Maximising the UK National Wealth Fund’s growth impact

Following a commitment made by the recently elected Labour Government in the UK to bring together several of the country’s policy banks under a new National Wealth Fund, Daisy Jameson sets out recommendations for maximising the fund’s potential.

Policy banks – government-owned financial institutions – can help address several of the investment barriers faced by businesses and projects to help deliver the UK Government’s net zero and industrial strategy ambitions.

The new Government has committed to bringing together at least two of the country’s policy banks – the British Business Bank (BBB) and UK Infrastructure Bank (UKIB) – under a new National Wealth Fund (NWF).

CETEx has previously highlighted how the NWF provides an opportunity to reassess how UK policy banks operate, with a view to improving their effectiveness.

Following extensive engagement with experts within UK and international policy banks and Whitehall, we have identified three areas that should be at the core of the NWF’s policy design, learning from the experience of the existing UK and international policy banks.

1. Empowering the NWF to proactively support a sector’s development

Policy banks are required to be ‘additional’ – that is, they must not crowd out the market. Instead, they invest where the market is hesitant to go. Our research suggests that this ‘additionality’ is predominantly looked at through the lens of ‘market failure’, with UKIB assessing it on a deal-by-deal basis and the BBB taking a market-wide approach.

While we agree that a focus on being additional to the market is crucial, our research also highlights the danger of being too purist in assessing additionality. Waiting for clear signs of market failure before acting means there is risk of acting too late or not acting at all. It can lead to a reactive rather than proactive mindset, partly because the policy banks must justify why they are needed before they can act.

The NWF should be empowered to act differently. First, it should look to address market weakness, not just failure. Second, it should place a greater emphasis on fostering the development of a sector over time, in contrast with a project-by-project approach. Third, the status quo should be reversed: the NWF should be assumed to be needed and capable of acting unless proven otherwise. Taken together, this will empower the NWF to proactively invest in line with government policy and strategically support a sector’s development over the medium to long term.

Recommendation 1: the NWF’s additionality criteria prioritises proactive action by: (i) addressing market weaknesses; (ii) fostering sector development; and (iii) emphasising a presumption for action.

2. Integrating the NWF more effectively into government policy development

Policy banks are at their most effective when their activities are coordinated with, and take account of, the Government’s wider response to achieving a policy objective. For example, the NWF may invest in a project that is also receiving grant funding to cover development costs and revenue support to ensure commercial viability. In such a scenario, the NWF’s activity should aim to amplify the Government’s interventions, and government departments should try to design programmes that consider, and potentially integrate, the NWF’s finance offer.

Effective collaboration between policy banks and Whitehall ensures a cohesive offer is presented to project sponsors. It also enables the Government to consider in the round the right mixture of loans and grants to address a policy problem, with the aim of minimising the amount of grant required.

Our research found that while there are examples of existing effective collaboration between Whitehall and policy banks, improvements could be made to ensure they are working together as productively as possible.

Integrating policy banks into the development of government programmes

The NWF presents an opportunity to re-evaluate how policy banks and Whitehall work together, with a view to better integrating policy banks earlier into the policy development process. To do this, the NWF will need to marry its project-by-project/market-wide approach with government tendency to design sector-specific programmes.

Broadly, UKIB assesses deals on a case-by-case basis while the BBB intervenes at a market-wide level. On the other hand, government regularly designs sector strategies that involve implementing grant programmes and/or revenue support mechanisms.

These different approaches can make it hard to integrate policy banks into central government policy processes, particularly in the initial stages when government departments are working on high-level policy design and there is limited engagement with capital markets. The BBB may struggle to design sector-specific interventions, while UKIB prefers to assess tangible projects.

Recommendation 2: the NWF is more deeply embedded into the core of government policy design to achieve a step change in policy banks’ activities and develops collaborative approaches to facilitate this process.

Risk appetite

One way policy banks can address investment barriers is by having a different risk appetite to the market. For example, UKIB’s Strategic Plan states “our risk appetite is different to commercial institutions”.

Government departments will be more effective in incorporating the NWF into their policy development if they understand how its distinct risk appetite translates to the specific policy problems they are tackling.

The existing policy banks have already begun to do this. Last year, UKIB published a series of sector snapshots that set out, for seven sectors, the specific risks they want to help address. Our research found that these were warmly received by government and market.

However, our research suggests more could be done to articulate how a policy bank’s risk appetite differs from what the market is willing to provide. A lack of understanding can lead to officials either overestimating the risks policy banks can take or being unable to differentiate the policy bank offer from the market offer.

The NWF will be at its most effective if it can clearly articulate at a sector level how its risk appetite differs from the market and what this can achieve in terms of amplifying policy and addressing market weakness.

Recommendation 3: the NWF articulates, on a sector and portfolio basis, how its risk appetite differs from that of commercial institutions.

Information sharing

Our research identified that, at times, a lack of clarity regarding the status of policy banks has meant information has not flowed freely between them and Whitehall, deterring collaboration and delaying progress. It is critical that government departments understand the NWF’s status as a government body, not a market entity, and treat it as such. Without a relatively unhindered flow of information between the NWF and Whitehall, it will be difficult for the NWF to be integrated into the Government’s policy development.

Recommendation 4: the NWF’s legislation and framework document establishes that information can flow freely between itself and government departments.

3) Incentivising the NWF to foster the long-term development of financial markets

Policy banks have impact by deploying capital. They must also generate a return sufficient to cover operational costs and grow their balance sheet. This focus on developing a pipeline of investible deals can create tension between doing in-year deals and working with government to foster long-term market development. The more time spent on short-term deals, the less attention can be devoted to nurturing future markets.

Our research found that the need to deliver a pipeline today has been prioritised over efforts to address long-term financing challenges that may not lead to investible projects for several years.

Our view is that the NWF needs to be incentivised to do both – invest today and foster the markets of tomorrow. This is particularly important for immature net zero sectors, where the technologies and project economics are unproven.

Recommendation 5: the Government ensures the NWF’s key performance indicators incentivise the fund to tackle both short- and long-term financing challenges.

The Government’s commitments to bring together the UK’s policy banks under a National Wealth Fund provides an opportunity to create a step change in the way policy is developed to deliver against Labour’s clean energy and economic growth missions. Following the recommendations set out here will maximise the fund’s potential in delivering this change.