Tuesday, 4 November 2008

Financial crash an opportunity for climate investment

The past few weeks have seen a significant change in global approaches to government involvement in the economy. The role of the State in working to ensure the sustainability of the economy has gone from a contested thesis to one palpably evident. At last!

As we enter a period of economic slowdown, expected to last at least two years, governments are being reminded of the Keynesian model of growth- and employment-inducing investment during economic downturns.

Japan tried this in the 1990’s recession with modest impact; but made a big mistake (which they were warned about) in investing in infrastructure and road building projects of dubious value (there were lots of freeways "to nowhere"). The trick with this sort on investment is to look for opportunities for knock-on effects, stimulating further economic activity. Roads to nowhere don't qualify.

Apart from the challenge to its financial system, the world faces a different and greater challenge: to rapidly reduce greenhouse gas emissions in an attempt to head of the spectre of catastrophic climate change - and a subsequent contraction of the economy, estimated by Nicholas Stern to be up to 20%.

The UK Government has recently announced that their legislated target cuts on 1990 emissions by 2050 will be 80%; incoming President Obama is pursuing 80% cuts by 2050. The urgency of the need for action has been highlighted by recent climate news, such as disappearing Arctic ice and clathrate releases from Siberian seas. These developments place the current trajectory of climate change at the upper and most dangerous end of IPCC projections, and have led commentators such as Stern to argue that required emission reductions in western countries will in fact be closer to 90%. The speed by which emissions are cut, a key factor in avoiding potential climatic tipping points, mean that very high growth rates are required for concurrent low-carbon energy generation and energy-use reduction initiatives. This means a focus is required on rapid and concurrent industry development and on barrier removal, especially in skills and infrastructure.

We have a big opportunity here: to both facilitate capital investment that will immediately stimulate economic activity and employment AND address the key challenge for western economies: rapidly cutting emissions through the de-carbonisation of the economy.

Concern has been expressed that the scale of government debt incurred to address the current financial crisis will not leave room for further stimulatory investments.

The beneficial effect of stimulatory investment could, however, still be engineered through partnerships between governments and long-term investors, such as pension funds.

Pension funds have long agued that the problem they face is more the availability of appropriate long-term investment opportunities than the availability of funds. Indeed, some commentators have put the view that a contributing factor to this year’s financial crisis involved too much pension fund money seeking too few quality investments, and a subsequent flow of funds to unfortunately higher risk asset classes.

There is an elegant fit between the major investments required to quickly de-carbonise economies and the need of pension funds for long-term, quality investment opportunities. This is an opportunity for governments to achieve economic stimulus plus help head off climate disaster, without significantly affecting public debt loads. Amazing!

Sunday, 2 November 2008

What does the financial crisis mean for responsible investment?

Responsible or sustainable investment is about getting returns over the longer term, about avoiding short-term benefits that sacrifice the medium and long-term.

Most commentators agree that the current crash is rooted in the focus on short-termism over long termism. Of rapidly expanding sub-prime portfolios with, it's now clear, not enough focus on the sustainability of returns; of incentive schemes that demanded sacrificing long term outcomes by maximising quarterly results; of pushing leverage to the max without allowing for inevitable market shocks.

We need incentives, governance and regulation aligned to recover the balance between sustainable investment and the necessary energy of liquid markets.

The crisis has shown that longer term horizons require looking at the ecosystem supporting investments and at ensuring economies will be robust enough to continue to give us returns. We know that improved governance gives, on average 1-2% better returns over the longer term ; we know from the Stern Report that tackling climate change will costs the economy 1-2% of growth versus not tackling it costing us 10% of growth.

The crash is more likely to push back the extreme short-termist virus that has infected society, and shift funds to responsible investment.