Financial markets will prove a critical lever in the move to creating sustainable social and economic growth for New Zealand. The Aotearoa Circle's Sustainable Finance Forum's report investigates how.
Creating a financial system that generates wealth but protects the environment will position New Zealand - or any country who manages to achieve the task - at a competitive advantage when courting the increasingly large pools of international green finance. We talk to EY Oceania Climate Change and Sustainability Services Director Pip Best about the interim report, and the issues it's hoping to help address. It has been edited for clarity:
EY: If we start at the beginning, how did this report come about?
Pip Best: The Sustainable Finance Forum report is the first initiative from the public private partnership - The Aotearoa Circle. Their purpose is to look after the environment of New Zealand and reverse the decline of natural resources. It felt that this had to be their first initiative because the finance sector is so key in terms of making investment decisions that impact the environment. It also follows very similar reports in other regions, including Europe, the United Kingdom, Canada, Norway, China and Australia.
EY: So, what are we talking about when we say "financial system"?
PB: We are talking about everything from the retail sector to government. So, financial advisers, Kiwisaver funds, banks, insurance, investment managers, social enterprise, philanthropy... pretty much anything that deals with money, simplistically.
EY: One of the points the report makes is that there are issues around market short-termism; an inability to properly price social and environmental costs; and a lack of information that all leads to capital mis-allocation. So, is the solution to encourage people to re-imagine how to allocate capital or reconsider the areas that they should be investing in?
PB: Yes, so three things I would say. The first is around leaders pushing businesses - as a leader in your business - to consider these things. There is a lot of talk but not much action in terms of leadership. Then secondly the part that you are talking around, around re-weighting or changing investments is what we term 'greening the financial system'. That is about trying to incorporate the value of environment and social impacts into investment decisions. Then finally there is just this part around just there is not enough money going into these projects for us to meet any of our international targets or basically prevent a really bad version of climate change happening at the moment.
EY: If you are looking at anchoring an idea of a sustainable financial system in New Zealand to the Maori world view and the principles behind that world view which they talk about, when obviously New Zealand operate's in a global financial system, what if those components don't necessarily match? How does that change the way that you can effect change in your domestic system if the global system isn't implementing the same ideas?
PB: This isn't being led by governments anymore, but actually it is large institutional investors that are starting to lead in this space and they're starting to commit their money or their portfolios or making the commitment to align their portfolios to sustainable investments. That is mainly driven out of Europe predominantly at the moment and in the US as well. It's almost like if we don't do this we are the ones that are behind not the other way around.
EY: What is your sense, because I think you have worked in this realm for a little while, about how quickly that move towards changing our thinking can happen? It feels like there is a groundswell. What's your estimate for short-to-medium term change?
PB: It is really around active investors who pick and choose what they want to invest in, and who can really make decisions through divestment and investment in certain sectors. That's this idea underpinning the Net-Zero Asset Owner Alliance. We've set a target in this report of 2030 to have a sustainable financial system. That is aligned to international commitments and also similar time frames of other initiatives.
How quickly do I think this will happen? Similar style reports to this in other regions have their regulators and others reporting back on actions for prudential changes etc. by 2025 at the latest. So, I would say that is the time frame where we can see significant change. There has also been a really recent increase in activism in this space which is increasing awareness. But I'm seeing conversations and initiatives starting to move really quickly.
About forty seven of the central banks have formed the Network of Central Banks and Supervisors for Greening the Financial System. That has moved so quickly from [Bank of England Governor] Mark Carney talking around 'tragedy on the horizon' which was flagging that this was a financial risk, to having an international group actually looking at what actions they can do. So, things that even a year ago were probably not even spoken of - for instance central banks using their own balance sheets to invest in sustainable investments, or changing capital adequacy requirements so it could penalise or incentivise sustainable investments - are now frequently talked about.
EY: How can we stop good intentions like this become a footnote to a footnote in regulations or governance requirements, so the velocity of this continues and it is actually executed?
PB: Yeah and that I guess is that point. What the Aotearoa Group has been really focused on is driving this through leadership for that exact reason. If you try and drive this through regulatory change, it takes so long and it gets so watered down that really it's just not leading at the pace we need. It really needs to be driven via leadership and by companies saying 'we need to make this change for all these reasons, and to try and capture this opportunity, or be attractive to international funds.'
EY: Is the report proposing to do anything differently in terms of valuing the economic and social impacts? How does the whole system work if, for example, one market or one country values environmental externalities differently to another country? Do we need a single global understanding of what the value of environmental degradation is or water quality?
PB: I think trying to get international consensus on anything like that again, it will limit us in the pursuit of perfection and we won't get action. Also, a lot of environmental impacts probably outside of climate change are local and therefore the value needs to be a local based value. For instance the usage of water, there is obviously areas that are scarce in water and areas that aren't so scarce, so the value of water in different regions does vary. So, I don't think we need an international standard.
Climate change is a global issue so that is where we do get some issues around this whole "What if I act and no one else does?" mentality.
EY: Do certain markets need to get to a level of economic development before they can think about making their own financial markets sustainable? Is there a sense that New Zealand and perhap Australia are at a level of economic development where we can actually think about reallocating capital and reprioritising why and how we spend money. Or can these principles be applied universally?
PB: Those understandings are all incorporated in international bargaining around [climate] commitments from each country. This argument is what blows up the whole Paris Agreement and why the US pulls out because they say they have been forced to do more than other regions because they are more developed. Australia and New Zealand are very developed countries. But if we are not going lead then nobody is. What are we waiting for? We see the international markets moving, capital markets moving. If you want to try and attract that capital and these are becoming large pools of capital, you're going to need to move to address thi challenge.
EY: The report touches on 'greenwashing'. Can you explain what that is and how you reduce it or how you minimise it?
PB: Greenwashing is just saying that something has environmental benefits and it doesn't necessarily lead to any real impact. The way this is dealt with is having data that's credible, being able to measure things and improving reporting. The big thing around this is the environmental component of a business is not required to measure or report with the same rigour and agreed metrics as for example, the financial component of a business. It has led to this issue where we don't monitor or require the same integrity around the environmental impacts of the company so we need to improve data, frameworks, standards and I guess the classification system of what we classify as 'green'. There is very strict standards and the importance of data generally is recognised in the financial systems, so it's about saying 'let’s bring the same regard into environmental and social markets'.
EY: Is that going to the financial materiality lens versus the real world impact lens that they talk about or is that something different?
PB: The financial materiality lens is basically the world that the business world is familiar with. If something is going to have a material impact on your business, you should be thinking about it. You should be planning for it. You should be reporting to your investors on it. So, that's really saying if there is an environmental risk that poses material impact to your business, and the predominantly used example is climate change, you should already be incorporating that into your strategy and your reporting.
It's probably not done that well yet but that is pretty much the standard of what is expected. The real world lens is where there is less understanding at the moment, which is that your business has an impact on the environment, and should your business have a material impact on the environment then this is something you should be discussing and talking about as well. That's the part that the current system which doesn't really have a framework around at the moment.
It goes to the point about leadership acknowledging that and reporting. Actually, not just reporting but managing that real world impact and reducing it or trying to find opportunities to provide positive impact rather than negative impact.