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New report finds “quiet revolution” in sustainable development finance

The United Nations Environmental Program (UNEP) recently launched the report of its Financial Inquiry into the Design of a Sustainable Financial System (“the Report”), established in early 2014 to explore how to align the financial system with sustainable development, with a focus on environmental aspects.

UNEP’s Financial Inquiry set out to respond three questions: 1) under what circumstances should measures be taken to ensure that the financial system takes fuller account of sustainable development?, 2) what measures have been and might be more widely deployed to better align the financial system with sustainable development? and 3) how can such measures best be deployed?

The report relied on practical examples of policy changes in banking, capital markets, insurance and institutional investment, drawing on detailed work in countries such as Bangladesh, Brazil, China, Colombia, France, India, Indonesia, Kenya, South Africa, the UK and the USA. It also relied on a number of papers it commissioned as background and a series of consultations.

There is a lot to welcome in the document that crowns this impressive exercise, starting with its systematic ambition. Head-on it stated that “Developing a sustainable financial system will only be achieved by going beyond both business-as-usual approaches to financial market development, and the adoption of ad hoc innovations.” In fact, a hunger to go beyond the easy fixes that conveniently fit a profit motive without forcefully demanding change and an attempt to reach for systemic solutions is a recurring thought in the document.

The Report adequately described the contradictions of the current moment as one in which “Public awareness and political engagement in pursuing sustainable development goals has never been greater” while the context of this progress is “one of an accelerating environmental deterioration, causing considerable human harm, threatening development models, and damaging vital life support systems.”

It sounded warning about the implications of financial short termism: “Sustainable development requires a long-term view in order to deliver fairness between generations. Short-termism exacerbates the tendency to discount the importance of future generations in today’s decision-making: an increasing challenge given the irreversible nature of many environmental challenges.” At the same time it avoided making the mistake of equating long term investment horizon with sustainable development: “Sustainable development is not the same as having a long-term time horizon, as there are many immediate social and environmental externalities that need to be addressed.”

One of the most useful methodological contributions of the Report might be its categorization the instruments for aligning the financial system with sustainable development. In undertaking the (admittedly monumental) task of assessing the contribution of the financial system to sustainable development, the Report started with a rather simple premise: “Financing sustainable development will require capital flows to be redirected towards critical priorities and away from polluting and unsustainable, natural resource intensive activities.” It then grouped tools to do so into five approaches, depending on whether they enhance market practice, harness the public balance sheet, direct finance through policy, encourage culture change or upgrade governance.

While doing so, it stated that the last one, upgrading the architecture of the financial system so it enables sustainable development, is the most underdeveloped one. It also placed this last approach on a higher level than the others, recognizing that the right governance architecture is a necessary underpinning for all the other approaches to work.

Within this section, the Report should be praised for not shying away from visiting the role of Central Banks. It examined the way in which Central Bank mandates have been stretched (more in developing than in developed countries, the Report says) to fit sustainability goals. But it did more than that by discussing the potential roles of Central Banks in encouraging sustainable finance through three functions, thus validating approaches that the economic orthodoxy normally resists: monetary policy, role as prudential authorities and regulators and performance of monetary policy operations.

On the minus side, it is a pity that in spite of its systematic ambition, the Report had to leave out of its purview some important sources of financing sustainable development such as illicit financial flows or direct investment. The omission, which the Report openly admits, risks opening room for questions about its conclusions, such as, for instance, “how validly can it address private finance needs without an accurate picture of the public finance that should be available?” or “how can it credibly discuss rules and regulations for the sector without considering the obstacles hardwired in the leafy set of requirements embedded in hard investment rules or indeclinable loan conditionalities?” Of course, the omission might have been a worthy sacrifice in order to make the result manageable and less unwieldy reading.

A perhaps less justifiable omission is that of human rights. The report mentions human rights as one of the topics it carried research on and includes contributions – in particular a forthcoming one by Wachenfeld, Aizawa and Dowell-Jones – among its background material. But rights have to be read by implication in the notion of sustainable development, and are never explicitly addressed, let alone integrated in an organic manner in the conceptual framework.

The Report recognizes this early on: while the Inquiry’s mandate concerns sustainable development, its principal focus has been on the environmental dimension of sustainable development, examining the ways in which financial policy and regulations can contribute to reduced pollution, improved natural resource stewardship and action on climate change.”

But how much of an excuse, or even an acceptable methodological shortcut, can that be at this point of the 21st century? As stated by the CSO Reflection Group on Global Development Perspectives in its landmark report on the subject a few years back: “The international community must deepen the understanding of sustainable development in all its dimensions. . . A paradigm shift suggests the need to surpass non-comprehensive and short-term strategies and take steps towards building equitable, inclusive societies that are committed to the welfare of the population and are based on human rights.”

A third weakness in the Report is that it suffers, at points, of some naiveté. It speaks of a “quiet revolution” taking place in which “concepts such as natural wealth and the circular, green economy have moved from the margins to become the substance of economic strategies and policies for businesses and nations.” In doing so, it likely overstates the “revolution” and understates the “quietness” of it.

This perception of a quiet revolution seems buttressed by references taken at face value of what the private sector and other duty-bearers claim to be sustainable or “green.” Indeed, the number of banks and other financial entities that claim to uphold sustainability or responsibility principles in their investments has undoubtedly grown. But few (in the US the precise number is zero) of these are supported by third party-validated certifications or monitoring exercises, which essentially forces outsiders to believe the company’s own word and assessment of how well they are doing. As put by the Minister of Financial Markets of Sweden: “The business of sustainable investments is of course a matter of trust, as is the case when shopping for organic groceries. When it comes to organic produce, a third party gives the product its seal of approval, which indicates a specific level of sustainable ambition from the producers. This can then be matched to our own preferences as consumers when it comes to sustainability. In the world of sustainable investing, however, an informed choice requires careful due diligence which only a few investment professionals are capable of.”

At another point, the Report essentially endorses, without any qualification or balancing opinion, reinsurance company SwissRe’s demand for: “A tradable asset class . . . to enable insurers and other investors to easily access sustainable infrastructure investments.” Indeed, the reference resonates with the proposals that the Business 20 and World Economic Forum have been promoting especially in the Group of 20. Substantial analyses of these controversial proposals, however, have shown the risks they pose of skewing the balance of rights in favor of investors and at the expense of communities and citizens that are supposed to benefit from such infrastructure.

It is likely that this third weakness of the Report could be, at least partially, attributed to the second one. Indeed, a human rights framework, with its focus on the empowerment of those who are disempowered, accountability of duty-bearers and participation of right-holders, would have inevitably led to ask the questions of who is winning and who is losing from the adoption of concepts such as “natural wealth” or “green economy.”

While such questions ended up being sidelined, the Report was not entirely oblivious to such challenges. In fact, at the end it stated that “many aspects of the linkages between the financial system and sustainable development remain underexplored.” One should also appreciate its candid admission that even in its assessment of impacts of potential interventions the information available is very incomplete. And in its leadership attempting to do so in spite of limitations, the Financial Inquiry has produced a framework that even human rights practitioners are bound to find useful for their own analysis and action.


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August 2018
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