Positive Finance

A Toolkit for Responsible Transformation

Hervé Guez, Philippe Zaouati

• Publisher: Routledge
• Year: 2017
• Print ISBN: 9781783535163
• eBook ISBN: 9781351284028
• Topic: Business
• Subtopic: Business General
• Index: Business

For some, finance is the enemy: solely responsible for the global financial crisis and symbolic of an outdated model that is catapulting us toward social and ecological ruin. Such a view can seem tempting. The 2007-2008 meltdown of the financial system was intimately bound to the financialization of the economy and its consequences. However, in reality the crisis in finance is an indicator that our economic model is obsolete. It is possible to imagine another way, which would consist of seeing finance as a "toolkit" for building a solution to the crisis.Positive Finance presents a way to transform the economic model and reduce the ever-widening gulf of inequality, while taking into account environmental constraints. In order to achieve this, the authors argue that we must re-envision the allocation of capital in order to support social and technological innovations, to design and build sustainable infrastructure, and to finance the energy transition.

Reinvented, finance could become a powerful lever for setting these transformations in motion. This book is dedicated to proving that such leverage is within reach: here, the authors present a toolkit for putting money to work in the general interest.

1
Introduction

For some, finance is “the enemy,” the sole culprit of our latest economic crisis, and the manifestation of an obsolete model that has placed us on a collision course with social and environmental calamity. Such a view is understandable. The consequences of an ongoing “financialization” of the economy are tightly bound to the financial system’s meltdown in 2007 and 2008—especially the excessive risk-taking promoted by the banking sector’s compensation model and a corresponding broadening of the income gap to new proportions. This reached a paroxysm with the sub-prime mortgage crisis, aka: how to burden your clients with crippling debt while assuming zero risk. Public authorities all over the world have responded to the problem with an unprecedented avalanche of regulatory measures. These have included: attempts (rapidly abandoned) to segregate banks’ proprietary trading activities; increased treasury and liquidity requirements for financial institutions and similar regulations for insurance companies; and tighter regulation of the derivatives market and constraints on compensation. However, the effectiveness of these efforts is called into doubt by a number of factors, not least among them a well-mounted and vigorous defense on the part of the financial sector. This is reinforced by the fact that the excesses of the financial system are merely symptomatic of an outdated economic model. Finance professionals simply adhered to a time-honored economic dogma, behaving like perfect Homo economicus.

That said, what is to be done? Should we be trading in our current model for that of the “positive economy” and injecting a heavy dose of altruism into our mechanisms of exchange, as was suggested by the focus group chaired by French economist and author Jacques Attali, founding president of the European Bank for Reconstruction and Development and former presidential advisor?¹ Of course, absolutely! Such a course involves a profound shift that is both essential and hopeful in nature. And, while resistance to change remains strong, the urgency of our situation forbids us from yielding to such pressures. Yet there is perhaps another, more humble, way forward—a complementary rather than alternative path: treating the financial realm itself as a “toolkit” able to provide a solution to the crisis. After all, transforming the economic model and bridging the ever-widening chasm of inequality—while respecting environmental constraints—is likely to prove tremendously expensive. In order to support social and technological innovations, to build new, more sustainable infrastructure and to finance the energy transition, we need to rethink how capital is allocated. We need to deploy savings to satisfy the needs of a positive economy. Reimagined, finance could become a powerful instrument at the service of this transition.

Of course, thinking of finance as a solution, as a tool for building a positive economy, does involve a certain overhaul, and, perhaps, a bit of renunciation. For one thing, Homo economicus will have to go, as will the notion that financial markets always arrive at a fair price. We will then have to adjust to the reality that finance must take into account the general good. Finance is by no means an “objective” tool; it can be positive, or positively harmful, depending on how it is employed. When we make use of a financial mechanism, we need to ask ourselves to what end we are doing so. Finance can no longer justify its existence by pointing to services of which it is the primary beneficiary. Getting back to basics, the function of financial operations ought and must be to aggregate capital and invest it: in other words, to direct capital towards companies or projects. One has to admit that the markets, especially stock markets, are doing a poor job of fulfilling this role. But, if capital should be collected, then from whom? Invested in what and to what end? It is no longer possible for us to delegate these crucial decisions to the market’s invisible hand.

The new paradigm we propose is one in which finance is concerned with the general good, which it furthers by investing savings in projects that offer added social and environmental value. However, because it involves future generations, added value from these endeavors can only be defined and measured over the medium and long term. Finance must return to the long view so as to be in sync with our social and environmental concerns.

Just how are we to shift the horizon and make positive finance the cornerstone of a truly positive economy, rather than an errant chip off the block of capitalist activity or merely a form of whitewash? Let us be clear: a positive economy is not the same thing as the real economy, a term often thrown around, but frequently signifying little more than the pursuit of business as usual. Talking about the real economy is no solution by itself: the economy will have to change in order to become sustainable and positive.

We invest in the world we create; the converse is also true. As a result, the way savings are handled plays a crucial role in the transformation of finance and of the economy. Let’s look at why.

