Following our consultation - – we identified nine priority conditions that need to be addressed to transform the financial system:
The emphasis on short-term investment objectives in assessing investment performance, results in less attention on long term risks and value creation opportunities in investment decision-making. Accountability, remuneration and incentive structures focussed on short-term objectives, for example, lead to short-term objectives and thinking being cascaded throughout the investment system.
Framing beneficiary interests solely in financial returns fails to properly account for social, environmental and ethical considerations. This can result in a system that is unable to engage with or respond to beneficiary interests, or the needs and interests of a sustainable economy and long-term future financial value.
Policies that do not address market norms and practices, or provide conflicting signals to markets, can be ineffective. Policy outcomes may not be achieved within the timeframes required, capital may not flow at the scale or the rate required, investors may not use their influence to encourage companies and other actors to take action, and the problems that policy interventions were intended to address may continue to persist.
When political pressure leads policy makers to prioritise the interests of firms over the interests of the public, ensuing regulation will not properly value public goods or adequately price externalities. This creates information asymmetries in markets affecting capital flows by incentivising activities that are harmful to the long-term health of society and the environment.
The business models of market actors such as brokers, rating agencies and consultants often focus on short-term financial performance and downplay the importance of long-term value creation and ESG issues, amplifying the negative impacts of the other underlying conditions.
Principal-agent problems can mean that the views of asset owners are not properly communicated to companies or to other investment actors. They can exacerbate short-term pressures, introduce significant transaction costs for monitoring and oversight, lead to inadequate focus on ESG issues and sustainability impacts, and incentivise behaviour at odds with the goals of a sustainable financial system.
A financialised system is one in which the primary emphasis is on issues that can be captured or measured in financial terms, and where issues that are less easily financially quantified receive less attention. Financialisation results in the financial system paying less attention to considerations such as the value of a clean environment, decent work or economic health.
Market and regulatory failures, such as inadequate valuation of public goods or pricing of externalities, can distort incentives. They can mean that investors are incentivised to invest in areas that are harmful or exploitative rather than beneficial to the long-term health of society or the environment.
The way investor beliefs and values are expressed and delegated through the investment chain can signal to the investment market whether sustainability is a priority for asset owners. This includes how processes, practices, capacities and competencies that flow from these beliefs set a framework for the priorities and outcomes of investment activity.
We focus on effecting change through the investment value chain which includes:
- Beneficiaries (e.g. savers, insurance policy holders)
- Asset owners (e.g. pension funds, (re)insurers)
- Investment managers, advisors and service providers (e.g. investment consultants, rating agencies, investment banks)
- Companies and issuers, securities exchanges, and related regulators/regulations
For further information about our 2016 sustainable financial system consultation and our framework to support it, please see the Sustainable Financial System, Principles, Impact - supplementary report.
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Nine priority conditions for a sustainable financial system