RI annual review

The financial system needs to change - Q&A with Christian Thimann

How vital is the role of finance in meeting the objectives set out in the Paris Agreement and the 2030 Agenda for Sustainable Development?

The role of finance is very important. If all countries want to meet the climate and sustainable development goals, global investment patterns will change very significantly over the next two decades. It will shift away from coal, it will lower investments in oil and gas and it will boost investments in energy efficiency, renewable energy sources and related technology. This requires a large change in investment patterns. Given the challenges created by the global financial crisis and the subsequent sovereign debt crisis, sustainable finance could provide the best opportunity for creating prosperity, while also ensuring there is minimal impact on the environment as a result of further economic growth.

In December 2016, the European Commission (EC) established a High-Level Expert Group (HLEG) on Sustainable Finance. Its aim was to develop an overarching and comprehensive European Union strategy on sustainable finance in order to integrate sustainability into financial policy.

The Paris COP 21 Agreement was a landmark event in that it was the first time that the financial sector was mentioned as having a specific role in addressing environmental issues. Finance permeates almost all areas of life, from the way we produce goods and services, to how those goods are packaged, transported and consumed. Each part of the cycle requires capital and investment. The sector is vital in terms of facilitating and directing capital flows, which was why the French government inserted financial services into the agreement.

We need to re-orient capital flows. Banks, which to date have not had their potential contribution to sustainable development realised in areas like project finance and specialised lending, should be encouraged to boost their role in sustainability. The same could be said for insurance companies and pension funds - a possibility for greater investment in long-term equity assets and infrastructure, provided regulation facilitates this.

Asset managers are uniquely placed to help capital flow towards more sustainable investments. Embedding sustainability into stewardship codes and asset management agreements, requiring fund managers to disclose how they integrate environmental, social and governance (ESG) factors into their strategies and how they vote on ESG issues, are all part of the measures that could be pursued.  AXA IM is well advanced in this area.

To what extent will achieving these aims require substantial change to the way the financial system operates?

There is no doubt significant change and investment is needed. The EU has recommended that the cost of implementing the required changes could run to €170 billion a year - to make adjustments to areas such as developing renewables, transporting goods, energy efficiency and green buildings - so it’s a big investment. A large part of that commitment is making financial firms aware of the risks but also the opportunities within sustainability. Previously it was  an industry pretty much agnostic on these issues but this mind-set is changing.

To deliver systemic change, ESG factors - both risks and opportunities - will need to be integrated into corporate governance, core indices, accounting standards and credit ratings. They will also need to be reflected in the role played by the European supervisory authorities (ESAs), such as through common guidelines and supervisory convergence on ESG disclosure.

Today many parts of the financial system are very short-term oriented. There is too much focus on short-term value extraction from instruments such as equities that are in principle meant to be held a long time.

"But actually, the average holding of equity has fallen from over eight years two decades ago to only eight months now. This is too short to consider long-term aspects of finance."

Long-term investors are opening their eyes to sustainable opportunities because the risks of not doing so could be very costly. The economic costs of stranded assets and the risks around highly-challenged sectors, such as coal, are issues that are fundamental to long-term investment decisions. AXA Group has been a leader in divesting from stranded assets such as coal that have a significant negative impact on the global climate. It is our belief that if we want to decarbonise the global economy in line with the 2°C Scenario, certain divestments are needed.

Policy is also very important, understanding for example, how assets should be taxed and priced. Germany for instance created significant subsidies for investing in renewables. What we want is for policymakers to create conditions that can help us achieve the 2°C Scenario – where we can limit the average global temperature increase to that level.

To accelerate the low-carbon transition, the HLEG’s interim report made some recommendations. What should investors take from these?

The HLEG is undertaking a lot of work in this area. For example, it is developing a taxonomy of what is green and what is not - this can be developed into a European standard and label for green funds alongside other sustainable assets. We’re also keen for investors' fiduciary duty to encompass sustainability matters, to develop a classification system for sustainable assets, and create better disclosure for financial institutions and companies on sustainability decision-making.

We also want to introduce a ‘sustainability test’ for EU financial legislation and create ‘Sustainable Infrastructure Europe’ to channel finance into sustainable projects. In addition, we want to enhance the role of ESAs in assessing ESG-related risks and unlock investments in energy efficiency through relevant accounting rules.

One of the most critical points to come out of these developments is that financial institutions will consider it their duty to factor in ESG and climate considerations when making investment decisions and this will have a profound effect on financial systems in the long term. It means asset managers will need to equip themselves with the competencies to deal with these issues so they can make informed decisions on behalf of their clients. 

All of these elements are featured in the final report, published at the end of January, which were taken up by the EC in its Action Plan, released in March.

It’s a very exciting moment. If you think COP21 took place in 2015, was ratified in 2016 and then in 2017 and 2018 we put these pieces in place. This year will be the first year of changing rules and investor behaviour on sustainable finance, and Europe is leading the way. At sector level, the insurance sector is particularly concerned with long-term investment and mitigating climate risks, and at this sector level, AXA is leading the way. This is something we can be proud of.