The financial system is not operating sustainably and it often fails society. We need to realign the system with sustainable, equitable economies. As investors, we need to go beyond ESG integration to achieve a sustainable financial system. Investors have a central role to play.
The sustainable financial system (SFS) programme focuses on nine key risks and challenges that could undermine a sustainable financial system.
The near universally adopted modern portfolio theory (MPT) put forward by Nobel laureate Harry Markowitz in 1952 is blind to the effect of portfolio investment on the capital markets’ overall risk/return profile and on the macro systems upon which the market relies for stability.
Long-term social issues – the ‘S’ in ESG – matter for investors. They are key factors determining both long-term GDP growth and the level of equilibrium of interest rates.
Within the space of six years, finance technology – fintech – has gone from a technology that skirted the edges of the investment sphere to receiving billing at this year’s G20 summit where the world’s industrial leaders described its impact as something akin to a new industrial revolution.
On 7 March 2018, the European Commission released an action plan for financing sustainable growth. The plan is a response to recommendations from the High-Level Expert Group (HLEG) on Sustainable Finance, which were submitted to the Commission on 31 January 2018.
Most consultants and their asset owner clients are failing to consider ESG issues in investment practice – despite growing evidence of the financial materiality of ESG issues to portfolio value.
ESG considerations seen as niche service offerings, often entailing extra costs, and only to be provided when explicitly requested by asset owner clients.
Relationships between asset owners and investment consultants have a major influence on whether and how investment consultants take account of ESG issues in the advice that they provide.
Market structure issues are compounded by consulting practices and processes.
Policy and regulatory issues influence the relationships between asset owners and their investment consultants.
Our central conclusion is that investment consultants are unlikely to take action on ESG issues without stronger incentives to do so from their asset owner clients.