Introduction

The world has changed and developed over the past century at a previously unmatched pace. Technological progress, mass education and involvement in societal change are accompanied by excessive exploitation of the natural environment and the destruction of the basis for our survival. This entails significant ramifications for the financial industry, which is intertwined with every economic sector through investment and lending.

Over the long term, it will no longer be possible to continue "business as usual" on the basis of familiar strategies – be it with respect to saving our planet or in view of our financial system. Every effort will have to be undertaken in the coming decades to bring about fundamental transformation in a wide variety of economic sectors if we want humans to be able to survive in every part of this planet in the long-run. This article will describe three essential conditions for that vital transformation and map out how each of those conditions is interlinked with the others. What is required is the consistent diversion of invested funds into transformative companies and projects; clever and consistent regulation that sets the right incentives; and a new attitude on the part of financial market players – including a change in business practices.

Where do our society and the financial markets find themselves today?

Given that the financial industry is intertwined with every sector of the economy around the globe, there is immense pressure to act in response to global, societal and ecological challenges. The two greatest global challenges out of the many we face are the limited availability of finite natural resources and climate change.

Research on global warming has made tremendous advances in recent years. It has highlighted that the primary hindrance to humankind's continued development is not the consumption of finite raw materials; instead, moderation is required because of planetary boundaries¹. Once these boundaries are reached, there is the risk of irreversible damage to the environment and thus the basis for human survival.

According to the Potsdam Institute for Climate Impact Research (PIK)², four of the nine planetary boundaries have already almost been crossed as a result of human activity: climate change, loss of biosphere integrity, land-system change, altered biogeochemical cycles.³ If things continue as they have been and we burn through all available finite resources, such as coal, oil and gas, we are only fuelling the climate crisis, rendering human survival on Earth impossible.

We will thus be confronted with significant upheaval in the 21st century, due to humankind's blatant exploitation of the environment over the past decades. Researchers and scientists thus speak of the necessity of social-environmental transformation if humans are to be able to survive on this planet in 100 years' time.

The following areas will undergo radical transformations, entailing a fundamental change in our economic structures and way of life:

• Energy: the energy supply will need to be decentralised, largely renewable and much more efficient with respect to the use of energy and electricity than at present. A much higher price per tonne for CO₂ will lead the way. This will require more decentralised electricity grids, sturdy infrastructure and a change in the way we heat our homes and businesses.
• Agriculture: we will need to reduce the share of meat in our diets and eat more regional and seasonal fare. Organic foods will become the standard. Rendering financial assistance available will be the key to transforming agriculture and improving incomes for farmers.
• Transport: this will go hand-in-hand with the changes to how we produce and consume energy. Researchers speak of "factor-10 mobility", i.e., that in future we will reduce the number of automobiles in urban areas to one-tenth of the current fleet. The agenda for the coming years includes intelligent, sustainable mobility, supported by digitalisation and considerable investment in rail infrastructure, public transport and new cycle lanes, alongside urban redevelopment and workplace transformation.
• Consumerism: the four fundamental principles behind self-sufficient lifestyles and consumer habits – decluttering, decelerating, disentangling and decommercialising – will lead to significant changes in the way we spend our money. This does not necessarily mean going without, but rather "living differently".
• Finance: a different attitude towards the incentives provided by money, alongside the greatest-possible transparency and a clear focus on financing the real economy and sustainable business models will be the hallmarks of the new financial industry. This means significantly reducing complexities that create no added value for society and instead financing socially and environmentally responsible ventures and innovations.

Let me be clear: the transformation of the financial industry is one of the most important levers of change in the other areas because the financial industry operates within the political framework to render public and private funds available so that change is possible.

According to the United Nations Conference on Trade and Development (UNCTAD), USD 3.3-4.5 trillion in public, private, national and international funds will be needed annually to finance the Great Transformation⁴ and to fund the implementation of Agenda 2030 and its 17 Sustainable Development Goals (SDGs)⁵ – in emerging economies alone. The total amounts are even greater: the European Union estimates that the annual funding requirement just to achieve its climate and energy targets by 2030 is EUR 180 billion.⁶

These amounts go far beyond national budgets and are more than a matter of fiscal debates in the German parliament. So this raises two questions: How can we – society in general, and the financial market specifically – achieve this? And what has to change?

