.”
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