Niharika Singh
President, UCL Women in Finance | BSc Economics, UCL
Perhaps the buzzword of the current decade, “sustainability” has taken the world of finance and business by storm. The emergence of several UN-sanctioned reports on the climate crisis coupled with the urgency of media outlets have made the word quite hard to ignore. The Intergovernmental Panel on Climate Change (IPCC) has even stated that the world will see the escalation of food shortages, wildfires and other natural disasters as early as 2040; a year well within the lifetime of most of the Earth’s population[1]. The Paris Agreement and the Kyoto Protocol are the two main international agreements put forth by the UN to alleviate this crisis. Their objectives are as follows: to accumulate the finances needed to battle climate change, implement a new technological framework for industrialized countries, and aid developing countries to meet their national climate objectives.[2] Considering the climate crisis has been a product of the Industrial Revolution, where machinery built on the fabric of non-renewable, environmentally harmful resources replaced labor, changes to the current economy are needed to move towards finding a solution. Developed economies must learn to be more resource-efficient in their production processes while developing economies must forgo these problematic structures and build an economy that is resource efficient from the outset.[3]
The Importance of Sustainability in Finance
What does it mean to be sustainable, one might ask, since the definition of the word has been lost amongst the numerous corporate branding campaigns placing sustainable economic development at their forefront? Sustainability, according to the Cambridge Dictionary, is “causing little or no damage to the environment” and therefore “[being] able to continue for a long period of time.”[4] From that, it is impossible to fathom why businesses would want anything but for their models to be based around principles adhering to environmental sustainability. However, the objective truth is clearly far from this deduction.
A majority of business models that have thus far existed in the modern economy have given profit precedence over all else. As Milton Friedman, a principle figure in 20th century economics, put it, “the social responsibility of a business is to make profit” and generate surplus for its owners[5]. His logic is hard to argue with because when businessmen begin selling goods, they do so because the surplus from business outweighs their opportunity cost of not having one. However, climate change increases the risk of investments made across all markets and therefore poses a threat to these same businessmen. Policies aimed at reducing greenhouse gas (GHG) emissions along with how extreme weather will impact industries like agriculture, infrastructure and energy increase the volatility of stocks[6]. Under such conditions, pressure from investors has strongly tilted the scales of business objectives in favor of sustainability over profit. This is evident from the way that industry leaders like JP Morgan and Morgan Stanley have ensured that their environmental, social and governmental (ESG) investment priorities are highlighted on their website and hired Sustainability Officers[7]. But then comes the danger of “greenwashing,” a term used to describe corporations who deceptively market themselves as environmentally beneficial when their practices are anything but that.
Corporate Greenwashing
It is often difficult for companies to match the scale of their rhetoric with their actions but even so, it is surprising how short-sighted some companies continue to be. The consideration of environmental factors for many firms has just been to impress incoming millennials or address investor concerns [8]. Corporations seem unwilling to change their core business model or purpose, without which it is impossible to expect a turnaround in the world’s carbon footprint and larger goals for sustainability.
Corporate greenwashing dates back to the 1960s when, in response to the anti-nuclear movement, nuclear power giant Westinghouse printed adverts about its safety despite knowing the health risks involved[9]. This trend has stretched into the 21st century where large corporations like BP and Blackrock have both been guilty of corporate greenwashing. To illustrate, BP’s chief executive came out in support of carbon pricing but on the other hand, his company contributed millions to a campaign lobbying for the removal of a carbon tax law in Washington. Further, Blackrock has always emphasized their need to positively contribute to society, however, their actions contradict the power of their words. According to the Financial Times, in 2018, Blackrock only supported 10% of their shareholder’s climate-related investment proposals and failed to join Climate Action 100+, a campaign led by investors to push for carbon neutrality[10].
The Future of Finance
Greenwashing aside, what are the real ways the finance industry can move forward? The global investor statement, which makes up part of the Climate Action 100 initiative, is a great place to start. The ending few remarks lay out the perfect recipe firms can follow when looking to alter their business practices. They are as follows: work with policymakers, identify low carbon investment opportunities, analyze the impact of climate policy to investment portfolios and report on the actions taken in order to monitor progress. This four-pronged plan seems enough to brush even the dirtiest firms squeaky clean.
The Growth of ESG Investing
Investment that takes ESG factors into consideration lies at the core of transforming the finance industry; a few specific actions that make up ESG investing are sustainability themed investing, negative/positive screening and the integration of environmental, social and government factors during financial analysis. This sector has fortunately seen a meteoric rise in the past two decades. In particular, sustainable investing assets have globally grown, with the highest compounded annual growth rate being that of Japan (308% over 4 years).[11]
Source: GSIA. “Global Sustainable Investment Review 2018.” GSI Alliance , Hermes Investment Management, RBC, UBS, 2018, http://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf.
A more relevant figure is perhaps the ratio of sustainable investing assets to total managed assets for Europe, the US, Canada, Australia/New Zealand and Japan.
