In the run up to the autumn spending review, prime minister Boris Johnson proclaimed a vision of a “green industrial revolution”. His ten point-plan indicated that funding was to be raised through a range of new “blended finance” initiatives in line with last year’s Green Finance Strategy published by the Department for Business, Energy and Industrial Strategy (BEIS). This approach sees the role of the state to be to ‘crowd-in’ and act as guarantor to private financial investors, and pension funds.

In line with expectations, the spending review announced a new ‘national infrastructure bank’ – despite the previous Green Investment Bank being sold off to private equity group Macquarie only three years ago. It can be assumed the new bank will run on lines similar to the British Business Bank: a state-owned but privately managed institution. The government’s plans align with a broader coalition of calls for greater involvement of private financial institutions in contributing to the financing of sustainable development. The Bank of England, for example, is seeking ways to promote “productive finance” i.e. investment that expands productive capacity, furthers sustainable growth and can make an important contribution to the real economy.

While we await full details, the government’s approach seemingly depends on the financial sector having the appetite and capacity to go green. The appetite is taken as given, with the consequence that there are no signs of coercive policy on the horizon. In November, the government voted down a Labour amendment to the Pension Schemes Bill which would have mandated occupational schemes to adopt investment strategies aligned with net-zero greenhouse gas emissions “at the pace the science demands”.

What then is holding UK funds back on the capacity side? The thinking is that investors are inhibited by a lack of appropriately designed investible assets. This is where the national infrastructure bank can step in, alongside the newly-announced Sovereign Green Bonds and the long-awaited Long Term Asset Fund (LTAF) – a new type of open-ended investment fund focussing on “illiquid assets” (i.e. assets such as infrastructure that require a long-term commitment because their difficult convertibility into cash). The new transparency rules with which corporations have to comply – Climate Related Financial Disclosures – will also make it clearer to investors how to make the green choice.

The question is whether these measures will be enough. The debate linking pension funds with patient, productive investment is a long one, and there is a sense of déjà vu as we go over it once more. Disappointment in short-termism from the industry throughout the 1970s – and the associated lack of productive investment in British industry – was behind the Wilson Committee in 1981, whose remit could usefully be picked up and dusted off for the present Bank of England project. Lord Davies from the last Labour government sought to promote productive pension fund investment, setting up Infrastructure UK to investigate ways to make this happen. As chancellor George Osbourne also included pension fund support as a key part of his economic recovery plans. This belief in pension fund potential is supported by experiences in other mature pension fund countries such as Canada and Australia, where infrastructure has been more successful as an asset class.

In the UK however, pension funds conform very little to the “patient investor” image. The most interesting recent trend has been a shift in asset allocation, particularly of defined benefit (DB) schemes; these pensions have moved away from company shares into bonds and “alternative assets”. However, within the alternative asset class, the focus has been on private equity and hedge funds, rather than infrastructure – and even within the latter asset class the vast majority invest in existing fee-generating infrastructure rather than financing the construction of new projects.

So why in the UK, despite all these efforts, have funds not only failed to move towards patient investment, but in fact arguably moved further away? Answering this requires acknowledging the transformation of UK finance towards a more “market-based” system, where the liquidity of financial assets is crucial, and is often guaranteed through provisions of cash as collateral. Pension funds, especially maturing ones that are paying more pensions than contributions received, have to carefully monitor their liquidity and limit their investments into illiquid assets. This is also the case in the newer “auto-enrolment” pensions, where there remains very little appetite for long-term “illiquid” investment, in part due to this liquidity requirement.

The importance of liquidity can be seen in the debates around the Long-Term Asset Fund (LTAF). This proposed fund will focus on illiquid long-term assets, but remain open-ended (i.e. allow redemptions from investors, if at a reduced frequency). This structure is supposed to encourage pension fund participation (particularly defined contribution funds, seen as lagging defined benefit in this area), as it allows for a degree of liquidity and daily pricing, to allocate their portfolio to illiquid investments. Leaving aside the question as to whether the LTAF would meet the requirements of “productive investment”, there remains a fundamental contradiction between redemptions and daily pricing and genuinely long-term investments, and it as of yet unclear how this mismatch would be adequately bridged by the LTAF. On the other hand, it looks unlikely that pension funds would contribute to illiquid assets without this type of investment option.

This contradiction reflects a greater problem in the UK financial system. It seems unable to finance long-term investment, because nobody wants to bear the uncertainty and illiquidity that it entails. Collective funds appear to make illiquid assets liquid, but this is contingent on the market remaining liquid to allow redemptions and/or sale of fund shares to other investors.

But when the crisis comes, all investors contribute to the “dash for cash”, seeking liquidity above everything else. Pension funds are no exception.

Ultimately, it is the state that is best placed to bear the significant risks and costs associated with the transformation towards an environmentally sustainable economy. Pensions can be relied upon to keep bond markets liquid. With appropriate regulation, they could be forced to shift away from the worst emitters. Asking any more from them than this would require structural reform of the financial system itself.