Our current financial system is a legacy from a time when our understanding of socio-ecological systems, natural resource management, and environmental degradation was limited. Historically, utmost importance was placed upon economic growth and development, with little consideration for the integrity of the environment, sustainability , or the well-being of future generations.
In recent years—especially following the Paris Climate Agreement (COP21)—we have witnessed new ways of thinking and doing business emerge and gain traction among academics, practitioners, and policymakers. In the minds of many, the financial system is no longer a closed, isolated system; it has evolved into a larger socio-ecological system where finance, social well-being, and planetary health are highly interlinked. In fact, our world cannot move toward sustainability , address climate change , reverse environmental degradation, and improve human well-being without aligning the financial system with sustainable development goals.
Academics, policymakers, and practitioners are currently developing a variety of new tools and products to include environmental and social factors in the way we make and evaluate business decisions; in some cases the proposed ideas and approaches have been controversial. This book aims to add to the discourse on the design of a sustainability -oriented financial and economic structure by exploring how a system can be designed that (a) is environmentally and socially responsible, (b) is aligned with planetary boundaries, (c) manages natural resources sustainably, (d) avoids doing more harm than good, (e) is resilient and adaptable to changing conditions, and (f) addresses climate change . We define a “sustainability-oriented financial system” broadly as a financial system that is in line with larger sustainable development goals to promote social and environmental well-being for current and future generations.
This transdisciplinary edited book presents chapters by some of the leading academics and practitioners on designing a more sustainable financial system. The first objective is to explore the system and sector-level designs of a sustainability -oriented financial system. We consider large-scale changes to the role of finance, banking, business, and economic theories and take a deeper look into the challenges and opportunities of moving from theory to practice with an example centered on carbon pricing . The second objective is to highlight some of the innovated best practices, tools, and financial products that make up a sustainable financial system. We look at new approaches to social and environmental responsibility and risk management , as well as financial solutions to sustainable development challenges. Finally, our third objective is to consider the role of regulation , codes of conduct, and policymaking. We discuss the implications for more or less regulation and the role of common standards and codes of conducts.
A transition toward a more sustainable financial system in order to support sustainable development goals is inevitable and is already in progress. We hope that readers will gain a deeper understanding of this important transition through the ideas, practices, policy recommendations, and first-hand experiences presented in the following chapters. Moreover, we hope this book will lead to further research, development, and implementation of new tools and methods—ultimately shaping a financial system aligned with sustainable development goals.
We explore the following topics:
1.1 System and Sector-Level Transitions Toward Sustainability
Chapter 2
An Alternative Finance Approach for a More Sustainable Financial System
By Rosella Carè, Annarita Trotta, and Alessandro Rizzello
The financial crisis of 2007–2009 has raised concerns about the role of the neoclassical finance approach. Specifically, over the last several decades, alternative voices have emerged in questioning the foundations of the traditional view. Recent critical perspectives reject the assumptions and paradigms of mainstream literature that focus on mathematical and statistical methods alongside rules and parameters in order to understand the dynamics of the financial world, which are ultimately more complex. At the same time, financial systems are experiencing new financial instruments, channels, and models that emerge outside of the traditional financial system. This phenomenon represents the first step toward a reaffirmation of the “finance” mission as the servant of the economy. Concepts such as “alternative financing instruments”, “alternative financing channels”, and “alternative forms of finance” can be found with increasing frequency, emphasizing aspects such as ethics, solidarity, and social justice. Moving from these considerations, this chapter explores—through a systematic literature review—the “alternative finance” landscape, by identifying nine key themes, discussing the linkages, interrelationships, and common threads that run through all these aspects. The work contributes to the ongoing efforts to understand the opportunities, challenges, and trends for a more sustainable financial system.
Chapter 3
Social and Environmental Responsibility in the Banking Industry: A Focus on Commercial Business
By Beatriz Fernandez Olit, Marta de la Cuesta González, and Francisco Pablo Holgado
This chapter carries out a review of the social and environmental responsibility of banks and suggests a different approach to defining and measuring it based on the diversity of banks’ models and their activities. Corporate Social Responsibility (CSR) within the banking industry should include several intra-sectoral approaches, adapted to better manage the higher risks of universal banks or to adequately disclose the positive impact of smaller banks on their communities. The chapter argues that the trend of current homogenization of the banking industry is going to be unfavorable in terms of future sustainability and responsibility. This chapter will also look at a horizon of large, quoted banks with highly diversified activities. Alternative governance models (cooperative, public, semi-public savings banks), small and medium-sized banks, and entities focused on financial intermediation, and the retail markets are being undervalued and induced to disappear in Europe, as well as globally.
