Transitioning to net zero carbon – challenges and opportunities

29 September 2021

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“Tackling Climate Change” – a Virtual World Tour ahead of COP26: United Kingdom: Part 2

While a fast-growing number of corporates, financial institutions, organisations and private investors have kick-started the transition to more sustainable business practices, the journey to get there will not only be shaped by sector origin and the nature of their business, but also by country specifics – lawmakers, regulators, societal expectations and the strength of the economy.

So: what about the UK? Clearly ambitious to become a leader in tackling climate change, as outlined in our first article, and according to ESG rating agency RobecoSAM’s global Country Sustainability Ranking, already one of the Top 20 sustainable countries in the world[1], we’ll have a closer look in this second article about the UK’s specific challenges on its journey to net zero carbon, and we outline some of the opportunities the country’s framework provides for its market players and for the UK economy as a whole. We will cover the wide field of Green Finance in our next, and final, article (link to article 3) in this series about the UK.

We see the following key challenges and opportunities for the country:

Challenges Opportunities

COVID-19 pulled the UK into a deep recession in 2020

Brexit brings uncertainty about environmental policy alignment to the EU

Climate risks – but the UK has the right instruments in place to address these

Harder-to abate sectors – but the UK’s green recovery plan takes aim

The green recovery post pandemic and the 2021 UK budget

Historically firm regulators are pushing ahead with green policies

Public bodies and private sector organisations drive the green agenda

The UK’s green challenges… are very much green opportunities, too

Challenge 1: COVID-19 pulled the UK into a deep recession in 2020

The magnitude of the recession the COVID-19 pandemic caused has been unprecedented in modern times – the UK’s GDP declined by 9.9% in 2020, the steepest drop since records began in 1948[2]. During the first lockdown, GDP fell by a staggering 24% in the two months to April 2020. When a new coronavirus variant hit the country, driving up COVID-19 infection rates in December, the government introduced a third lockdown, with restrictions slowly being eased between March and July 2021 on the back of a successful vaccination programme.

To reduce the effects of the pandemic on the economy, the UK government was determined to do “whatever it takes” to support businesses and workers, introducing emergency measures in spring 2020, which included the furlough scheme, additional funding for the NHS, and grants for the self-employed and businesses, with financial support totalling more than £280 billion[3].

Looking at the year ahead, economists differ in their forecasts about the UK economy’s recovery, with some expecting that consumer spending will increase considerably over the coming months underpinning strong growth, while others point to the expected rise in unemployment this year which could lead to consumers being more cautious. On average the GDP is predicted to grow 4.3% in 2021.

Clearly, companies and government were fully focused on COVID-19-related priorities and decisions – so where did this leave the ambition and commitment to tackle climate change? A similar adverse event, the financial crisis in 2008, had resulted in a notable shift away from environmental priorities[4]. However, this time is different: UK businesses and the government, by large, rose to the challenge, rethinking and strengthening their approach to social and environmental responsibility.

Yet, post-pandemic, will businesses sacrifice this conscience in order to steady their own ship, hit by rising costs and falling demand? The answer is a clear ‘yes’ in favour of sustainability in all its forms. Economists, investors and corporate decision makers have been looking very closely at which business characteristics contributed to comparatively stronger resilience of some companies – and not just those where sales soared during the pandemic such as technology firms or online meal delivery services. Their conclusion: businesses that have given ESG issues priority are considerably better equipped to deal with the consequences arising from the pandemic and will also be more resilient when faced with future threats[5].

So, as enormous a challenge as the pandemic turned out to be, ESG proved to be the remedy – strengthened by calls for a green, sustainable recovery post COVID-19, which we’ll outline further in this article.

Challenge 2: Brexit brings uncertainty about environmental policy alignment to the EU

Beyond the COVID-19 pandemic, Brexit has presented another major challenge to the UK economy and UK businesses. When the UK left the EU on 31 December 2020, the UK government took control of public policy that had been delegated to EU institutions and agencies, including environmental policies: previously, 80% of the UKs environmental laws came from the EU[6].

With UK businesses left uncertain about how possible changes in environmental law could affect their operations, so far – as legal experts point out – there haven’t been any major changes to environmental regulation since the transition period ended. The ~500 major items of EU environmental law continue to apply or be ‘retained’ in UK law in the short term[7].

