By Armen Papazian, CEO of Finoptek (pictured below), and Saker Nusseibeh (pictured right), CEO of Hermes Investment Management
We are finally starting to realize on an official level that our economies, our industrial activities, and our financial decisions have a very direct and tangible impact on Earth, and the sustainable development of human civilization.
The Paris climate change agreement and the UN global sustainability goals are a testimony to this fact. All this is good and great. However, we have a much deeper challenge to face, and a more radical shift is required in our mindset in order to truly usher in the wave of change needed.
Money and finances are key to almost every type of new initiative. From software design to the latest app, from industrial manufacturing to the latest gadget, from agriculture to the latest genetically modified tomato, finance and capital allocation determine what gets done, and what stays in the realm of ideas.
Indeed, in order for an idea to be funded, its value has to be established for those who are considering investing or raising the funds.
The problem is that we seem to have a dichotomy between what we perceive to be solid economic and financial rules and our unease about the effect of our economic activity on the ecosystem we live in.
It is interesting that many investment houses are now moving to say that they now consider ESG factors in their decisions, as are companies. They are doing so because COP21, hopefully, has finally underlined the point that the impact of our investment and commercial decisions are both long term and profound.
However, it seems to us that in considering these factors, investors, like executives, are looking at it as an additional risk mitigation overlay to normal or standard economic and financial metrics. That to us is a profound problem in that it seems to separate out what are accepted ‘normal’ economic-based decisions and ESG considerations.
Under this scenario, for example, BP’s decisions were logical financially, except that the management failed to mitigate the possible financial risk of an ecological disaster. Surely, this artificial separation between ‘normal’ economics and ESG considerations is neither workable in the long term, nor logical, for ESG matters, then surely it has to be part of the economic and financial framework.
Traditional economics and finance has taught generations of company executives, investors and regulators to value money through the lens of two major parameters, risk and time. Open any finance textbook, advanced, intermediary, or beginners, and have a look at the two pillars of Value that these books teach. Across the planet, in almost all languages, when you are taught mainstream principles of finance, of value, you are taught Time Value of Money, and Risk and Return. This then forms the basis of all discounting models and asset pricing models used in finance today.
Adjusted, tweaked or not, these models derive their conclusions of value from the Risk Return and Time Return of investments, combining them into a rule(s) of decision making that treats the environmental and societal impact of the investment as exogenous. At best, the models deal with positive or negative externalities qualitatively, as an addendum to the core mathematically represented axiomatic relationships of monetary value.