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New UK parliamentary term could see continued momentum of green gilt issuance

July 11, 2024
Kevin Leung

Key Findings

The new government is expected to revitalise climate policy, which can be supported by continued green gilt market growth.

Green gilts play a rising role as a fundraising tool and a catalyst for private investments as the UK races with peers to reach net zero.

The UK government should update its green financing strategy, formulated to clearly show proceeds’ contributions to sectoral decarbonisation pathways.

Clarity on green gilts’ use of proceeds remains a challenge in the absence of a science-based UK taxonomy.

Following the results of the UK general election held on 4 July 2024, the Labour party has formed the next government. The new government is committed to reaching net zero by 2050, with some form of interim climate policy pledges; this could see continuity of the country’s green gilt programme.

Since the UK government first launched its green gilt programme in September 2021, its accumulative cash issuance has reached nearly £40 billion, with proceeds allocated primarily to transportation and, to a lesser extent, renewable energy, climate adaptation, nature and energy efficiency. The government has planned to issue £10 billion of green gilts in cash in 2024-25 (0.37% of 2023 GDP) and already issued £3.5 billion in cash in the first two months of the financial year.

The 2021 green gilt launch follows the Climate Change Committee’s recommendations for the 2020 Sixth Carbon Budget that suggests “UK low-carbon investment each year will have to increase from around £10 billion in 2020 to around £50 billion by 2030”. A recent policy brief by the Oxford Smith School of Enterprise and the Environment has considered the changed economic context and suggested that “additional annual public investment in low-carbon technologies needed from now to 2030 could be limited to £6-£8 billion per year with a balanced policy mix to crowd in private investment”.

The former government’s step back on climate policy in 2023 drew concerns among green gilt investors. The Labour government’s pledge of “clean power by 2030” covers the electricity system, solar and wind power capacity, and green hydrogen—this could suggest a change in the direction of travel, potentially alleviating the concerns. The zero-carbon electricity system commitment has been brought forward by five years, and the target of quadrupling offshore wind by 2030 seems more ambitious than the previous government’s goal of 50 gigawatts by the same year. The aim of tripling solar power by 2030 appears in line with the previously set goal of 70 gigawatts by 2035.

Consistent and robust implementation of climate policy over the new five-year parliamentary term will determine whether the UK meets its interim climate objectives—essential to prevent a disorderly transition. While the required investments may vary, sovereign green debt financing is becoming an increasingly important fundraising channel; it also plays a rising role as a catalyst for private investments. Additional benefits such as overall sustainable bond liquidity and market creation, as illustrated in a working paper by the International Monetary Fund, should encourage continued green gilt issuance.

The track record of green gilt oversubscription reflects strong investor appetite, indicating the potential to meet future issuance needs.

The UK government has become the world’s third-largest sovereign issuer, after France and Germany. Japan is a latecomer to the labelled bond market but plans to issue ¥20 trillion (US$120 billion) of transition bonds to fund the ¥150 trillion of public-private investments over the next 10 years outlined in its green transformation plan. Japan’s plan implies an average annual labelled issuance accounting for 0.34% of 2023 GDP.

By credibly growing the green bond market, the new government could drive public and private investments to secure an orderly transition and yield long-term socio-economic benefits. To improve the credibility of future green gilt offerings, the government should formulate a comprehensive medium-term green financing strategy, clearly illustrating how planned and actual proceeds will contribute to the UK’s interim and long-term net-zero targets. Issuances should demonstrate coherence with sectoral decarbonisation pathways, providing quantifiable impacts of interventions, including research and development expenditures, subsidies, direct investments and blended finance initiatives. This transparency will help investors predict and measure impacts, which will in turn attract the growing base of investors with a climate-related mandate.

Clarity on green gilts’ use of proceeds has remained a challenge, which may undermine decarbonisation efforts. The UK’s current green financing framework defines the use of proceeds only by high-level project categories. Without a climate-aligned technical screening criteria-based taxonomy to determine the green bond proceeds’ eligibility, there are increased risks that capital will be deployed into underperforming projects that lead to carbon lock-in—despite being labelled as green. For example, IEEFA found that the latest government incentives for carbon capture will increase long-term reliance on fossil gas within the UK energy mix, falling short of net-zero goals. Under the current framework, these incentives can be financed by green gilts, which may deter some investors.

Nevertheless, IEEFA applauds the progress shown in the post-issuance report, which discloses the allocated proceeds by project, description of each project or policy and impact metrics attributable to the proceeds.

The green gilt issuance has so far been focused on reopenings of the bonds maturing in 2033 and 2053 to build up liquidity up to benchmark sizes for conventional gilts. Germany has instead taken an approach to establish a green bond yield curve, covering eight maturity dates between 2025 and 2053. A continued commitment to green gilt issuance could support UK market development—if credibility is enhanced, the real economy impacts could be far-reaching.

Kevin Leung

Kevin Leung is a Sustainable Finance Analyst, Debt Markets, Europe, at IEEFA. He has authored reports on topics relating to sustainable credits, transition finance and sustainable finance regulatory initiatives.

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