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Rishi Sunak is being urged to issue a new generation of green bonds that would offer higher returns to investors if the UK government fails to hit its climate change targets.

The Social Market Foundation (SMF) said its plan for sustainability-linked bonds would provide ministers with a greater incentive to meet carbon-reduction goals and would help boost the UK’s prospects of being a global financial hub for green finance.

A report to be published on Tuesday by the thinktank calls on the chancellor to follow the example of Chile, the first country to peg the borrowing costs on its government debt to tackling global heating.

Scott Corfe, the research director at the SMF, said: “Financial services will be key for delivering on net zero, and green finance could be one of Britain’s great economic success stories in the 2020s. Already, 200,000 financial services workers are in green jobs – a number that will undoubtedly grow over the coming years.

“Government needs to work in partnership with the financial services industry to make Britain the leading hub of sustainability-linked finance. Leading by example, the chancellor should issue a new generation of sustainability-linked government bonds which would tie interest payments to the country’s net zero targets. Not only would this support green financial services but the prospect of financial penalties for missing net zero targets would strengthen the government’s commitment to decarbonisation.”Advertisemen

Corfe said Sunak should start small in order to test investor interest but added the Chilean example suggested demand would be high.

In March, Chile issued a $2bn (£1.6bn) sustainability-linked bond, which was four times oversubscribed. Returns to investors depend on the country adhering to its climate change pledges, including that it emits no more than 95 metric tonnes of carbon dioxide or equivalent by 2030, and renewables account for 60% of electricity production by 2032. If Chile misses a target, it incurs a financial penalty.

Sunak is keen for London to be a centre for green finance and last year announced a programme under which the proceeds from green bonds would be used for environmental projects. The Treasury says two bond issues had already raised £16bn but it would need to be confident new forms of funding would result in strong, sustained demand and represent value for money to taxpayers.Sign up to the daily Business Today email or follow Guardian Business on Twitter at @BusinessDes

“The UK is a world leader in green finance and the chancellor set out a clear pathway at Cop26 for the UK to become the world’s first net zero-aligned financial centre,” a Treasury spokesman said.

The SMF said issuing a sustainability-linked bond would show the government was “fully committed” to decarbonisation. The threat of financial penalties for overpromising and underdelivering could prove “a powerful way of holding government true to its word on net zero”.

The interest rate, or coupon, on a standard government bond is set when it is auctioned to investors, with the interest rates on index-linked bonds adjusting in line with inflation.

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