We Could Be Heroes

At first glance, the close of the second decade of the 21^st Century gave little cause for celebration for those looking for a sustainable future for mankind. Greenhouse gas emissions reached an all-time high[ii], the Madrid Climate Change Conference - COP25 - ended in failure and Australia burned. A report published in the journal Biological Conservation[iii], reported on the catastrophic collapse of global insect populations; and around the world more than 820 million people do not have enough to eat[iv].

But the world is not helpless in the face of these challenges. In 2015, United Nations Member States adopted a set of 17 Sustainable Development Goals (SDGs), designed to provide a guide for a planetary course correction. The SDGs call for action by all countries - poor, rich and middle-income - to promote prosperity while protecting the environment (see figure 1).

Figure 1 The SDGs

As we approach the fifth anniversary of the adoption of the goals, around the world policy makers, academics and non-governmental organisations are coming to the realisation that International Financial Centres (IFCs) may hold the key to unlocking the solutions the world desperately needs to deliver the SDGs.

Diamond Dogs

Financial systems i.e. the framework of regulations - standards, market infrastructure, relationships and responsibilities within which trading takes place and services are offered - are a product of society and should serve societal needs.- Society is concerned about climate change, environmental destruction, and inequality but financial systems, historically, have struggled to adequately address these issues.

Financial services have a critical role to play in the delivery of SDGs as they direct the flow of finance into more, or less, sustainable activities which constrain future development paths for nations. In February 2016 the United Nations Environment Programme published a report on the design of a sustainable financial system which “serves the long term needs of a healthy real economy, an economy that provides decent, productive and rewarding livelihoods for all, and ensures that the natural environment on which we all depend remains intact and so able to support the needs of this and future generations”. [v]The report identified four criteria  that identify whether a financial system is contributing to sustainable development:

• the encouragement of long-term investment;
• reflection of pricing signals and risk;
• the encouragement of development and growth;
• resilience to shocks.

Absolute Beginners

Green Finance refers to any financial instrument or financial services activity – including insurance, equity, bonds, commodity and derivatives trading, analytical or risk management tools – which results in positive change for the environment and society over the long term (sustainability)[vi].

The most basic “greenness” criterion of a company or project is that it contributes to reduce greenhouse gas emissions. However, increasingly, financial services organisations are tailoring their products and services to deliver on SDGs.

In 2015 the United Nations Global Compact (UNGC) and KPMG International Cooperative (KPMG) developed the SDG Industry Matrix[vii], which was designed to map the Sustainable Development Goals onto strategic industry activities.

In the five years since the development of the matrix, the explosive growth of new financial instruments, such as green bonds, along with enhanced analytics have increased attention on green finance.

Graph 1 The Growth In Green Finance

Source Global Sustainable Investment Alliance 2019[viii]

Four factors are driving the growth of this sector:

• Consumer demand: According to a Morgan Stanley report[ix] millennials are nearly twice as likely to invest in funds focused on social or environmental outcomes.
• Technological advancement: Rapid developments in computing and communication technology, such as “distributed ledgers” and the spread of smart phones, have opened new opportunities for providing banking and other financial services to citizens of developing nations[x].
• Regulatory frameworks: Enhanced reporting requirements for listed companies, combined with stringent regulations regarding air and water pollutions, have driven demand for investment in environmental technology[xi].
• Reduced Risk: ESG focused investments outperform the market as ESG focused companies have lower capital costs and better risk profiles, according to MSCI[xii]. Recently, a new driver has emerged: that of carbon risk, where analysts are considering how a company’s exposure to fossil fuel-related risks may result in the creation of “stranded assets”[xiii].

