Why finance fails the environment in the long term

Publication Date: 

Wednesday, 24 June 2015 - 3:47pm


Claire Jones

Actuaries normally concern themselves with the managing of assets and liabilities, helping to ensure the long term success of organisations and business ventures. But this familiarity with long term thinking means that actuaries are well placed to contribute to other long term questions, such as those relating to the financial system and environmental sustainability.

In 2014, my professional body the Institute and Faculty of Actuaries – a UK not-for-profit organisation that educates, supports and regulates actuaries – set up the ‘Resource and Environment Board’ to help understand the long-term nature of environmental risks and to encourage the actuarial profession to be forward looking in reflecting these risks in its work.

Since then the board has produced an initial literature review of ‘Sustainability and the Financial System’ consisting of a systematic search of 125 top rated journals and 355,000 articles. The review considered papers published in the highest-rated academic journals in the disciplines of economics, finance and the social sciences, as ranked in the 2010 Association of Business Schools Journal Quality Guide, linking broad concepts of Banking, Finance and Monetary Policy with broad concepts of Sustainability, the Green Economy and Ecology.

Dispiritingly, the review found only 40 research papers that addressed how the financial sector related to the broader issue of sustainability. This represents a substantial knowledge gap in a crucial area of long term decision making. Much more high quality research is needed to help fill it.

The review found consistent pessimism about the role traditional economics plays in promoting behaviours that contribute to resource depletion and the inability of the current financial system to reform these behaviours.  Three key themes were identified where further research is needed to understand the implications of sustainability for anyone working with long term financial institutions:

  • The sustainability of the policy of pursuing growth without limit within a finite ecosystem.
  • The potential replacement of GDP as the key metric of economic activity and success since it does not capture the depletion of existing natural or human capital, promoting capital erosion.
  • The limitations of discount rates for making financial and capital allocation decisions due to the potential unintended consequences for sustainability. With the current approach the far future may appear worthless and possess negligible capital value.

Nico Aspinall, incoming chair of the Resource and Environment Board and one of the authors of the review, summarised the board’s findings as follows:

“We found that current research shares the general view that the growth-oriented economic model we currently use results in an increasingly fragile financial system and that the current system does not provide any incentive to fully recognise natural environment and resource constraints. In addition, there is little analysis of the wider impact of the natural environment on the financial system and economy.

We found that the solutions offered in the existing research are relatively limited and small-scale in their outlook.  There is a vital need for further research, particularly for actuaries and others who are required to take a longer term outlook, to ensure our financial system is sustainable in the long term.”

At the review’s London launch event in May, leading finance expert Lord Adair Turner spoke in agreement with the review’s findings, and warned of the dangers of lazy financial thinking for economy and the environment.

“If you discount the far future at the sort of rates of return that private sector participants believe they are going to get, or even very low estimates of that, you will do nothing about climate change whatsoever,” said Lord Turner.

“In essence I think we have, in the relationship between finance and the real economy, a set of major problems that even if we didn’t have a problem of sustainability we couldn’t necessarily rely on free financial markets to achieve optimal results.  And when we introduce the exponalities of the environment and climate change we can rely on it even less.   And that’s why I think it’s very valuable that actuaries are thinking carefully about what is the link between sustainability and the financial system and what is their role in that,” he continued.

Professor Richard Werner, lead author of the review, highlighted the research as only the “…necessary and important first stage of a research programme”.  The Resource and Environment Board hopes to continue to push the difficult issues of long term decision making to the forefront of research, and help provide the empirical and statistical support needed to start solving them once and for all. That leading academic journals have failed to address the hard questions of the compatibility of finance with sustainability, let alone the solutions, means actuaries can play an increasingly important role in finding the solutions to sustainable finance.

Claire Jones is a Senior Consultant with Lane Clark & Peacock LLP and volunteers for the Institute and Faculty of Actuaries as a member of its Resource and Environment Board and its Resource and Environment Research Committee.

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