Reinventing the financial system

If we are to effectively tackle climate change and achieve our other environmental, economic and social goals there needs to be a complete reinvention of the financial sector and its 'world view'.

Is New Zealand’s current financial system sustainable and equitable?

No, replied 95 percent of the system’s stakeholders in a recent survey.

That is the most startling fact in a report by the Sustainable Finance Forum.

The Forum is the first work stream of The Aotearoa Circle, a grouping of major companies and government agencies formed a year ago in “the pursuit of sustainable prosperity and reversing the decline of New Zealand’s natural resources.” Other streams are underway on the likes of sustainable land use and biodiversity.

This interim report lays out the comprehensive reinvention the financial system required to help New Zealand achieve its climate, environment, economic and social goals. The Forum is seeking feedback on its proposals with the goal or producing a final report next July which will lay out the pathways to a complete transformation of finance by 2030.

Failure is not an option. If the overhaul is incomplete or ineffective, we will flounder.

Meanwhile, some other jurisdictions and their finance sectors are well ahead of us, notably the EU, UK and Canada and the G20’s Task Force on Climate-related Financial Disclosures.

Are we making progress?

Not yet. Less than 1 percent of “estimated funds under management are being invested in strategies that set-out to achieve positive social or environment impact,” the report concludes.

So far only a few bonds or loans have been issued in New Zealand linked to climate or other environmental outcomes. Whereas the global issuance of green bonds has quadrupled in the past five years.

Our big banks dominate the financial system, leaving capital markets to play a minor role compared with other developed countries.

Those banks are among the leaders pushing for fundamental system change through the Sustainable Finance Forum and elsewhere. For example, the NZ subsidiaries of Westpac, BNZ and ANZ were among the 130 banks from 49 countries which signed up to the Principles for Responsible Banking the UN launched at its climate summit in New York City in September.

But they have barely begun the long and arduous journey to reinvent their strategies and business models. Every new initiative will have to compete against their double digit returns on capital from business as usual.

Likewise, some major stock exchanges and countries require companies to disclose their climate-related financial risk. Yet, the NZX does not yet require them to do so. Only 28 of the companies in the S&P/NZX50 at the end of May acknowledged climate change as a business factor.

More hopefully, 42 of the 50 largest listed companies reported on social metrics such as gender diversity.

But overall, the majority of companies were not using an internationally recognised framework for reporting on their Environmental, Social and Governance performance, the NZX says.

A financial, business and investment risk

Yet, directors of companies and investment vehicles are personally liable if they fail to make adequate assessment of, and take appropriate action on, their business’s climate risks. This is the conclusion of a review by Chapman Tripp for The Aotearoa Circle, which was peer reviewed by Alan Galbraith QC.

“Climate change has evolved from being a mere environmental or ethical concern to a financial, business and investment risk,” says Chapman Tripp partner Daniel Kalderimis.

“It will not pose a material financial risk for every business and investment, but where it could do, that risk needs to be taken into account in decision-making. Where a material climate-related financial risk is identified, directors and fund managers should formulate strategies to address it. This is the same advice that would apply for other material financial risks, such as projected company performance, domestic economic forecasts, global trade disruption or cyber-security concerns.”

The Government says it will introduce legislation to require such disclosure by major listed companies. But that may not be passed in this parliamentary term, and National is less keen on such mandatory reporting.

Other Government initiatives include the setting up of Green Investment Finance with $100 million of initial capital, the allocation in Budget 2019 of $219 m to a sustainable land use fund to help farmers change their systems, and membership of the 44-nation Coalition of Finance Ministers for Climate Action, which was launched earlier this year.

The Reserve Bank last year added climate risk as a factor in its financial stability framework and is already producing insightful analysis.

Likewise, the NZ Superannuation Fund has by far the most comprehensive climate and environmental investment disciplines in the country. It has begun to articulate some of the key imperatives. For example, having invested $2.5 bn so far in dairy farms, horticulture and forestry it is worried about the impact of climate change on those assets.

“The physical impacts of climate change, if left unchecked, will have far ranging and unpredictable impacts on our rural assets and communities,” it said in its recent submission on the Government’s proposals to make the Emissions Trading Scheme effective.

“We believe the New Zealand agricultural sector must reduce its emissions profile materially to retain its licence to operate, protect its brand and maintain market access over the long term, or face losing market share to other producers or to substitute products.

“The pace of change on farms needs to increase significantly to reduce emissions. Delaying action will, we believe, be more costly in the long term, as the adjustment needed to meet targets will then be more severe.”

But, it argued, the Government’s current proposal to make farms financially liable for only 5 percent of their emissions from 2025 (with allocation of free credits covering the other 95 percent) will not incentivise emissions reductions.

“The calculations suggest $0.01 per kilogram of milk solids on a dairy farm, which is very low when compared to cost structures of, say, $4 to $5.50. To get short-term change and some urgency, the free allocation should reduce significantly over the next 10 years.”

Given the Super Fund’s intensive work on these issues, it is helpful its chief executive, Matt Whineray, is co-chair of the Sustainable Finance Forum with Karen Silk, one of Westpac NZ’s most senior executives.

Using it [Te Ao Māori] as the bedrock on which to build our truly sustainable finance system is essential for us. It would also be our distinctive contribution to the sector’s global transformation.

In common with similar overseas reports on sustainable finance, the Forum’s work tackles the central issues of how to move the sector on from its short-term timeframes, its almost exclusive focus on financial goals rather than incorporating other critical ones, notably environmental and social, and its failure to charge for the external damage done, particularly to ecosystems and society.

Similarly, it explores those environmental and social underpinnings to sustainability in depth. On the first, for example, it draws heavily on Environment Aotearoa, the comprehensive measurement of our ecosystem performance undertaken by the Ministry for the Environment.

This summary of MfE’s latest integration of all environmental domains, is essential reading for understanding the enormous challenges we have. The fact we are more dependent on our natural environment for earning our living in the world economy, and on defining ourselves as a people and nation, than any other developed country only heightens the issues for us.

The report is also worth reading for the way it integrates social, environmental and economic issues. It draws, for example, on the work of Kate Raworth, a British economist. A good introduction to her insights is this talk she gave in this year’s Auckland Writers Festival, or her latest book Doughnut Economics: Seven Ways to Think Like a 21st Century Economist.

The report, though, differs in one significant way from those overseas. It describes a view of the world in which there are no externalities – either ignored or charged for. Rather, all actors – people, natural resources and earth systems – are intimately linked and interdependent, in the past, present and future.

That worldview is Te Ao Māori. Using it as the bedrock on which to build our truly sustainable finance system is essential for us. It would also be our distinctive contribution to the sector’s global transformation.

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