At the same time, the UK government has taken steps to prevent ‘governance gaps’ and tabled a wide-ranging Environment Bill in 2018 that will establish a new domestic system for setting and achieving environmental targets and create a new regulatory body – the Office for Environmental Protection (OEP), mirroring the work of the European Environment Agency – to oversee the law enforcement[8]. However, the Environment Bill, which will join the Agriculture Bill and Fisheries Bill as a legal framework for the environment for the UK outside of the European Union, has received harsh criticism from environmental campaigners[9], and its amended version has seen many delays. The bill finally returned to parliament on May 26 for its report stage and third reading in the House of Commons. It is now being scrutinised by a House of Lords committee. Further amendments will be proposed at its third Lords reading when peers will have the chance to vote on the bill[10]. The Environment Bill is expected to receive Royal Assent – the final step in the process of becoming law – later in 2021.

While environmental law and climate policy were two areas of controversy during the Brexit negotiations, the “level playing field” agreement between the UK and the EU (as well as the general commitment of both sides to “strive to increase their respective environmental levels of protection”) should mean – according to legal experts – that UK environmental rules won’t significantly diverge from those enacted at EU level[11].

Still, the complexity for UK businesses will increase: apart from preparing to comply with domestic environmental laws, businesses based in the UK that want to access the EU market will also face market-led pressure to abide by EU rules[12], such as for example the EU Taxonomy Regulation, published last year, which introduced environmental disclosure requirements for companies and financial market participants. The taxonomy aims to create a common language and a clear definition of what is ‘sustainable’ by establishing a list of environmentally sustainable economic activities[13].

A final complication for UK businesses will be that most environmental rules in the UK are devolved. As such, with the Environment Bill mainly covering England, it could well be that companies will have to adhere to different environmental targets and laws if they operate in Scotland, Wales or Northern Ireland[14].

Challenge 3: Climate risks – but the UK has the right instruments in place to address these

UK businesses are increasingly assessing the physical and transition risks of their businesses due to climate change, which directly impact their financials. And while some might be more affected than others, climate change impacts every single sector. The knock-on impacts of severe weather events include disruption to supply chains and distribution channels, asset write-offs as a result of damage to property, while revenues can also be under threat with production capacities diminishing as a result of the physical impacts of climate change. Equally, climate risks also alter the availability of raw material and energy supply.

Looking at financial impacts, here are just two examples: the authors of the UK’s third Climate Change Risk Assessment (CCRA3) expect annual damages to non-residential properties due to flooding to be around £670 million, while Unilever estimates that it loses some €300 million per year as worsening water scarcity and declining agricultural productivity lead to higher costs in its supply chain[15].

In the LSE Climate Risk Business Survey 2020[16], which was undertaken by the Grantham Research Institute to help inform the Business and Industry Chapter (Chapter 6) of the CCRA3, the 225 respondents from across the UK and a wide range of sectors (e.g., Agriculture, Manufacturing and Services) reported that heavy rainfall (26.61%), surface water flooding (26.61%) and high temperatures (16.97%), including heatwaves, were the most frequent prolonged or extreme weather-related events directly or indirectly impacting businesses over the last year. The main impacts of these events were increased operation costs (19.02%), drop in labour productivity (e.g. staff unable to work or access sites) (18.05%) and physical damage to assets including buildings, stock, materials (17.56%).

Furthermore, the required decarbonisation will involve large-scale structural change across the UK’s economy as elsewhere, leaving UK businesses exposed to transition risks, which are driven by, for example, changes in policies, technological changes, changing customer preferences – due to heightened environmental awareness. Transition risks also include risks of higher costs of capital: investors might either demand a higher coupon on the capital markets or even turn away from companies if they can’t show that they are making the required progress on their path to net zero.

Overall, the CCRA3 report points out that business engagement in CCRA-related discussions has increased since CCRA2, which appears to be in line with growing climate awareness, recent public discourse, and regulatory change in the finance sector. Business discussions also reveal significant concern about possible reputational issues arising from inaction or failure to withstand climate risks[17]. However, UK’s SMEs appear less proactive than larger UK corporates in terms of addressing risks, due to a narrower range of skills available to them as well as limited information and low levels of understanding of risks posed by climate change.

