Sustainability has become a buzz word in the financial sector. But it is not only a word. Sustainable is reshaping business models, generating new products and services, affects recruitment, remuneration and management structures. So this is a genuine and far-reaching change.
There are two main reasons why this is happening now.
First: The financial crisis in 2007-08 triggered a deep recession in many countries. Unemployment soared, first in manufacturing, then in the public sector as states cut spending to tackle budget deficits. Income inequality increased. And the financial sector – in particular American investment banks – was seen as the culprit. That label is visible in politics, media – even in popular culture; “The Big Short”, “The Wolf of Wall Street”. The main movie villain these days is the banker…
Secondly: New temperature records show that the planet is heating up. As a result, politicians and decision makers have scrambled to make statements, declarations and agreements which taken together will have a profound impact on the financial sector. In Paris last year, a record number of leaders took a decision to stop global warming, and their agreement has since been ratified by the EU, the US, China, India and scores of other countries.
Both these factors are of great importance. Public and media distrust means the financial sector has to work hard to regain confidence. Many banks need to improve governance, tighten codes of conduct, make remuneration less short-sighted etc. Global warming and political decisions to curb temperature will likewise drive changes in lending, investing and new products.
The investments needed on a global scale to transform the energy sector – from fossil fuels to renewables – are huge. At the same time, hundreds of millions of peasants in India, China and other populous emerging economies are moving from the countryside into the cities – creating need for housing, infrastructure, waste management, fresh water etc. The investments undertaken for this urbanisation will create a capital stock which will be with us for decades. This necessitates that investments are made with a long-term, sustainable view. And then, of course, there is the need for reforestation, cleaning up toxic rivers and remediation of environmentally damaged land.
Thus, the need for investment in “green” energy and infrastructure runs into trillions of dollars, world-wide. There is no way the public sector can scrape together such sums. They will have to be furnished by the private sector and be allocated by banks and other financial institutions, via bank lending and through the capital market.
Consequently, sustainable banking has climbed high on the agenda. The G20 now have Green finance as one of their top priorities. The G7 countries have stated they will not extract all fossil minerals in the ground. This has lead Mark Carney, Governor of Bank of England, to warn that failure to assess such “stranded assets” correctly could cause a systemic crisis in global finance.
Scores of manufacturing companies are now investing in energy efficiency and moving out of fossil fuels. As they do this, it is obvious that also the financial sector must become more responsible and more sustainable. Not only because of external pressure – the need to transform energy and infrastructure – but also because even bankers are human beings, who want to work in companies that we are proud of.
As a result, we see more and more banks reshaping their business models, becoming more long-term, launching new “green” products and services, monitoring and reporting their actions in a transparent way. Sure, some of it may be “greenwashing”, but I am sure most banks are serious about their commitment.
The term “sustainability” is very broad and includes several different aspects of banking. The most common terminology speaks about three dimensions: Environmental, Social and Governance, or ESG in our lingo. Environmental is obvious: reduce your own emissions, but also make sure your core business – lending, investing etc – contribute to improved environmental conditions. Governance is equally obvious: be transparent, long-term and responsible, compliant with regulations, laws and mores. For banks, consultants and law firms, one conclusion is that tax advice to clients must be made for business reasons; that advice which is given solely to evade taxes is not acceptable.
Social commitment may mean many different things, depending on what kind of business you run and in what environment. But health and competence of the employees is of course crucial, as well as initiatives to support the social structure in the company’s neighbourhood: local sports teams, initiatives to fight drugs among youngsters, support to local entrepreneurs etc. In emerging markets, social commitment often means support to local schools, improving sanitation and building water closets, as well as decent working conditions, gender equality and a form No to child labour.
The point is that sustainability includes many actions and strategies, in all parts of business. The new “Sustainable Development Goals” of the UN can be seen as a global strategy for sustainable growth and eradication of poverty. All companies, in all sectors, will eventually have to align their actions to this global standard.
Gradually, the task is evolving, from creating a “strategy for sustainability” to building a “sustainable strategy” for the business as a whole. The difference may sound esoteric, but actually, it is of great importance. Sustainability is no longer an external restriction, it is part of core business. Actually, in the long run, it ought to be so natural, so self-evident, that we cease talking about “sustainability” as such, since it’s such a no-brainer that it is part of core business.
So what does sustainability look like in practice? Let me give you a few concrete examples from my own bank, SEB. SEB is the only Nordic bank included in Dow Jones Sustainability Index, and we have pursued this challenge for several years. We do it both to make a positive impact and because we believe it will have a positive long-term impact on our bottom line. We still have many improvements to make, but here is a little sample of what we do:
We support young and local entrepreneurs, from the very first attempts to create business cases in high school and on to leading rapidly-growing companies. We actively try to influence them to write sustainable business plans, we arrange competitions and award prizes. In this way we nudge young entrepreneurs – while gaining new corporate clients.
SEB invests in micro funds to promote small-scale entrepreneurship in emerging markets. This is a way to gain yield from an alternative asset class while at the same time supporting literally thousands of aspiring entrepreneurs and thereby stimulate growth and transformation in poor societies.
Our Investment management not only excludes a number of non-sustainable companies and sectors from being part of our funds, but also actively seeks to include companies and sectors which have a positive impact. This selection is increasingly taking place via computer algorithms which, so far, have managed to both increase yield and improve environmental impact.
SEB is one of the founding fathers of the Green bond, which makes it possible to fund environmentally sound projects via the capital market. The market for green bonds is still small, compared to the total global bond market, but it is growing rapidly and will continue to do so, now that both China and India face huge investments in urbanisation, infrastructure and renewable energy.
SEB International Private Banking is, driven by client demand as well as desire from their employees, developing a framework for how to discuss and advice clients on sustainable investments and Impact investing. They have also developed sustainable or impact portfolios with a multi-asset approach. For them, the key is to align investments with the customers’ own values.
While the palette of green products and services have been expanding – and will continue to do so – there are several challenges ahead.
As regards green bonds, the likely rapid growth of the markets also entails a risk of green-wash. Several projects may want to dress up in green and call their funding green, even if that is not correct. Therefore, emissions of green bonds should take place within a more distinct framework, where “green” is defined, vetted by second opinions and monitored in a transparent way.
For a bank, deposits, credits and lending make up the bread and butter of business. Here, we see clear changes coming. Financial regulators are starting to demand measurements of the impact – environmental and social – of credit portfolios. At the same time, depositors, both private clients and institutions, want to make sure their deposits are not used in an unsustainable way, like financing investments in coal mining or nuclear weapons.
All this means that banks and other financial institutions must put great efforts into measuring and monitoring their credits and fund management – just about all activities. Previously, we have been good at financial analysis. Now we must become good also at analysing the financial effects of climate change, regulatory change, environmental policy and technical change.
In one sense, this is what we always have done when new sectors and raid technical change has created new business and driven “creative destruction”, as Joseph Schumpeter called it. But now we need to hone those skills in a new setting, as external pressures, employees, media, technical change all entail a need for rapidly increasing knowledge about environment, climate change, energy and human rights.
Those banks who are able to meet this challenge will come out winners. The rest are losers.