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Financial reform is essential for tackling environmental problems. Moves in China, France and Bangladesh point to progress

Nick Robins and Simon Zadek

Thu 26 Jun 2014 17.06 BSTFirst published on Thu 26 Jun 2014 17.06 BST

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 For Christine Lagarde, the goal of the financial system is to ‘to put resources to productive use, to transform maturity, thereby contributing to the good of economic stability and full employment’. Photograph: Graham Turner for the Guardian

Hesitantly at first, but now gathering momentum, governments across the world have started to add a new suite of policy instruments to the sustainable development toolbox. Whether it’s green credit guidelines for banks in China, a revitalised definition of prudent investing in South Africa or non-financial disclosure requirements in Europe, the message is clear: reforming the financial system is a necessary part of the transition to a green and inclusive economy.

Six years on from the first tremors of the 2008 crisis, we are entering a new phase in financial reform. Collapse has been averted and stability strengthened – though signs of incipient housing bubbles show how hard it remains to replace the dynamics that fostered the credit crunch. Now the task is to rethink the rules that govern the financial system so that it’s ‘fit for purpose’.

What is that purpose? For Christine Lagarde, managing director of the International Monetary Fund, the answer is clear: “We can identify the true purpose of finance. It’s goal is to put resources to productive use, to transform maturity, thereby contributing to the good of economic stability and full employment – and ultimately, to the wellbeing of people, in other words to enrich society.” This emphasis on ultimate purpose was also underscored by Bank of England governor Mark Carney in his recent reaffirmation of the Bank’s mission (pdf) to “promote the good of the British people by maintaining monetary and financial stability.”

In our century defined by mounting resource stress, hazardous levels of local air and water pollution along with global climate disruption, these aspirational goals cannot be realised without factoring in the environmental and social dimensions.

Traditionally, financial policymakers and regulators left the promotion of the green and inclusive economy to their colleagues in other parts of government. But this is now changing, with growing recognition that the financial system suffers from an array of market failures – short-termism, misaligned incentives, inadequate transparency and ill-defined responsibilities – which entrench the allocation of capital towards resource and carbon intensive assets.

Unsustainability is increasingly appreciated as a potential driver of systemic risk, highlighted by Carbon Tracker’s work on unburnable carbon and stranded assets. In addition, there are concerns that some post-crisis regulations – such as Basel III for banking and Solvency 2 for insurance – could have unintended consequences for long-term financing, just as governments are trying to scale-up funding of green infrastructure.

This is not just a theoretical discussion – with a growing number of green financial policies starting to emerge across banking, insurance and investment. What is striking is that most of the action flows from the developing world – speaking to the urgency of the environmental crisis felt in these countries as well as to a regulatory culture that has long seen financial policy as having a developmental role.

In Bangladesh, the Central Bank has made it mandatory for the banks it regulates to introduce environmental risk management systems and is now actively monitoring implementation, including the volume of green finance. China’s Banking Regulatory Commission introduced its ‘green credit guidelines‘ in 2012 with the goal of encouraging banks to “increase the support to a green, low-carbon and recycling economy, fend off environmental and social risks, and improve their own environmental and social performance.” From 2010 to 2012, lending in China for energy efficiency and environmental protection more than tripled to RMB 3.58tn (UK £338bn).

The latest addition to this “green banking” trend came in April 2014, when the Central Bank of Brazil introduced a new resolution requiring the banks it regulates to implement environmental and social risk policies. By 2015, banks in Brazil must put in place the necessary governance structures so that environmental and social factors become a core component of overall risk management. South Africa has also been in the vanguard of updating its pension policy to make it clear to institutional investors that prudence now means incorporating critical environmental, social and governance factors.

It would be wrong to get the impression that nothing is taking place in the post-industrial world. France has paved the way with the world’s first strategy for ‘financing the ecological transition’ (pdf). This year’s agreement by the European Union to introduce corporate disclosure rules for sustainability was also striking in the way that it not only formed part of the EU’s overall post-crisis financial reform package, but also that its strongest supporters included investors arguing that without disclosure they could not make informed financial decisions. Long used to managing the risks of natural hazards, insurance policy is now being extended to climate change, with US states such as California leading the move to get insurers to report their exposure to climate risks and their strategies for resilience. And in the UK, the Prudential Regulatory Authority, part of the Bank of England, has accepted an invitation from the government to complete a climate change adaptation report. With a focus on insurance, the report will examine the impact of climate change on the PRA’s objectives and the role of insurance regulation in supporting adaptation to climate change.

These and many other examples could mark the beginning of a new era of green financial reform. If this is to take place, then a number of steps are needed. First, the scope of policy innovation must be broadened to embrace more countries with a more comprehensive approach to finance. Second, we need common principles to guide the integration of environmental and social factors into mainstream financial policy and regulation at both the national and international levels. And, third, a creative dynamic is needed between formal financial policy and cutting-edge standards flowing from civil society and from the market itself, such as the Principles for Responsible Investment and the Principles for Sustainable Insurance.

Bringing together financial reform with sustainable development is needed not just to confront the environmental and social fractures facing the global economy, but also to allow the financial system to fulfill its core purpose – serving the real economy in a sustainable and inclusive fashion.

Nick Robins and Simon Zadek are co-directors of UNEP Inquiry into the Design of a Sustainable Financial System. The UNEP Inquiry has just released an invitation to participate in its work.

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