Moving forward in more sustainable financial systems requires a return to a business model that is closer to customers. Technology can be helpful on the democratization of financial services. However, it could involve new risks: standardization of products, less personal advice, and financial exclusion of population with insufficient access, knowledge, or confidence in technology. Banks should guarantee credit to SMEs and, at the same time, question their financial support to other less transparent agents. There is a need for CSR that has an impact on the behavior of the retail-banking sector, as this sector supports the (productive) economy. Policymakers should be able to evaluate if the banking industry is fulfilling its role of facilitating responsible and inclusive access to banking services.
A more relational and sustainable business model would help banking institutions address the UN’s Sustainable Development Goals, specifically the 12th goal (responsible consumption and production) and the 10th goal (reduce inequality avoiding over indebtedness and financial exclusion ).
Chapter 4
Seeking Greener Pastures: Exploring the Impact for Investors of ESG Integration in the Infrastructure Asset Class
By Roy R. Sengupta, Tessa Hebb, and Hakan Mustafa
This chapter looks at one of the most crucial aspects of sustainable development across the world, which is infrastructure. Infrastructure factors into the design and liveability of all communities in the world and will make a major difference in both developmental and environmental goals in the long term. Estimates have shown that it will require over $30 trillion of additional infrastructure investment globally if we are to meet the Sustainable Development Goals by 2030. Government s acting alone do not have sufficient financial resources required to meet these needs. In order to get the financial system working in a sustainable way for communities, we must find a way to leverage the resources of private capital for sustainable infrastructure. This part of the book seeks to explore ways in which such private capital can be leveraged for infrastructure, which has positive Environmental, Social , and Governance (ESG ) impacts.
This chapter considers the role in which economic theory plays in sustainable infrastructure investment, including the relevance of concepts such as information asymmetry, as well as the issues which sustainable infrastructure investment could help to solve, and some of the obstacles and trends in the field of sustainable infrastructure investment. The key argument of this chapter is that sustainable infrastructure (defined as infrastructure which scores well on Environmental, Social , and Governance factors over its lifecycle) is able to provide competitive returns for investors ; returns that, over the long term, match or even exceed the returns of non-sustainable infrastructure. Overall, the chapter identifies both barriers to increased uptake of sustainable infrastructure investment, but also a general feeling of cautious optimism regarding the future of such investment, as evidenced in both the literature and the interviews.
Chapter 5
Pricing Carbon: Integrating Promise, Practice and Lessons Learned from the Chicago Climate Exchange (CCX)
By Paula DiPerna
Carbon pricing is an essential pillar in the architecture of any new sustainable financial system to help address climate change because it makes otherwise invisible costs visible. But moving from theory to practice has proven elusive. To help accelerate progress, this chapter presents lessons learned from the Chicago Climate Change (CCX), which operated from 2003–2010 and pioneered carbon pricing worldwide using the cap-and-trade mechanism, including spearheading a landmark joint that created the first carbon market pilot program in China, the Tianjin Climate Exchange (TCX) . CCX, which began trading in 2003, was the world’s first and only carbon market that covered all six greenhouse gases and had international links.
Fueled by passion, imagination, and bold investors , including a leading US philanthropy, CCX went from a hunch and an instinct to an expansive practical working system that covered many major companies in the United States. In fact, through CCX, the United States had more emissions capped and subject to a rules-based reduction schedule than any other nation in the world at the time even though the United States had no national regulatory structure to require greenhouse gas reductions. The chapter describes how CCX, voluntary but legally binding, coaxed and cajoled companies into action, building up an extensive network of early adopters who believed that getting started on climate change before being forced to had commercial logic and made for visionary management.
The chapter takes the reader from the early days of CCX founding to the halls of the US Congress, the streets of China and traces the up’s and down’s CCX faced as it broke new ground. The chapter also makes recommendations for how the world can make up for lost time on carbon pricing , implement actual pricing systems, and credibly weave socio-ecological responsibility into financial system design.
1.2 Innovations in Best Practices, Tools, and Financial Products
Chapter 6
Designing Carbon: Neutral Investment Portfolios
By Gianfranco Gianfrate
Designing a sustainable financial system will require profound innovation in the ways investors measure and manage climate -related risks. Currently, the main approaches to embedding environmental aspects in the investment process are “exclusion list s”, ESG ratings , active engagement with the management of companies more exposed to environmental risks, and the adoption of climate risks-adjusted valuation metrics. While those approaches have contributed to making investment activities more sustainable, this chapter introduces new evidence pertaining to the magnitude of climate change risks, which demand more decisive actions to reduce and mitigate the risks borne by institutional investors. In theory, the p...