By Ian Fraser
Today’s system for allocating capital via the global financial markets, whose agenda is set by short-termist investors, is looking increasingly broken. One of its worst traits is that it encourages, or perhaps even forces, corporate managements to focus on growing the bottom line to the exclusion of people and planet.
Some non-commercial mechanisms for over-riding these pressures exist. They include subsidies for renewable energy (which in the UK is called the “feed-in tariff”) plus things like the taxation of carbon emissions, and perhaps also the Basel III regulatory framework for banks. None of these work particularly well, though.
The London-based asset management group Aviva Investors, which has £250 billion of assets under management, believes it's time that investor and corporate behavior was rethought, and has sponsored a major new report arguing for a more holistic approach.
Choosing the right path
The report, written by non-profit organisation Forum for the Future, suggests that, since accelerating climate chaos is likely to seriously undermine pension fund returns in the not-too-distant future, investors may as well wake up and adjust their approaches, even if this leads to inferior returns in the near term.
The report is titled 'The Sustainable Economy in 2040: A Roadmap for Capital Markets' (pdf) and argues that the current system is channelling capital into activities that are pushing the planet to the limits of its capacity, which in turn means that investors’ long-term interests are being put at risk.
The report's authors believe that investors, including pension funds, ought to be using their financial clout to pressurize corporations into prioritizing sustainability. They want investors to oblige companies into reporting their strategies for making their businesses sustainable and detail how they intend to handle emerging risks such as climate change, water stress, loss of biodiversity and population growth. Forum for the Future's Alice Chapple told Professional Pensions:
Our framework shows one cannot carry on depleting resources and bumping up against those environmental limits ad infinitum. When is it we make the decision to stop? Is it when we realize there is no opportunity to stop climate change, or is it planning ahead and saying if we migrate our portfolios gradually over the next 30 years we can manage them in a way holders will benefit from in the long term... For trustees there is an opportunity to see from this work it is not about arbitrary, ethical decisions; it is about hard-nosed long-term commercial decisions that will deliver returns for their fund members.
The road to recovery
The report suggests ten steps investors, companies and policymakers should follow to wean themselves off their addiction to the fast buck:
- Investors should require all companies to report on their long-term strategy and how this makes the business more sustainable.
- Companies should report in their accounts the value of natural, human and social capital, so that investors can understand the importance of factors which are often overlooked.
- Financial institutions should demonstrate that the products and services they sell serve the long-term public good. In particular, they should demonstrate they do not increase risk and instability in the system.
- Fund managers should develop funds that invest in companies aligned to the vision of a sustainable economy. This would require a reassignment of existing pension subsidies but no new spending.
- Pension funds should ensure that all investment mandates require fund managers to take social and environmental issues into account as part of their fiduciary duty.
- Companies of all types should change their remuneration systems so they reward staff for performance on activities which build long-term value rather than for generating short-term returns.
- Insurance companies should charge higher premiums for activities that create systemic risk by contributing to climate change, the depletion of natural resources, and social instability. This may initially need government support.
- Financial institutions should develop and scale up financial instruments (such as bonds) designed to fund long-term sustainable activities.
- Government should set up institutions and mechanisms that galvanize private-sector investment into sustainable activities, where the current risk-reward profile is not attractive.
- The public and private sectors should engage in more effective dialogue about how to build a sustainable economy to enable better sharing of perspectives, skills and knowledge. Secondment schemes should be considered.
The report also provides investors with specific guidance on investing in five sectors described as fundamental to a sustainable future: food, health and wellbeing, energy, mobility and finance. The report's executive summary (pdf) concludes by saying:
Some will argue that the goal of a sustainable economy in 2040 is unrealistic. This report undoubtedly highlights that it is a massive challenge. But what is striking is that it is, in principle, possible to achieve if we deliberately set out to do so. It is also clear that the way financial markets operate over the next 30 years will be one of the most important enablers of, or barriers to, achieving that goal.
Aviva Investors, which has already started adopting some of the proposals, and Forum for the Future are by no means voices in the wilderness. Similar themes are being explored by FairPensions, and Sallie Pilot, director of research and strategy at corporate reporting consultancy Black Sun, recently said she believes that integrated reporting (as opposed to purely financial reporting) is already becoming mainstream.