Source: GSIA. “Global Sustainable Investment Review 2018.” GSI Alliance , Hermes Investment Management, RBC, UBS, 2018, http://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf.
The rise in sustainable investing can be attributed to the strict mandates issued by governments of countries such as France’s compulsory report of climate risk for all firms and the Supervisory Review and Evaluation Process (SREP) in Europe which governs how banks handle risk/capital requirements. Further, a high proportion of employees at financial firms are made up of Millennials that know climate change will have the maximum impact upon their generation and the ones after[12]. This has also played a huge role in changing firms’ motives for investing sustainably: “just because investors say so” was replaced with the understanding of the benefits sustainable investing can bring in the long run.
In practice, the costs associated with increased investment in the low-carbon economy can easily be offset by the avoided operating/financing costs in industries like fossil fuels. Renewable energy, without a doubt, is the future. The net financial benefit from this restructuring has the potential to grow to US$1.8 trillion from the years 2015-2035, as shown in the figure below.[13]
Source: Nelson, David, et al. “Moving to a Low-Carbon Economy: The Financial Impact of a Low Carbon Transition.” Climate Policy Initiative, CPI, Oct. 2014, file:///Users/mac/Downloads/moving-to-a-low-carbon-economy-the-financial-impact-of-the-low-carbon-transition.pdf.
Conclusion
It is evident that despite the political and social turmoil climate change has stirred up, it remains difficult to reconcile goals of profit with those of sustainability. Whether or not the world should shift from basing business on the growth paradigm to a sustainable level of consumption continues to be a heated debate among economists. In the end, placing a cap on consumption interferes with market forces and contradicts the idea of a free market economy but is a necessary consequence of the climate crisis. The significant demand for capital to finance the transition to a low-carbon economy and pressure from investors puts the responsibility on firms in private financing to pave the way forward. The next 10-15 years are crucial, and the finance industry must integrate sustainability into their business models if they wish to succeed.
References
[1] Davenport, Coral. “Major Climate Report Describes a Strong Risk of Crisis as Early as 2040.” The New York Times, The New York Times, 8 Oct. 2018, https://www.nytimes.com/2018/10/07/climate/ipcc-climate-report-2040.html.
[2] United Nations. “UNFCCC EHandbook.” UNFCCC, United Nations, 1 Nov. 2016, https://unfccc.int/resource/bigpicture/#content-the-paris-agreement.
[3] Tukker, Arnold, and Sophie Emmert. “Fostering Change to Sustainable Consumption and Production: an Evidence Based View.” Journal of Cleaner Production, vol. 16, no. 11, July 2008. ScienceDirect, doi:10.3897/bdj.4.e7720.figure2f.
[4] “SUSTAINABLE: Meaning in the Cambridge English Dictionary.” Cambridge Dictionary, https://dictionary.cambridge.org/dictionary/english/sustainable.
[5] Friedman, Milton. “The Social Responsibility of Business .” The New York Times Magazine, 13 Sept. 1970.
[6] European Climate Foundation. “Climate Change: Implications for Investors and Financial Institutions.” European Climate Foundation, https://europeanclimate.org/climate-change-implications-for-investors-and-financial-institutions/.
[7] JP Morgan Chase. “Sustainable Investing.” J.P. Morgan Institutional Asset Management, https://am.jpmorgan.com/us/institutional/our-thinking/esg-sustainable-investing.
[8] Clark, Pilita. “Time's up for a Golden Age of Corporate Greenwashing.” Financial Times, Financial Times, 19 May 2019, https://www.ft.com/content/407260f2-787d-11e9-bbad-7c18c0ea0201.
[9] Watson, Bruce. “The Troubling Evolution of Corporate Greenwashing.” The Guardian, Guardian News and Media, 20 Aug. 2016, https://www.theguardian.com/sustainable-business/2016/aug/20/greenwashing-environmentalism-lies-companies.
[10] Clark, Pilita. “Time's up for a Golden Age of Corporate Greenwashing.” Financial Times, Financial Times, 19 May 2019, https://www.ft.com/content/407260f2-787d-11e9-bbad-7c18c0ea0201.
[11] GSIA. “Global Sustainable Investment Review 2018.” GSI Alliance , Hermes Investment Management, RBC, UBS, 2018, http://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf.
[12] Somani, Sharmeen, and Scott R. Stroud. “Green Is the New Color of Money: Greenwashing and Advertising Ethics.” Media, Ethics Initiative, University of Texas, Austin, 30 Apr. 2019, https://mediaengagement.org/wp-content/uploads/2019/04/48-greenwashing-case-study.pdf. [13] Nelson, David, et al. “Moving to a Low-Carbon Economy: The Financial Impact of a Low Carbon Transition.” Climate Policy Initiative, CPI, Oct. 2014, file:///Users/mac/Downloads/moving-to-a-low-carbon-economy-the-financial-impact-of-the-low-carbon-transition.pdf.