The last of these bears closer scrutiny as, according to available data, some financial centres derive a significant fraction of their listed companies’ revenues from fossil fuels:

“Much of this fossil fuel revenue often comes from a handful of companies: Gazprom, Rosneft, and Lukoil in Moscow; PTT in Bangkok;  PKN Orlen in Warsaw; Royal Dutch Shell in Amsterdam; KOC Holding in Istanbul;  and OMV in Vienna.  Each account for more than 10 per cent of total corporate revenue reported on their exchanges.  BP and Glencore in London, and Sinopec and Petrochina in Shanghai each account for between 7 per cent and 9 per cent.  In Bombay and Toronto, by contrast, the exposure is more thinly spread over a larger number of smaller fossil fuel companies. 

 As the case for action on climate change becomes ever more urgent, national and international action to curb carbon emissions such as the roll out of electric vehicles, is beginning to impact on the profitability of these companies[xiv], potentially leading to ‘stranded assets’, e.g. fossil fuels on balance sheets that have little likelihood of ever being available to be ‘burnt’ (Long Finance began this debate in 2006 as ‘what happens if everything that could be burned was?’ and found that fossil fuels ‘on balance sheet’ grotesquely exceeded scientific temperature change limits, leading to the unburnable carbon, stranded assets debates).”[xv]

Many IFCs, particularly in Europe and China, have seen the writing on the wall and as a result, green finance is no longer seen as a fringe activity but as a profitable and desirable business area which drives financial markets, serves society, and enhances the status of financial centres which demonstrate expertise.

Around the world, financial centres are competing to enhance their share of the green finance market.

Graph 2 Global Improvement In Quality Of Green Finance

Source: Long Finance 2019 The Global Green Finance Index 4[xvi]

Changes

Innovative products and services require international scope for growth and sustainability:

• Services and products need to trade across national borders in order to grow markets.
• Some services, such as mobile banking, have high transactions costs and must be traded at scale for them to be economically viable.
• Some services, such as insurance, must diversify in order to spread risk.

The development of this international scope requires collaboration between policymakers, financial services providers, and financial centres on regulation, standards, and benchmarking.

Organisations such as the UN have been acting as matchmaker in this regard and a number of international collaborations have been established to deliver this end. These include:

• UN Network of Financial Centres for Sustainability (fc4s.org/)
• The Sustainable Stock Exchanges Initiative (https://sseinitiative.org/)
• Global Investors For Sustainable Development
• The Global Islamic & Sustainable FinTech Centre

However, IFCs are not waiting for invitations from the UN, OECD or World bank to drop through their letter boxes. Many IFCs are setting up bilateral agreements on green finance with their peers in an attempt to develop new products, break down barriers and grow markets.  The recent Nigerian Stock Exchange (NSE) and the Luxembourg Stock Exchange (LuxSE) MoU[xvii], designed to expand the green bond market, are a case in point.

Golden Years

The world has more than 100 international financial centres, and many more centres serving local and national economies. IFCs should have a key leadership position in the delivery of SDGs but this is a mantle they have yet to assume.

Financial centres are key to sustainable economic growth as they provide the framework for investment and savings that drives infrastructure investment and entrepreneurial endeavour. Their prime purpose is to meet growing global funding needs, and these are expected to be particularly high for the next  10 to  20 years. IFCs are therefore in a key position to direct the flows of finance that will determine development for the world for years to come.

Financial centres hold a unique position. They are neutral platforms for the facilitation of frictionless trade.  Unencumbered by political baggage, they have the capacity to be thought leaders as their views are given weight by policymakers and the dialogues they initiate have the ability to direct the attention of financial service providers.

IFCs are ideally placed to create a new agenda for change; what is required is a call to action, similar to that which led to the foundation of the United Nations in the wake of the devastation of the Second World War[xviii].  Here is a first attempt:

WE THE WORLD’S INTERNATIONAL FINANCIAL CENTRES, ARE DETERMINED:

• To save succeeding generations from the scourges of climate change, poverty and economic turmoil, which is bringing untold sorrow to mankind, and

 

• To reaffirm faith in the protection of the earth’s vital life support systems; in the dignity and worth of the human person; in the equal rights of men and women and of nations large and small, and

 

• To establish conditions under which sustainable development can be maintained, and

 

• To promote social progress and better standards of life for all.

