BUS604: Innovation and Sustainability

Global finance is a highly-regulated industry. Banks, insurance firms, stock exchanges, asset managers, public pensions, and other institutional participants are regulated by national and supra-national entities ranging from Central Banks to dedicated financial regulators. If many financial market participants are to significantly alter their practices and align themselves with sustainable development, financial regulation must first permit them to make these changes. 

Since the 2008 crisis, regulators have revamped a wide range of banking, insurance, and investment rules to enhance stability and reduce the risks of excessive leverage and complexity. Resulting measures include Dodd-Frank in the US, Solvency II in the EU, and Basel III's global standards on bank capital adequacy, stress testing, and liquidity risk. 

Though all well-intentioned, some aspects of these reforms are having unintended negative consequences for sustainable development. Basel III will impact the availability of bank lending to long-term projects, such as infrastructure, by raising capital charges for such loans. The impact of the insurance regulation Solvency II on European institutional investors is similarly significant: one estimate suggests that insurers who invest in large-scale wind-farm assets in Europe need to reserve US$12 million of equity capital for every US$100 million invested, while the reserve requirements for an equivalent investment in Canada is only US$3 million.

There are some indications that regulatory bodies are considering proposals even more damaging to prospects for the Global Goals. Business leaders who are serious about the transition to a sustainable economy can help push financial regulation in the right direction by showing how a sustainable approach fits with the goals of postcrisis regulatory policy. More sustainable regulations would reduce systemic risk. By enabling the right type of long-term investment, they will contribute to growth boosting, much needed infrastructure, and provide better returns for individual investors in a low-yield environment at the same time. In particular, global rulesetting bodies, like the Bank of International Settlements, International Monetary Fund, International Accounting Standards Board, and the International Organisation of Securities Commissions, need to test thoroughly the impact of any proposed standards and mandates (which are likely to be relatively short-lived) on achieving the longer-term Global Goals and the global climate target of remaining below two degrees of warming. 

Regulators should consider whether their actions are unnecessarily constraining businesses and finance providers that would otherwise be doing more for the Global Goals. The G20 and Financial Stability Board (FSB) should consider inserting the principle of sustainability into their regulators' mandates. More specific remedies could include: Global Goals-related Risk Reduction, which would refine the Basel rules on determining risk weighting to take into account the contribution of a bank's financing to the Global Goals; improving pension and insurance regulations to enable institutional investors to invest more in emerging market infrastructure; improving regulations to enable bond issuance and investment for long-term, sustainable finance for various sectors; and stronger certification and ESG standards for green bonds and climate bonds.

Another essential job is to build on the work of the Financial Stability Board's (FSB's) Task Force on Climate-related Financial Disclosures (TCFD). Under Michael Bloomberg's chairmanship, the TCFD is developing voluntary, standardized climate-related financial risk disclosures for companies to use when providing information to investors, lenders, and insurers. It will be the role of business leaders, along with civil society, to ensure that take-up of the recommendations is universal. The task force has a particular focus on the physical, liability, and transition risks associated with climate change. We believe that the next challenge could be for the FSB to extend this approach to other areas relevant to achieving the Global Goals, starting with broader environmental issues, like water and land use, and moving on to social issues. 

At the national level, meanwhile, business leaders can help push countries to develop national sustainable finance roadmaps. The UNEP Inquiry into the Design of a Sustainable Financial System has done excellent work in partnership with national governments and regulators in a series of countries including Indonesia, China, and the United States. These roadmaps include articulating how the regulation of financial actors – banks, insurance companies, institutional investors, and capital markets – needs to evolve so as to support sustainable development, promoting not only sustainable infrastructure investment but also financial inclusion, SME financing, and more. 

Box 10: Innovations in finance that can speed progress on the Global Goals

Some of these ideas have been in the market longer than others, but all can directly support the Global Goals for Sustainable Development. 

Development impact bonds (DIBs) enable private investors to provide upfront funding for development programmes, with international aid donors or country governments making the repayments and an additional coupon if evidence shows that programmes achieve pre-agreed outcomes. In Swaziland, for example, aid donors are exploring using a DIB to fund a new approach to antiretroviral treatment for HIV and TB – allowing them to share risks with private investors while also gaining from the private sector's skills in complex coordination and performance management.

Green bonds are conventional bonds, issued by corporations, cities, commercial banks, development banks, or national governments, whose proceeds are earmarked for projects with climate or other environmental benefits. The first "labeled" green bond was issued by the European Investment Bank in 2007. By 2015, US$42 billion of green bonds were issued. Estimates suggest that up to US$100 billion of green bonds could be issued by the end of 2016. There are still concerns about the lack of a consistent definition for what makes a bond "green"; pressures for standardization and independent verification are growing. The faster one set of common market standards and practices emerges, the faster green bonds will become both more liquid and also more efficiently priced. This is essential if green bonds are to scale; today they account for significantly less than 0.5 percent of the total bond market.

Crowdfunding platforms use the internet's capacity to reduce transaction costs as a way to enable large numbers of people to invest small amounts of money (primarily through debt, but increasingly through equity as well). The website Kiva, for example, has matched 1.6 million lenders to 2.2 million borrowers since its launch in 2005, with a total of US$949 million lent via the site.

New insurance mechanisms are creating powerful new ways of building resilience among some of the world's poorest people and countries. These are the least likely to hold insurance, with 70 percent of global economic losses resulting from uninsured risks. In the Caribbean, for example, where flood and tropical storm damage has caused over US$5 billion of damage in the last 30 years, new weather index based insurance products are providing cover to low-income people and lending institutions exposed to climate losses to help them manage the risks of more frequent and severe extreme weather events.

Blockchain or mutually distributed ledger systems are creating new ways of keeping records securely and across multiple locations. All users "hold" the ledger in a distributed fashion, transforming the role of "trusted" third parties. Already, the technology is being used for applications as diverse as land ownership registries, individual identity records, and custody of natural assets like fish or forestry products.