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2019 | Book

The Role of Finance in Achieving Sustainability Read chapter Read first chapter

The Financial Ecosystem

The Role of Finance in Achieving Sustainability

Authors: Satyajit Bose, Guo Dong, Anne Simpson

Publisher: Springer International Publishing

Book Series : Palgrave Studies in Impact Finance

Part of: Springer Professional "Wirtschaft+Technik" , Springer Professional "Wirtschaft"

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About this book

Long term asset owners and managers, while seeking high risk-adjusted returns and efficiently allocating scarce financial capital to the highest value economic activities, have the essential and formidable role of ensuring the sustainability of return. But generally accepted financial accounting methods are ill-equipped to provide clear signals of the risks and opportunities created by scarce natural and human capital. Hence many investment managers in global financial markets, while performing due diligence on portfolio companies, examine metrics of non-financial performance, especially environmental, social and governance (ESG) indicators.

Broken into three sections, this book outlines the rationale for and methods used in six areas where financial acumen has been harnessed to the goal of combining monetary return with long run sustainability. The first section offers an introduction to the role of finance in achieving sustainability, and includes an overview of the six areas—sustainable investing, impact investing, decentralized finance, conservation finance, and cleantech finance. The methods section of the book illustrates analytical tools and specialized data sources essential to those interested in increasing the level of social responsibility embedded in economic activity. The applications section describes and differentiates each of the six areas and their roles in advancing specific measures of sustainability.