To identify the UK’s overall exposure to material ESG risks, investment management firm, Nutmeg, looked at the UK equity market, its industry groups and their ESG risks with the help of a mapping exercise, using the SASB (Sustainability Accounting Standards Board) Materiality Map[18], a framework that focuses on 26 sustainability topics organised under 5 broad ESG themes that are likely to impact the operating performance of companies across industries: ‘Environment’, ‘Social Capital’, ‘Human Capital’, ‘Business Model and Innovation’, and ‘Leadership and Governance’.

Taking the FTSE All-Share Index (excluding investment trusts) as a representation of the UK market, the investment firm’s researchers found that the companies in the FTSE All-Share index are most exposed to the Social Capital theme – which includes issues that affect the productivity of employees, management of labour relations, health and safety of employees, and the ability to create a safety culture[19].

Moving from dimensions to more specific sustainability issues, the biggest area of concern proved to be ‘Product Design & Lifecycle Management’; a category related to incorporating environmental considerations in characteristics of products and services, encompassing lifecycle impacts (i.e. packaging and distribution) and a company’s ability to address customer and societal demands for more sustainable products, as well as meeting evolving environmental and social regulations.

However, there are clear signs that corporate UK is already addressing these two highest scoring material ESG risks – amongst, of course, other risks – with measures reaching from the increasing use of recyclable materials and more electricity efficient products, to diversity & inclusion programmes, wellbeing and mental health initiatives, and wider community projects. Furthermore, in solving ‘Social Capital’ related issues as well as those arising under ‘Product Design & Lifecycle Management’, the UK can play to its strengths of having a progressive and ambitious corporate governance and regulatory environment.

Challenge 4: Harder-to abate sectors – but the UK’s green recovery plan takes aim

To achieve full decarbonisation, it’s imperative to reduce, and eventually eliminate, emissions from so-called “harder- to-abate” sectors, in particular the cement, steel and chemicals industry; and heavy-duty transport sectors such as shipping and aviation. With steel, transport equipment, shipping, and oil and gas the main industries in the UK, apart from banking and finance and the wider services industry, the country has a considerable share of harder-to-abate sectors.

While independent organisations, such as the Energy Transitions Commission (ETC) – an international coalition of business, finance and civil society leaders from across the spectrum of energy-producing and using industries – have defined a path to decarbonise the harder-to-abate sectors and claim that this is technically possible by mid-century at a cost to the economy of less than 0.5% of global GDP, the ETC and others have repeatedly warned that this transition will not be achieved “unless policymakers, investors and businesses jointly take immediate and forceful action to transform economic systems”[20].

Immediate and forceful action is indeed what the UK’s government has taken with its post-pandemic green recovery plan – outlined in our first UK article – reflecting the government’s ambition to financially support the build-out of key decarbonisation technologies such as hydrogen, electrification of industrial processes, and carbon capture.

UK creates its own green opportunities

While Brexit and the COVID-19 pandemic brought immense challenges for the UK, the country’s green recovery plan, its 2021 budget and new regulatory measures, all suggest that the country has found a way to turn those challenges into ESG opportunities:

Opportunity 1: The green recovery post pandemic and the 2021 UK budget

When almost 200 companies wrote to Boris Johnson earlier last year requesting that post-coronavirus recovery efforts should include a green recovery plan, the transition to more sustainable practices took root[21].

In July 2020, Prime Minister Boris Johnson announced £350 million of funding to help UK industry cut carbon emissions. The package includes:

  • £139 million to cut emissions in heavy industry by supporting the transition from natural gas to clean hydrogen power, and scaling up carbon capture and storage (CCS) technology which can stop over 90% of emissions being released from industrial plants into the air by storing carbon permanently underground
  • £149 million to drive the use of innovative materials in heavy industry; the 13 initial projects will include proposals to reuse waste ash in the glass and ceramics industry, and the development of recyclable steel
  • £26 million to support advanced new building techniques in order to reduce build costs and carbon emissions in the construction industry
  • A £10 million boost for state-of-the-art construction tech which will go towards 19 projects focused on improving productivity and building quality, for example, re-usable roofs and walls and “digital clones” of buildings that analyse data in real time
  • Launching a new National Space Innovation Programme backed by £15 million initial funding from the UK Space Agency, which will see the first £10 million go towards projects that will monitor climate change across the globe, which could protect local areas from the impacts of extreme weather by identifying changes in the environment
  • Opening-up bids for a further £10million for R&D in the automotive sector, to help companies take cutting edge ideas from prototype to market, including more efficient electric motors or more powerful batteries[22]

Four months later, in November 2020, the UK government went further, presenting a far-reaching ‘Ten Point Plan for a Green Industrial Revolution’, which will mobilise £12 billion of government investment, and potentially 3 times as much from the private sector, to create and support up to 250,000 green jobs[23]. We have outlined the plan’s details in our first UK article.