Since 2006, more than 1,300 financial institutions, asset managers, pension funds, institutional investors, consultants, and ratings agencies have signed the United Nations “Principles for Responsible Investment” (PRI). In doing so, they have committed to investing in structures and projects that respect the environment, social issues, and rules of good governance. Among them, these 1,300 or so entities manage very considerable sums; if they were to genuinely respect their engagements, their collective strength would be enormous. But, despite very encouraging numbers,² Socially Responsible Investing (SRI) remains a niche market at the periphery of the financial world, like an exception that serves to confirm the general rule. Actors in the world of finance alternate between extreme caution, often the watchword of large investors, who are risk-averse, and more adventurous approaches, which are confined to specialized units with limited impact. This explains to a great extent why SRI has often been dismissed as greenwashing.

The general apathy toward Responsible Investment is partially due to incomprehension on the part of the public from whom savings are drawn. SRI is too sketchy a concept for the moment. What is all this for, individual investors ask? How can one even measure the social or environmental impact of this kind of investment? Does SRI actually influence the actions and behavior of corporations? To answer these questions, a group of French asset management professionals ventured to formulate a concise definition in 2013. Aimed at the wider public, this definition does something new by emphasizing the goals of SRI, focusing on “why” instead of “how.” The definition thus explains that SRI funds invest in “companies which contribute to sustainable development.” That sounds perfectly straightforward; however, practically speaking, what does it mean? There are several ways in which companies can contribute to sustainable development. They can mitigate their social and environmental risks by addressing the general interest through robust Corporate Social Responsibility (CSR); however, they can also offer innovations, develop energy-saving products and create new services that improve the world we live in.

Thus, a responsible investor is attentive to the quality of CSR policies and committed to being a responsible shareholder: for instance, by voting at general meetings and engaging in dialogue with company management. But such investors need to be granted more power. Management of publicly traded corporations is controlled by shareholders according to complex mechanisms designed to align the interests of these two groups. This arrangement has a marked tendency to promote a focus on shareholder return, if necessary at the expense of any and all social or environmental concerns. It is high time we restored the executive role of caring for the corporation as such, which means all of its many stakeholders: its shareholders certainly, but also its employees, clients, creditors, and its environment. How can this be done? In part by restructuring shareholders’ rights to accord greater weight, in terms of dividends and voting rights, to shareholders who maintain their presence for an extended period, who are thus genuinely implicated in the company’s strategic planning and who are therefore responsible investors.

Influencing corporate behavior through enhanced CSR or by financing innovative technologies certainly contributes to shaping a more positive economy. However, the issues we face call for even bolder measures. Savings can create and support new models, such as green growth, or the third industrial revolution, that are founded on rational altruism and sharing.³

First of all, the ecological transition: how can we finance energy-efficient residential renovation on a large scale—especially when occupants lack the resources to invest in onerous building work? How do we ensure that future energy savings cover the cost of investments made today? How can we accelerate the development of renewable energy in emerging countries? Traditional models of finance are not designed to address these questions. Risks need to be distributed differently among public authorities, private investors, users and technology providers. A new form of partnership between the public and private is needed. A similar overhaul is required in order to enable the financing of alternative production models, particularly that known as the “circular economy.” Granted, finance is showing a growing interest in green growth, particularly when it comes to financing renewable energy, which is currently heavily subsidized in a considerable number of countries. This enthusiasm, however, does not by any means signify that the energy transition as an issue has been resolved. Creating or renovating infrastructure for the production and transport of energy, improving the energy efficiency of our buildings and lifestyle, and preparing for climate change are all projects demanding enormous investments that involve complex risks: not least because any results are far in the future and heavily contingent on future developments in technology. Financing such a vast transformation takes both determination and genuine innovation.

The topic of financing has been raised in Europe, where it has taken the form of a “2020 Climate and Energy Package.”⁴ At the global level, the issue is currently being treated in the context of the OECD and G20, with a proliferation of initiatives aimed at directing savings toward financing the energy transition and, indeed, “positive” infrastructure more generally. This new trend could radically accelerate the process, giving rise to a wide market in financing for the energy transition. Here, money could be “earmarked,”⁵ transparently permitting investors to allocate their resources based on informed choices. Though still in its infancy, a striking illustration of this type of solution is the green bond market, which consists of products destined to finance environmentally responsible infrastructure that bring together private investors and public authorities.

Similar financial innovations can also be placed in the service of social objectives. The concatenation of demographic and economic pressures has exacerbated inequalities at every level of our societies, leaving traditional financial models ill equipped to address the needs of society’s poorest members. It is practically impossible to stir interest in projects or services that appear unprofitable, or too small, or geared toward what is often called “the bottom of the pyramid.” Ever since the success of the Grameen Bank and the Nobel Prize awarded to its founder, Muhammad Yunus, microfinance has been a recognized and respected activity which has demonstrated how poverty can be reduced on a significant scale, entirely thanks to financial innovation. Microfinance has experienced its share of difficulties in its growth process but, more importantly, it finances only a marginal portion of economic activity. Can its core model be generalized? Are there other financial innovations we could imagine that can help to reconcile adequate returns on savings and solutions to pervasive social problems? This is the central question for impact investing—and attempts are under way to find answers. In 2013, the British presidency of the G8 decided to place social impact investment on the agenda to illustrate that the United Kingdom’s Liberal-led government was ahead of the curve in this area. It is certainly true that the country has innovated considerably in the realm of social sector financing—including the creation of a major public fund for financing social initiatives⁶ and the launch of Social Impact Bonds (SIB)—very probably because the state is withdrawing from this domain. Rising sovereign debt in all developed nations is pushing authorities to disengage from a number of costly social programs, even as widening inequalities are forcing a larger segment of the population toward the margins of societies.