 

WE WILL:

 

• Work together to frame the questions for policy makers, regulators, and financial service providers on how to embed green finance in financial systems;

 

• Lead the international and domestic policy discussions which will shift the Overton Window[xix] to make green finance the de facto choice, allowing policy and regulatory progress on the SDGs to be made; and

 

• Work together to establish benchmarks and standards which will allow the legislative and policy barriers applying friction to international trade to be torn down.

 

Footnotes:

[i] Wichmann J 2018 How The Finance Industry Can Save The World https://www.weforum.org/agenda/2018/12/how-the-finance-industry-can-save-the-world-regenerative-capitalism/

[ii] Friedlingstein P Global Carbon Budget 2019 ESSD Volume 11, issue 4 https://www.earth-syst-sci-data.net/11/1783/2019/

[iii] Sánchez-Bayoa F & Wyckhuysbcd K 2019 Worldwide Decline Of The Entomofauna: A Review Of Its Drivers Biological Conservation Volume 232, April 2019, Pages 8-27

[iv] UN 2019 The State Of Food Security And Nutrition In The World 2019 http://www.fao.org/3/ca5162en/ca5162en.pdf

[v] UNEP 2016- Imagining a Sustainable Financial System http://unepinquiry.org/wpcontent/uploads/2016/02/Imagining_a_Sustainable_Financial_System.pdf

[vi]    Long Finance 2018 The Global Green Finance Index https://www.longfinance.net/programmes/financial-centre-futures/global-green-finance-index/about-ggfi /

[vii]    UNGC & UNGC 2015 The SDG Industry Matrix https://home.kpmg/content/dam/kpmg/xx/pdf/2017/05/sdg-financial-services.pdf

[viii] GSIA 2019 2018 Sustainable Investment Review http://www.gsi-alliance.org/wp-content/uploads/2019/06/GSIR_Review2018F.pdf

[ix] Morgan Stanley 2018  https://www.morganstanley.com/pub/content/dam/msdotcom/ideas/sustainable-signals/pdf/Sustainable_Signals_Whitepaper.pdf

[x] UNEP 2017 Fintech, Green Finance And Developing Countries http://unepinquiry.org/wp-content/uploads/2017/06/Fintech_Green_Finance_and_Developing_Countries-input-paper.pdf

[xi] Herman R 2017 Drivers For Environmental Technologies Selection In The Shipping Industry: A Case Study Of The North European Sulphur Emission Control Area Int. J. Environmental Technology and Management, Vol. 20, No. 3/4, 2017

[xii] MSCI 2018 https://www.msci.com/documents/10199/48e85d65-66d4-40e7-b316-c64a95b83a04

[xiii] Long Finance 2019 https://www.longfinance.net/programmes/sustainable-futures/london-accord/reports/value-and-values-warming-world/

[xiv] Energy Voice 2020 Shell Sees 36% Drop In Earnings On Weaker Oil, Gas And LNG Prices https://www.energyvoice.com/oilandgas/221197/shell-sees-36-drop-in-earnings-on-weaker-oil-gas-and-lng-prices-articleisfree/

[xv] Z/Yen 2019 Value And Values In A Warming World https://www.longfinance.net/programmes/sustainable-futures/london-accord/reports/value-and-values-warming-world/

[xvi] Long Finance 2019 The Global Green Finance Index 4 https://www.longfinance.net/media/documents/GGFI_4_Full_Report_2019.09.27_v1.0.pdf

[xvii] This Day 2019 NSE, Luxembourg Stock Sign MoU To Expand Green Bond Markets https://www.thisdaylive.com/index.php/2019/10/10/nse-luxembourg-stock-sign-mou-to-expand-green-bond-markets/

[xviii] UN 1945 Preamble To The United Nations Charter https://www.un.org/en/sections/un-charter/preamble/

[xix] The Overton Window https://en.wikipedia.org/wiki/Overton_window