In March this year, Chancellor Rishi Sunak delivered another timely boost to the country’s sustainability ambitions with the 2021 budget. Apart from key announcements about how the UK can cement its leadership in green finance – which we’ll cover in our next article about the UK – the Chancellor laid out the following initiatives:

  • Investment & job up-skilling: driving net-zero innovation and helping create “green collar jobs” while new investments in green tech, energy, and a range of sectors should help fuel new business growth & green job creation
  • The announcement of a new national UK lender – the UK infrastructure bank – is positive news: by focusing on local projects and bridging the gap left by the private sector, a new UK infrastructure bank will help cultivate expertise at a local level and create new investment opportunities whilst simultaneously supporting the green recovery plan and the Government’s “levelling up” agenda
  • Reforming the Bank of England (BOE) mandate to include sustainability: helping drive down the cost of issuance and increase demand for green bonds, supporting the UK green bond market
  • Green gilts & green retail savings are game changers for investors & corporates: creating a liquid sovereign green curve & generating more demand through retail avenues will deepen & diversify the green bond market and entice more corporate borrowers to issue in this format. A recent analysis of European bond markets by NatWest has shown that when sovereigns take the lead on green borrowing, corporates tend to follow, often leading to more domestic corporate green bond issuance and greater diversification among the domestic green issuer base

Opportunity 2: Historically firm regulators are pushing ahead with green policies

The UK, as outlined in detail in our previous article, is renowned for its progressive corporate governance principles and for its closely watching regulators. Conducting business in such an environment has kept UK enterprise and other UK organisations on their toes and has honed their ability to be alert towards and prepared for new regulations that need to be implemented.

While compliance comes with considerable costs for companies (UK businesses spent an estimated £2.5 billion on environmental protection in 2017, and £2.1 billion in 2016[24]), a number of studies have shown that the ‘induced innovation’ hypothesis holds true: more stringent policies trigger greater investment in innovations, which in return can offset compliance costs as well as reduce other production costs[25].

The speed at which UK regulators introduce new, tighter measures is showing no signs of decelerating: whether the long awaited Environmental Bill for businesses (which redraws rules after the UK’s departure from the EU) or the Statement of Investment Principles (SIP) (which the Department for Work and Pensions (DWP) introduced for pension schemes with more than 100 members, requiring them to publish information about how trustees take into account financially material considerations such as climate change risks in their investment decision making[26]), regulators are closing in on all sectors to ensure that no one falls off or lags behind on the country’s sustainability journey.

Opportunity 3: Public bodies and private sector organisations drive the green agenda

While public scrutiny of governments’ efforts to tackle climate change and curb environmental damage considerably heightened in the past few years, government work on sustainable development kicked off much earlier in a number of countries, including the UK.

In 1997, the UK parliament established the Environmental Audit Committee tasked with evaluating the extent to which policies and programmes of government departments and non-departmental public bodies contribute to environmental protection and sustainable development and auditing their performance against sustainable development and environmental protection targets[27].

The Committee on Climate Change, an independent, statutory body stipulated by the UK Climate Change Act 2008, started its work in December 2008 with the purpose to advise the UK and devolved governments on emissions targets and to report to Parliament on progress made in reducing greenhouse gas emissions and on climate change adaptation preparations.

The National Infrastructure Commission was founded in 2015 to provide the government with impartial, expert advice on major long term infrastructure challenges and with a focus on recommending how to reduce the negative impact of major infrastructure construction and operation, and how infrastructure can actively contribute to the protection of the country’s natural resources and environment[28].

In September 2017, the UK set up the Green Finance Taskforce to make green finance an integral part of the county’s financial services sector. Based on the recommendations of the taskforce group, the government’s Green Finance Strategy[29] was published on 2 July 2019, setting out measures that help greening the financial system, catalysing investment, and driving innovation in green financial products.[30]

Following another policy recommendation by the taskforce, The Green Finance Institute took up its work in 2019. An independent, commercially focused organisation led by bankers, the institute develops scalable financial solutions that accelerate sector-specific transitions to a low-carbon future[31].

