Why sustainability is crucial to risk management
Policymakers and financiers seeking to bring equilibrium back to the markets should heed the thinking of financial sustainability advocates, a new report says.
Post-financial crisis efforts to shield the economy from volatility must be extended to include emerging sources of instability in the environmental, social, and governance realms if markets are to achieve robust growth and create wealth for all, according to Lenses and Clocks: Financial stability and systemic risks, a joint report released Monday by the UNEP Finance Initiative, the International Institute for Sustainable Development, and the Blended Capital Group.
"You cannot have a stable financial system that accounts for classical economic considerations while ignoring climate change, resource depletion, ecosystems destruction and other new and emerging risk," said Paul Clements-Hunt, report co-author and founder of The Blended Capital Group.
The imperative of detecting long-term financial risks -- a lesson of the recent financial crisis -- requires a heightened perception for unconventional, long-term risk which can be informed by the better lenses and more clocks that the sustainable finance grid of analysis provides, the report says.
Such long-term but steadily growing risks include climate change, resource depletion, social upheaval, and other risks stemming from environmental, social, and governance phenomena -- all of which are seldom identified and assessed by financial analysts, and therefore too rarely managed by financial institutions.
"Understanding these threats will inform the choices we make to benefit from the opportunities ahead of us and, in doing so, improve life of billions of our fellow human beings, rebuild the planet's natural capital and foster markets based on fairness and equality," said former British Prime Minister Gordon Brown, whose recent counsel on financial stability and sustainability to the UN Secretary General's High Level Panel on Global Sustainability informed the report.
"This study will catalyze a new conversation about the role of finance and investment as a force for good in society and will build on the hard lessons of the recent past," he added.
The report identifies six priority areas that have been in the sights of regulators and drawn the attention of responsible financiers in recent years, but remain a destabilizing threat to markets because the scrutiny of regulators has thus far failed to go beyond a conventional risk analysis. These are: over-the-counter trading, fiduciary responsibility, stock exchange listing requirements, banking risks, rating agencies, and insurance solvency supervision.
The report suggests that a more holistic risk analysis in these key areas of finance can be achieved, and brings into light regulatory initiatives that have had a pioneering role in pushing this debate forward.
"Markets have shown they have the capacity to bring growth and development that benefits hundreds of millions of people. However, the experiences of the past two decades show us that heightened volatility and systemic instability are linked to so-called advances in modern finance and capital markets where the real nature of risk is obscured or hidden," said Clements-Hunt.
"Essentially, we believe financial policymakers need to take a broader range of risks into account as they re-engineer the system and push for a more stable architecture that secures robust, inclusive and balanced growth that delivers for more people around the world," he added.
The report articulates a final set of recommendations to the international community:
Proposition 1: Build a deeper understanding of how policy-makers, market regulators and international financing institutions can support the growth and mainstreaming of responsible investment and inclusive finance approaches. Examine, identify, assess and replicate how innovative approaches can be scaled and accelerated to have a direct impact on meeting basic needs and supporting sustainability.
Proposition 2: Establish a monitoring body that ensures our global financial architecture is managed on sustainable fiduciary principles. The initiative will identify where there are flaws in the architecture, and advocate solutions.
Proposition 3: Investigate why long-term pension investment has not resulted in a financial system that more obviously serves the interests of savers and supports global sustainability.
Proposition 4: Build on the work of the Integrated Reporting Committee and others to promote transparency in the operations of financial and commercial organizations. This should include ensuring the principles upon which reports are based are sound and sustainable, and that those who provide such information are independent and that it is properly reported.
This article originally appeared in Globe-Net. It has been reprinted with permission.