A high-level inquiry into how to make the global financial system more sustainable has identified three broad areas in which institutional investment could be directed to “close the gap” to sustainable development.
The three broad policy areas are identified as capital allocation, investor governance and market incentives in the latest progress report of the United Nations Environment Programme’s Inquiry: Design of a Sustainable Financial System.
The review was launched in January last year and will present its final report – with policy options – in October this year.
But, according to its latest update (“Pathways to Scale”), policy around capital allocation needs to be reformed to help build a pipeline of institutional investment in long-term infrastructure. These could include standardizing financial instruments and developing the project bond market. Another approach is what’s termed ‘Evergreen Direct Investment’, which enables large, perpetual investors to invest through a structure similar to private real estate partnerships. And capital standards such as Solvency II could need to be adjusted as well.
The second policy area is referred to as ‘Investor Governance’ and argues that the rules that govern institutional investors—such as fiduciary duty, stewardship, risk management and accountability— “still do not effectively incorporate long-term environmental and social related risks”.
So the report suggests a range of other mechanisms to align investment practice with long-term sustainability such as greater transparency of funds to their savers and wider society, for example through the publication of portfolio carbon footprints, both through “voluntary action and regulatory requirement”.
Moving to market incentives, the report notes that many current benchmarks, metrics and incentives along theinvestment chain fail to reward sustainable value creation; efforts to promote long-term mandates are being “held back by institutional inertia”.
The suggestion is for “coordinated policy intervention” to ensure that fund manager remuneration is based on long-term performance, that investment bank research discloses the sustainability factors considered by the analyst, and that investment consultants’ fee structures are aligned with the long-term performance of the funds they advise.
The report also reckons the ‘green bond’ market could be helped to grow to $1trn by 2020 with more work on market principles/standards, issuance by cities, development banks and others and aggregation, securitization and covered bonds. Also suggested are guarantees to improve risk-return profiles, credit enhancement and “fiscal subsidies” to incentivize investors.
Central banks have a role, it is suggested too, as their monetary decisions and balance sheet policies, “could also have potential for marrying stability and sustainability”.
The next steps for the Inquiry are a final round of meetings and further thematic and sectoral research on issues such as credit ratings, environmental stress testing, fiscal policy, human rights, insurance, institutional investment and social banking.
The Inquiry, which is headed up by Nick Robins and Simon Zadek, has a high-level Advisory Council including figures such as David Pitt-Watson, the former Hermes chief who co-chairs the UN Environment Programme Finance Initiative, Anne Stausboll, CEO at the California Public Employees Retirement System (CalPERS), the largest US pension fund, and Nicky Newton-King, head of the Johannesburg Stock Exchange. Link to UNEP’s Publications Page.