Sustainable Finance: Investing in a better world

Matt Whineray. Photo / Jason Oxenham

The Sustainable Finance Forum is focused on the tangible aspects of the system it seeks to change, says Matt Whineray.

In the past 12 months the NZ Super Fund received contributions of $1 billion from the Crown to invest in smoothing out the increasing future costs of providing universal superannuation. For every dollar we invest, we ask ourselves: what is the risk associated with this investment and how does that risk impact on value? The Fund is forecast to continue to grow in size through the end of this century — so we care about how these risks play out over the long term.

Some risks are apparent — the debt levels of the business, its cash flow projections, the point in the economic cycle, etcetera.

Other risks are less so, "how will this energy company's business model need to shift to adapt to a changing climate?", "what is the regulatory threat this social media company faces if it does not protect its customers from online harm?", "what are the goodwill risks associated with a retail business failing to ensure its supply chain is free from modern slavery?".

The fact that accounting for these more intangible risks in assessing the value of a businesses is difficult doesn't make the risks any less impactful on investment returns.

That's why the Sustainable Finance Forum is focused on the tangible aspects of the system it seeks to change. We want to ensure capital flows (investing and lending), risk management activities (insurance) and financial processes (disclosures, valuation, oversight) assimilate "intangible" environmental and social factors as a means to promote sustainable economic growth and long-term stability of the financial system.

At the Super Fund, we believe environmental, social and governance (ESG) factors are material to long-term returns and actively incorporate them into our investment framework. Sustainable finance is no longer a niche topic, it's increasingly at the heart of investment allocation decisions.

We're actively looking at how to price in the cost of pollution, damage to biodiversity, increasing inequality or a changing climate into what we pay for an asset. This is part of a growing trend across the investment world to see what economists call "negative externalities" as material to the value of a business, and the underlying economic foundations are shifting to accommodate it.

For example, at a global level the Task Force on Climate-related Financial Disclosures (TCFD) continues to gather momentum in the drive for businesses to provide more information so investors can better assess climate risk. The UK has gone further than most, mandating disclosure requirements for large companies and asset owners by 2022.

In September the Principles for Responsible Banking were launched by the United Nations Environment Programme Finance Initiative in New York. They cover 130 banks from 49 countries, representing more than US$47 trillion (NZ$74t) in assets, including domestic banks Westpac, BNZ and ANZ. The principles are intended to align a bank's strategy with society's goals as expressed by the Sustainable Development Goals and the Paris Agreement.

The EU is introducing stronger reporting requirements regarding sustainable finance with a strong focus on taxonomy, while the Australian Prudential Regulation Authority has stated climate risk is foreseeable, material and actionable, which is backed up by a growing body of legal opinion stating directors have a duty to take this risk into account.

Back home we're seeing school kids leading with climate strikes and government following with introduction of the Zero Carbon Bill and extension of the ETS to agriculture. There's an increasing consumer focus on responsible investing in KiwiSaver, while ESG reporting was recently incorporated into the NZX corporate governance code.

The financial world now has a clearer view on how pollution and biodiversity destruction, social dislocation and inequality and a changing climate impact asset prices, whether through changing markets, regulation, social upheaval or increasing the cost of inputs.

Given these changes, boards and executives will fail in their duties if they do not consider and mitigate ESG risks in their operations, due to their impact on a business's licence-to-operate and long-term value. While you might not be doing anything about the impacts of climate change on your business's long-term prospects or care about the providence of your supply chain, investors are starting to price that inaction and exposure into their valuations, lenders are thinking about these issues in their credit decisions, insurers are considering them in their risk allocation choices, consumers are factoring it into their spending decisions and regulators are increasingly focused on the associated risks to the system.

That's why the focus is on the actors in the system: ultimately it is decisions inside individual businesses that drive good outcomes and long-term value.

Our goal is to build a financial system that intentionally plays a role in supporting transition to a low emissions, resource efficient, just and inclusive economy where long-term wellbeing is incorporated into decision making in an informed and transparent manner. To do that we've asked the following questions:

• How do we improve quality and accessibility of data required to understand and mitigate challenges associated with social and environmental issues?
• How do we improve consistency and transparency of reporting of risk associated with these issues and the mitigating actions that people take in order to address them?
• How do we improve awareness and understanding of the issues and opportunities and educate all system stakeholders — users, providers, intermediaries, influencers?
• Is there a need and how would you create stronger links between pricing and performance and achieving long term outcomes and overcome short-termism inherent in the current system?
• What policy and regulatory levers are required if you want to reorient where capital actually flows; to internalise externalities and societal costs?
• Should financial advice be required to consider ethics and sustainability?
• Would it be appropriate to incorporate a sustainability focus into the role of regulators and what would that look like?

Answering these questions is key to building trust and confidence of participants in the system to understand its purpose and their roles and responsibilities within it.

The outcome should be greater systemic resilience and agility through the incorporation of environmental, social risks and opportunities, with capital that is aligned accordingly. We hope the forum's final roadmap report delivers that, so finance can play its role in helping build a better society.

• Matt Whineray is CEO of the NZ Super Fund and co-chair of the Sustainable Finance Forum.

Read the Sustainable Finance Report here.