Nick Robins: Why shaping policy frameworks to drive sustainable value creation is the next frontier for responsible investors

We need to join up the buy-side and sell-side with the policy-side.

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Two numbers stand out from the tumultuous events that culminated in September’s Climate Summit in New York. The first was the 400,000 people who joined the Climate March through Manhattan, giving world leaders the political oxygen to move. And the second was the USD24trn in assets from investors across the world calling for comprehensive reforms to drive a prosperous and resilient low-carbon economy.
Indeed, the Summit was marked by a series of statements from investors, banks and insurers that blended pledges to upgrade their own internal practices with specific calls for policy and regulatory changes to grow the green bond market, boost the transparency of investor carbon performance, and introduce natural disaster stress tests across the financial system.
This increasingly intensive policy engagement around climate change is just one example of a more strategic effort by investors to reset the financial rules of the game so that they reward sustainable value creation. Leading funds and coalitions have been pursuing regulatory activism for many years, notably to improve corporate governance and disclosure. But in the wake of the financial crisis, the systemic nature of the policy challenge has become blindingly clear. Market failures are working against the interests of long-term investors, whether it is mispricing of carbon, misaligned incentives or market short-termism. Add to this the myriad bottlenecks that are preventing the innovation required to drive deliver a sustainable financial system, such as the under-funding of both R&D, barriers to entry that constrain innovation or an absence of robust standards for embryonic markets (such as green bonds). Accountability frameworks within the financial system still lag behind what is needed, not least in traditional corporate governance relationship between business and shareholders, but also in the stewardship duties between financial institutions and their ultimate beneficiaries, the world’s citizen savers.
It was against this backdrop that the United Nations Environment Programme UNEP) established its two-year Inquiry into the Design of a Sustainable Financial System at Davos in January 2014.The Inquiry’s aim is to identify policy options that would better align financial reform with long-term sustainable development – and its scope extends across banking, insurance, pensions and securities in the developing, emerging and post-industrial economies. The Inquiry is already finding a growing body of policy innovation to promote sustainability in financial markets – such as green credit guidelines in China, new pension rules in South Africa or stock exchange disclosure guidance in the USA. But this innovation is still embryonic and fragmented – and its full potential has yet to be realised. Our latest report summarises the state of play. (See PDF in “downloads” left-hand column)
Why should investors get involved in policy?
Responsible investors have long been focused on the challenge of integrating sustainability across their core investment and ownership strategies. Few – if indeed any – have completed the journey. There’s now recognition of the need to match this with action to shape the policy framework. According to the UN-supported Principles for Responsible Investment’s (PRI) 2014 member survey, just over 40% of respondents indicated that they had engaged in dialogue with policymakers or standard setters. Corporate engagement is both a responsibility and a necessity for long-term investors, but the sheer number of companies makes a comprehensive approach hard even with collaborative engagement. For broadly diversified, universal investors, policy engagement may well be as important – if not more – as the results will impact conditions across the marketplace.
This is the reason why the Inquiry is working on a number of levels to identify financial policy frameworks that reward long-term investing. Globally, for example, we’re partnering with the PRI to produce the first analysis of the why, what and how of policy engagement by investors to build a sustainable financial system. Three priority areas for engagement have been identified in the work so far. The first is the specific rules that are needed to enable ESG integration, such as corporate disclosure requirements, clarifications to fiduciary duty or changes to pensions law. The second is the fundamental regulations that govern key parts of the investment chain, such as derivatives or solvency rules, where the task is to

ensure that these enable rather than disable long-term investment strategies. The third is broader macro-economic issues, where responsible investors, as holders of the largest pools of capital, have to engage so that externalities such as rising inequality or carbon pollution do not impair long-term value. Alongside this, the Inquiry is partnering with the International Finance Corporation (IFC) and The Association for Sustainable and Responsible Investment in Asia (ASrIA) on a series of developing country consultations, including Colombia, Kenya and Indonesia. These will draw up practical roadmaps for mobilising institutional capital to underpin these countries’ green growth ambitions.
What is striking is how the design of long-term policy is becoming a part of the leadership agenda for major investors. In the USA, CalPERS has just approved its plans to engage in policy discussions around derivatives, housing finance, and credit rating agencies as part of its renewed focus on risk, governance, and transparency in the financial markets. These flow from CalPERS’ statement of investment beliefs which includes the recognition that “a long time investment horizon is a responsibility and an advantage” and provides the mandate for taking action to advocate “for public policies that promote fair, orderly and effectively regulated capital markets.” In Europe, Aviva’s CEO Mark Wilson has explicitly extended this focus on policy to sustainable development stating that: “In my view, there are a number of important global capital market problems that relate to sustainable development and are in need of correction by governments. We see the primary failure of the capital markets in relation to sustainable development as one of a misallocation of capital. One of the main sources of market inefficiency is the misaligned incentives that produce an excessively short-term view among many investors, analysts and brokers. I believe that the financial sector as a whole has a generational opportunity to build sustainable capital markets.”
Link to Aviva document regulators and central banks are also starting to recognize that dealing with sustainability challenges will require fresh thinking. At this year’s recent IMF and World Bank annual meetings, for example, Bank of England Governor Mark Carney highlighted how the threats to long-term prosperity and economic resilience from climate change manifest themselves outside of the traditional 1-2 year timeframe deployed by central banks. Short-termism is therefore something that is not just a problem for market participants. Overcoming this ‘tragedy of horizon’, to use Carney’s words, could therefore be a shared endeavour by long-term investors and financial market rule-makers.
Heading into 2015, there will be no shortage of critical policy decisions where responsible investors will need to collaborate and commit. At the international level, three stand out. The first is the G20 discussions on long-term finance to close the yawning infrastructure funding gap, and the need to ensure that these policies fully incorporate environmental, social and governance factors. The second is the launch of the new set of Sustainable Development Goals, where there is increasing focus on how to mobilise private capital alongside essential public finance. The third is the climate change negotiations, culminating in the Paris conference in December 2015, where the initial harvest of pledges made in New York will need to come to fruition. These three priorities are of course deeply intertwined. And one of the real contributions that investors can make is to show why a joined-up policy framework is so badly needed to avoid unintended consequences of regulatory change and deliver a truly efficient allocation of capital for the long-term interests of the world’s savers.

Nick Robins is Co-Director, UNEP Inquiry into the Design of a Sustainable Financial System.

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