To make our infrastructure and economy more sustainable, billions of euros in investments are needed each year. However, these investments are lacking because some fundamental aspects of the financial system and sustainability are directly opposed.
Sustainable finance’ seems to be the miracle cure, but—as I will show in this article—it actually worsens the situation. With the current laws and regulations, a sustainable future is moving further out of reach.
Is there an alternative?
<aside> 🇳🇱
Dit artikel is ook beschikbaar in het Nederlands. Die vind je hier.
</aside>
To understand the fundamental mismatch between the financial system and sustainable financing, we need to look at the bigger picture. To do this, I have provided a very simple model explaining how investors make decisions under the current financial regime.
The goal (highlighted in gray) is to increase capital—to make a profit. This is done by using capital to acquire the most profitable investments and minimizing the risk that the profit expectations are not met. To achieve this, we have seen a shift towards ‘passive investing’ in recent decades, where you invest a very small amount in a wide range of (different) things. A diversified portfolio is less risky, according to Markowitz’s mean variance portfolio theory.
The goal of the current system—to maximize profit—contains several aspects that fundamentally clash with the underlying principles of ‘sustainability.’
First of all, the highest financial return is achieved by extracting as much value as possible at the lowest possible cost.
At the moment, this can be done quite effectively through deforestation in South America, intensive agriculture and livestock farming, and manufacturing clothing in places where laws on working conditions and minimum wage either do not exist or are not enforced.
Secondly, you preferably want to extract that value as quickly as possible.
If you acquire capital earlier, you can invest it in something new sooner to further multiply it. This is the loop in the top-right corner of the diagram. It is entirely justifiable to deplete a piece of land in two years, even though you might have been able to do much more with that same piece of land over a period of ten years. At least, from the perspective of the current financial model that is.
Exploitation and short-termism. These two elements are fundamental components of the current financial system, but they are in direct conflict with what we understand as sustainability (long-term and value preservation). As long as this system remains in place, a sustainable future will remain an illusion, an idle fantasy. A fundamental transformation is necessary.
The failure of investors to contribute to the sustainability transition is acknowledged by governments worldwide. Especially here in Europe, many significant laws and regulations are already in place or coming into effect. Think of pricing emissions (mainly CO2), mandatory reporting of non-financial data, tax benefits for green investments… There’s a lot happening.
Although practice often lags behind, I certainly won’t deny that these developments can have a positive effect on the flow of money for sustainable investments. However, they do not change the fundamentals of the current system. Exploitation, preferably as quickly as possible, remains the essence of the financial model.