London has dominated as a leading global financial centre since the 1600s.

Until Brexit, there seemed no reason for this to change.

But the Trade and Cooperation Agreement between the UK and EU that outlined their future economic relationship made no significant provision for the UK’s financial services sector.

This precariousness led many to speculate about how Brexit may impact the UK’s financial services industry. For our part, we’re looking ahead to how the UK Government can ensure it is regulating the economy in the interest of safeguarding the planet and its people.

Post-Brexit the UK Government must prove its commitment to sustainable finance

The UK promised at the COP26 climate summit to become the world’s first Net-Zero-aligned Financial Centre.

But it’s the EU that has made major strides in sustainable finance regulation. While the UK contributed to much of this work, what can it now offer while going it alone?

Besides following through on its COP26 commitments, we argue the UK has the chance to go beyond what other nations have proposed: to focus on building a well-functioning financial system that has the explicit purpose of building a better society.

The UK can go beyond just asking financial institutions to disclose & classify activities

The EU has focused on classifying and disclosing the sustainability of existing economic activities. But in and of itself, this won’t create a more sustainable economy.

The University of Cambridge examined a wide array of research and found that “some studies find no correlation between disclosure and companies’ actual environmental performance…” with others even finding a “negative correlation.”

What’s more, dealing with issues individually – looking at climate change in isolation to biodiversity or considering environmental factors without addressing wider social considerations – makes little sense. It could actually create a huge regulatory burden for businesses disclosing across fragmented initiatives.

It is critical that we examine and redesign the workings of the system itself

To move beyond addressing issues one at a time, we should go back to basics and look at the fundamental incentives driving decision-making among executives and investors in companies.

For example, enacting the Better Business Act would require companies to operate in a way that benefits all their stakeholders, including workers, customers, communities and the environment, while still seeking to deliver profits for shareholders.

The government should also raise the ambition of important economic actors like pension schemes. It could do this by re-thinking their duties to act in the ‘best interests’ of beneficiaries and allowing them to take account of more than just financial return.

Brexit offers an opportunity to create a smaller, more robust and more purposeful financial sector

It is the real economy – the buying and selling of goods and services – that directly meets human needs.

But since the 1980s, there has been a shift towards 'finance-led growth': financial institutions have grown in power and influence in relation to the real economy.

“A century or more ago, 80 per cent of bank lending went to businesses for genuine investment. Now, less than four per cent of financial institutions’ business lending goes to manufacturing – instead, financial institutions are lending mostly to each other, and into housing and commercial real estate.” – Nicholas Shaxson

Research suggests that there is an optimum size for a financial sector, beyond which it acts as a drain on human and other resources. The UK far exceeds this point.

If one of the consequences of Brexit is that the financial sector decreases in size, there's an opportunity here: to create a smaller, more robust, more purposeful financial sector that promotes sustainable and inclusive economic development across the rest of the economy.

The financial system needs to rediscover its sense of purpose: its social usefulness

We are currently using the equivalent of 1.75 Earths to provide the materials we use and to accommodate the waste we produce.

So long as financial markets aren’t pricing in the “externalities” of carbon emissions, poor public health and inequality, the harm will fall on broader society rather than the businesses doing the damage.

We need to go beyond maintaining the status-quo with sustainability bolt-ons.

In the words of Andrew Haldane, then Executive Director of Financial Stability at the Bank of England, banks need to “rediscover their social usefulness”.

What this means in practice is the UK Government, via the financial regulators, should provide a clear steer for financial institutions that they should support and reward socially useful activities.

We need strong regulators that can ensure well-functioning markets, protect consumers and encourage socially useful activities

We need more planning and direction from the government if we are to tackle the massive existential threats we face. They must identify what outcomes we want to see and how to get there.

There is real potential to achieve this through the government’s ongoing review of the framework for financial regulation in the UK post-Brexit.

The EU and UK have both made important contributions to the sustainable finance agenda, developing new ways of defining concepts that are hard to pin down from an economic perspective.

But, post-Brexit, the UK Government should identify the kinds of financial activity that are useful for us as a society, and look closer at the fundamental incentives driving behaviour in these systems.

This is a significant moment in the history of financial regulation in the UK.

We should grasp the opportunity to face these challenges with an imaginative, outward-facing approach.