In its present form, the notion that investment can produce a “social return” (SROI) is new, and gives rise to financing mechanisms lying at the intersection of public, non-profit, and private enterprise that combine many of the functional aspects formerly specific to each of these sectors. These innovative instruments, commonly grouped under the term “impact investing,” are situated halfway between socially responsible investing (which continues to privilege financial return) and philanthropy (for which financial return is considered irrelevant). In France, this forms what is called the économie sociale et solidaire (the social and solidarity economy), and constitutes a non-negligible 10% of the country’s jobs. From May 2012 to March of 2014, this sector even had its own ministry, and its development is a topic at the European level as well, thanks to initiatives by former European Commissioner Michel Barnier and the creation of a fund for social entrepreneurship. But, although the tools are in place, social finance remains marginal: all too often entrenched in defensive militant positions, and thus unable to adapt to innovations or the emergence of a new type of social entrepreneur. Nonetheless, new approaches that are less fearful of finance continue to appear. Social Impact Bonds (SIBs) are one archetypal example.

The aim of these securities is to finance social programs using private funds (rehabilitation, reintegration, recidivism prevention, social housing, care for the homeless, etc.). Investor compensation is a function of each project’s success, creating a new generation of Public–Private Partnerships (PPPs). However, this new business model is open to question on several fronts. To begin with, is it not dangerous to “privatize” certain types of social services? But, as pointed out by the United Kingdom’s prime minister David Cameron, there are some things that the government does not do well: areas where other agents, such as social enterprises, charities, and voluntary bodies, may perform better.⁷ The topic is inexhaustible.

In any event, it is clear that, in order to accelerate the ecological transition and resolve social challenges, whether in developed or developing countries, the intelligent mobilization of capital is crucial. Equally important is the serious upstream analysis of projects from a financial and extra-financial standpoint, the measurement of investments’ impact, and a reconciliation of finance with the general good. Achieving these transformations, which are closely tied to a new vision of how to allocate savings, demands greater transparency, clear definitions for concepts, recognized labels and the smart deployment of public funds to provide incentives for private actors.

Notes

1 Ibid.

2 According to Novethic, a subsidiary of the Caisse des Dépôts et Consignations, which has been observing the SRI market in France for a decade, the assets under management of SRI funds have risen from €3.9 billion to €169.7 billion over the 2003–2013 period, increasing 40 times over in 10 years. See “2013 Figures on Responsible Investment in France: Novethic’s 10th Market Survey,” www.novethic.fr/fileadmin/user_upload/tx_ausynovethicetudes/pdf_syntheses/French_RI_market_2013.pdf, accessed September 19, 2015.

3 This concept is well described by the American essayist Jeremy Rifkin, in The Third Industrial Revolution: How Lateral Power is Transforming Energy, the Economy, and the World. (London: Palgrave Macmillan, 2011).

4 See ec.europa.eu/clima/policies/strategies/2020/index_en.htm, accessed June 12, 2015. At a national level, France produced a “Feuille de route pour la transition écologique,” which was presented in late 2012. The topic of financing returned to the spotlight in November 2013, following the government’s publication of a Livre blanc sur le financement de la transition écologique, and the banking and finance conference held in 2014.

5 “Earmarked” is here used in its literal sense of tracking, to make sure we know how money invested is actually spent.

6 “Big Society Capital” was created in 2012 by the UK government as a means of financing social enterprise. Two-thirds of its €700 million in capital will be provided by transfers from dormant accounts at British banks. See Mark King, “Dormant accounts to fund ‘big society’ bank,” The Guardian, July 19, 2010; www.theguardian.com/money/2010/jul/19/dormant-accounts-fund-big-society-bank, accessed August 2, 2015.

7 D. Cameron, “Social enterprises, charities and voluntary bodies have the knowledge, human touch and personal commitment to succeed where governments often fail,” speech presented at the Social Impact Investment Forum, London, UK, June 6, 2013; https://www.gov.uk/government/speeches/prime-ministers-speech-at-the-social-impact-investment-conference, accessed September 19, 2015.

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• Figures, tables and boxes
• Foreword
• 1. Introduction
• 2. Positive Finance for a positive economy
• 3. Savings as a means of transforming the corporation
• 4. Harnessing savings to transform the economy
• 5. Conclusion
• Glossary
• Primary organizations cited
• Acronyms and abbreviations
• About the authors