Table of Contents

Frontmatter
Chapter 1. The Role of Finance in Achieving Sustainability
Abstract
We describe trends which have led to calls on the financial system to aid in global efforts to ensure sustainable development. We outline the three traditional roles of the financial sector: allocation of scarce capital to its highest-valued use, the matching of savers to investors, and the generation of the most accurate possible signals of scarcity and abundance. We outline modes of analysis which can extend the traditional functions of the financial system to advance sustainability through the identification and evaluation of sources of long-term value creation that accounts for natural and human capital, the development of appropriate investment products for responsible investors, and the search for risks and opportunities arising from the potential transgression of planetary boundaries.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 2. The Financial Ecosystem
Abstract
We outline the concept of the circular flow of savings and examine the nature of the financial ecosystem and its role in allocating capital to the highest-valued uses, matching savers and investors, and crucially, generating accurate signals of scarcity in the face of planetary boundaries. We review a taxonomy of players in the global financial market, their functions in the financial ecosystem, and their specific capacities to improve the sustainability of the broader ecosystem. We draw parallels between natural ecosystems and the financial one and use insights from the fields of ecology and cybernetics to propose appropriate nodes to identify risks and opportunities for that the financial system might feasibly address.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 3. Governing the Corporation
Abstract
We review the scale and power of the corporation and compare it to national governments, showing that its impact on the natural environment and society is beyond the powers of regulation of any individual state. We explore the origins of the corporate form, from its early days as a vehicle for imperial expansion to its proliferation as the primary form of almost all economic activity. The scale and ubiquity of the corporation poses the question of how the company is governed: in short, its ownership and control. The rapid evolution of corporate governance as a focus of regulatory concern, and financial consequence, is explained as a response to harness this tremendous economic power to the wider objectives of the financial ecosystem.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 4. Accounting for Sustainability: Frameworks for the Aggregation of Financial and Non-financial Metrics
Abstract
This chapter begins by providing a brief history of the evolution of financial accounting and then addresses the need for non-financial metrics that track the value of natural and human capital in any complete assessment of company value, reviewing the decision-theoretic rationales for the integration of non-financial metrics in the capital allocation process. It examines the disclosure frameworks and standards that are intended to expand transparency on the social and environmental impact of corporate and government activities by taking into account the interests of stakeholders other than investors. The chapter ends by examining the Sustainable Development Goals as a common global vision for a plurality of constituencies with actionable goals and quantitatively measurable indicators.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 5. Signals of Scarcity and Financial Performance
Abstract
We outline the feedback loop through which the financial ecosystem, using a set of interconnected prices, can aggregate local information through decentralized efforts at arbitrage. This feedback loop has the potential to increase incentives for waste minimization and other activities which alleviate the scarcities caused by the approach of planetary boundaries. We discuss the existing frames of reference in financial analysis which can be broadened by incorporating non-financial information into the security selection process. We review the current state of regulations on non-financial disclosure. We conclude by summarizing the results of studies examining the link between corporate sustainability performance and corporate financial performance.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 6. Cost-Benefit Analysis and Discounting
Abstract
We outline the project evaluation tool known as cost-benefit analysis and describe methods commonly used to translate the value of ecosystem services into monetary units. These include revealed preference methods (hedonic pricing, travel cost, and defensive expenditure) and stated preference methods (contingent valuation and discrete choice experiments). Discounting, a key component of cost-benefit analysis, is a significant driver of the conclusions of cost-benefit analysis. We discuss appropriate methods to choose the social discount rate to value future social and environmental benefits and outline the limitations of the approach.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 7. The Monetization of Natural Capital in Corporate Investment
Abstract
We present examples of globally aggregated valuations of ecosystem services and place them in the context of the value of global GDP. We discuss the distinction between weak and strong sustainability and their implications for the interpretations of monetary value. There is a need to expand valuation models beyond the monetization of periodic flows of goods and services to a recognition of the value of inherent resilience with ecosystems, whose reward may consist of risk reduction rather than higher yield. We describe increasing efforts within corporations and among investors in the financial ecosystem to identify, measure, and value both the impacts as well as the dependencies of corporate economic activity on natural capital.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 8. Human Capital and the Returns to Stakeholder Relations
Abstract
We outline the development of the economic view of human capital as an asset, rather than as a cost, and describe the foundations of related valuation methods. We summarize the literature on the relationship between good human capital management practices and financial return. We link the recognition of this relationship to investor efforts to collaborate with civil society, labor unions, and regulators to improve disclosure and raise standards around working conditions and human capital management.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 9. Capital Structure and Social Capital: Diverse Forms of Investment
Abstract
We examine two cases to illustrate challenges and opportunities in the implementation of a shared value creation approach: the collaboration between a city and a major corporation that leads to a choice of ecological restoration methods for a brownfield site and a broader example of private for-profit provision of higher education services along with government subsidies. We review the concept of social capital and describe social network analysis, a widely used tool for revealing the attributes of social structures, and connect the concept of social bridges to financial arbitrageurs, broadly imagined. We conclude by briefly outlining areas such as public-private partnerships, cooperative enterprises, and securitization in municipal finance which attempt to invite a diverse range of stakeholders into the capital structure curation process.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 10. Sustainable Investing and Asset Allocation at Global Scale
Abstract
We describe the narrative framework called modern portfolio theory, including mean-variance optimization, the capital asset pricing model, arbitrage pricing theory, and the efficient markets hypothesis, that serves as a foundation for asset allocation and performance attribution in the investment management industry. We evaluate its key assumptions and implications. We then examine the financial and social objectives of universal asset owners and their methods of achieving those goals. In practice, sustainable portfolio choice requires a consideration of a far wider set of systemic risk factors than is dreamt of in modern portfolio theory, solutions to the principal-agent problem in financial intermediation and investor efforts at addressing collective action problems.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 11. Impact Investing
Abstract
Impact investing is a style of investing that self-consciously aims to allocate capital for beneficial environmental and social impact alongside financial returns. We begin with a history of impact investing emerging from the confluence of philanthropy, development finance, social enterprise, socially responsible investing, and traditional investing. We survey the landscape of impact investing, including the main actors in its ecosystem and new investment instruments. We then discuss challenges that limit its scale, such as the test of additionality, impact evaluation, and the dominant influence of plutocratic investors, and speculate whether it is time for a paradigm shift, one that moves the field away from focusing on investors alone and toward a participatory approach that elevates the stakeholder to a level on par with the investor.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 12. Decentralized Finance
Abstract
We describe the value of decentralized decision-making in the context of the assessment of systemic risks in the financial ecosystem and draw parallels to the lessons learned from the polycentric provision of local public goods. Greater resilience of the ecosystem requires methods of decentralized recruitment and quorum sensing, features that induce rapid optimization without centralized regulation in ecological systems. We describe the potential for recruitment and quorum sensing in two financial applications: securitization and thematic investing. Finally, we consider the potential and pitfalls presented by the use of blockchain and distributed ledgers to specific applications in sustainable finance, including prediction markets, distributed corporate governance, and trade finance.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 13. Conservation Finance and Payment for Ecosystem Services
Abstract
We outline the need for conservation finance arising out of the misaligned incentives for natural capital management between individual actors and society as a whole and briefly describe the range of institutional responses: regulation, privatization, and common property resource management. This chapter describes conservation finance and the range of financial mechanisms employed by governments, multilateral institutions, charitable organizations, and private investors to fund conservation activities. These include debt-for-nature swaps, conservation trust funds, markets and payment systems for ecosystem services, and environmental impact bonds.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 14. Financing Clean Technology Innovation and the Transition to Renewable Energy
Abstract
We outline the need to invest in clean technology innovation and the peculiar difficulties in financing research and development in this sector. The renewable energy portion of the cleantech industry could be characterized as asset-heavy, high-risk, low-return with a long development cycle, exacerbating financing difficulties. This chapter surveys financing options, differentiating between the financing requirements of technology development and asset deployment. The interplay between the fossil fuel and the renewable energy sectors creates challenges and opportunities, and the role of subsidies for the consumption of fossil fuel and the production of renewable energy makes investment returns very sensitive to policy shifts. We outline the potentially positive role of new financing instruments as well as corporate investment by oil majors.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 15. The Cooperative Movement and Social Enterprise
Abstract
We describe the cooperative movement, an early initiative to marry social purpose and commercial enterprise, and compare with social entrepreneurship, a more recent phenomenon at the intersection of philanthropy, public policy, and business. We describe the key drivers of the cooperative movement and social entrepreneurship, the characteristics of social entrepreneurs, and the various organizational forms of social entrepreneurship. We highlight the local specificity of these social movements and their consequent promise of poverty alleviation context-based sustainability, two challenges for which social entrepreneurs and social enterprises are well suited to eliminate. Finally, we draw out some key lessons for financial intermediation from the relative success of social enterprise in addressing key social problems.
Satyajit Bose, Guo Dong, Anne Simpson
Chapter 16. Toward the Common Wealth and the Common Weal
Abstract
The financial ecosystem is a common property resource that serves the needs of savers and issuers. We synthesize in this epilogue chapter the themes of the book and highlight how an enhanced practice of sustainable finance can foster the aggregation of the small voices necessary to incorporate the diversity of stakeholder perspectives into the financial ecosystem. We show that the crux of the matter lies not in what gets decided but who gets to decide.
Satyajit Bose, Guo Dong, Anne Simpson
Backmatter
Metadata
Title
The Financial Ecosystem
Authors
Satyajit Bose
Guo Dong
Anne Simpson
Copyright Year
2019
Publisher
Springer International Publishing
Electronic ISBN
978-3-030-05624-7
Print ISBN
978-3-030-05623-0
DOI
https://doi.org/10.1007/978-3-030-05624-7

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