In addition to these and other public bodies working towards the UK’s green future, private sector, and academia networks such as the “We mean Business coalition”[32], the “UK Climate Impacts programme”[33] and trusts such as the National Biodiversity Network Trust[34] are evidence that the UK is going green in all directions.

Weighing up the UK’s ESG challenges with its opportunities, there’s good reason to believe that the country could climb higher in RobecoSAM’s global Country Sustainability Ranking. To complete our portrait about the UK’s measures and progress to achieve net zero, our next and final article about the country will analyse its Green Finance market.

Read part 1 - Transitioning to net zero carbon – the UK's political and institutional priorities 

Read part 3 - Transitioning to net zero carbon – the UK's Green Finance market 

[1] https://www.robeco.com/uk/key-strengths/sustainable-investing/country-ranking/

[2] https://commonslibrary.parliament.uk/research-briefings/cbp-8866/

[3] https://commonslibrary.parliament.uk/research-briefings/cbp-8866/

[4] https://www.allenovery.com/en-gb/global/news-and-insights/publications/managing-esg-compliance-challenges-for-uk-listed-companies

[5] https://www.spglobal.com/ratings/en/research/articles/200420-the-esg-lens-on-covid-19-part-1-11444298

[6] https://greenallianceblog.org.uk/2021/04/15/how-post-brexit-law-making-is-jeopardising-the-environment/

[7] https://www.brexitenvironment.co.uk/2021/03/23/environmental-regulation-post-brexit/

[8] https://www.brexitenvironment.co.uk/2021/03/23/environmental-regulation-post-brexit/

[9] https://www.bbc.co.uk/news/uk-politics-55799191

[10] https://www.gov.uk/government/news/environment-bill-continues-through-parliament

[11] https://www.whitecase.com/publications/alert/environmental-law-after-brexit

[12] https://www.grantthornton.co.uk/insights/sustainable-finance-a-guide-to-the-eu-taxonomy/

[13] https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/eu-taxonomy-sustainable-activities_en

[14] https://www.brexitenvironment.co.uk/2021/03/23/environmental-regulation-post-brexit/

[15] https://www.mckinsey.com/business-functions/sustainability/our-insights/starting-at-the-source-sustainability-in-supply-chains

[16] https://www.lse.ac.uk/granthaminstitute/wp-content/uploads/2021/05/210507-LSE-Climate-Risk-Business-Survey-2020-.pdf

[17] https://www.ukclimaterisk.org/wp-content/uploads/2021/06/Technical-Report-The-Third-Climate-Change-Risk-Assessment.pdf

[18] https://www.sasb.org/standards/materiality-map/

[19] https://esgclarity.com/what-are-the-material-esg-risks-in-the-uk-equity-market/

[20] https://www.energy-transitions.org/wp-content/uploads/2020/08/ETC_MissionPossible_ReportSummary_English.pdf

[21] https://www.ft.com/content/49cac3b5-6463-4a21-9452-643b750431d9

[22] https://www.gov.uk/government/news/pm-commits-350-million-to-fuel-green-recovery

[23] https://www.gov.uk/government/publications/the-ten-point-plan-for-a-green-industrial-revolution

[24]https://www.ons.gov.uk/economy/environmentalaccounts/bulletins/environmentalprotectionexpenditureuk/2017

[25] https://www.lse.ac.uk/GranthamInstitute/wp-content/uploads/2014/11/Impacts_of_Environmental_Regulations.pdf

[26] https://www.ftadviser.com/Partner-Contents18/2020/10/09/Royal-London-the-DWP-strikes-back

[27] https://old.parliament.uk/business/committees/committees-a-z/commons-select/environmental-audit-committee/role/

[28] https://nic.org.uk/about/what-we-do/

[29]https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/820284/190716_BEIS_Green_Finance_Strategy_Accessible_Final.pdf

[31] https://www.greenfinanceinstitute.co.uk/about-us/

[32] https://www.wemeanbusinesscoalition.org

[33] https://www.ukcip.org.uk/about-us/

[34] https://nbn.org.uk/about-us/what-we-do/

ESG/Sustainability
ESG


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