How can we achieve this?

In times of increasing complexity, we should all be wary of solutions that are too simplistic. On the other hand, different solutions can be expedient as long as they are not one-dimensional and instead complement each other.

I would therefore like to outline three responses which, although they each operate on a different level, complement each other as a whole.

Diversion of financial flows

The European Commission stated its objective very clearly in its 2018 Action Plan on Sustainable Finance, and described it in unmistakable terms: the capital market should render a sustainable real economy possible. In its action plan, the European Commission elaborates on the challenges posed by climate change and the scarcity of resources and concludes that the key role played by the financial system lies in the diversion of investment into sustainable solutions. Put plainly and simply, we must steer funds away from climate-exacerbating, resource-wasting brown investments and towards environmentally friendly, socially compatible green investments.

Unfortunately, the European Commission's action plan fails to generally question the growth paradigm (for the time being), stating for example: "Specifically, this Action Plan aims to reorient capital flows towards sustainable investment in order to achieve sustainable and inclusive growth"⁷ In my view, we will also have to have the debate in the coming years as to the nature of growth we want and what paths there are towards a non-growth-oriented economy. This is because the roots for many problems lie in a systemic crisis that is oriented towards exploitation and which sees the economy as the only structuring axis of society. This requires a fundamental change, not "business as usual" under the cover of sustainability or the UN's colourful SDG icons.

Until our thoughts and actions become so radical, one potential avenue for consensus appears to be the diversion of private and public investment. In this respect, the SDGs can offer a sound path forward. For the first time, they spell out a precise definition of which societal goals can ideally be achieved through sustainable investment. They articulate the most pressing challenges of our age and hence also describe the relevant material issues for financial investors. This makes them the guiding benchmark for the responsibility of trust incumbent upon institutional investors around the world.

Beyond the ethical aspects, they are relevant from the perspective of risks and opportunities. It can be assumed that the UN's SDGs and the issues they address, such as climate change, social inequality and the use of finite resources, will gain significance going forward. These issues will undoubtedly be addressed in future regulation – preparations are already underway or on the horizon in certain countries; they will also be priced into financial products as potential systemic risks. At the same time, major investment will be increasingly channelled towards resolving our global problems, e.g., in renewable energy, sustainable farming and cities and infrastructure that are fit for the future. As a forward-thinking investor that is contemplating these aspects early on from a risk and opportunity perspective and with a determined attitude, Hannoversche Kassen expects to leverage considerable advantages in this regard.

Regulation, regulation, regulation – the way forward!

The regular laments of attendees at banking sector events over the past five years concerning the three great challenges (regulation, digitalisation and the low interest rate environment) bring to mind the film Groundhog Day: these three issues have always been a source of contention.

When pressure from Brussels began to climb in 2018 as a result of the recommendations of the European Commission's High-Level Expert Group⁸ and the Action Plan on Sustainable Finance⁹, virtually the entire financial lobbying industry (from the German Association for Occupational Pensions (Arbeitsgemeinschaft für betriebliche Altersversorgung e.V. – aba) and the German Insurance Association (Gesamtverband der Deutschen Versicherungswirtschaft e.V. – GDV) to the German Investment Funds Association (Bundesverband Investment und Asset Management e.V. –BVI) reflexively proclaimed: "We don't need any more regulations, we are burdened enough already. Just let us continue to police ourselves on a voluntary basis. The market can regulate itself best."

No, it certainly cannot! Over the past twenty years, waiting and hoping for the industry to regulate itself did not bring about any significant change. The share of sustainably managed funds is below five percent, sustainable financial advising is not widely offered by German banks, and the global environmental problems are worsening rather than improving.

Of course it is true that the sustainable financial market has taken great strides in the past twenty years and has posted solid growth – and all that without regulation. It is the avant garde that develops and implements ideas that serve as an example to the conventional market.

However, good ideas can only be implemented and scaled up if policymakers define clear standards, commit to sustainability¹⁰ and set out unambiguous guidelines. This also involves determining which investments are no longer acceptable, or alternatively making them less lucrative by imposing equity premiums to price in many more risks to account for environmental, social and economic factors than is the case for sustainable investments.¹¹

Capital charges imposed on banks, insurers and pension funds provide important incentives. In recent years, policymakers and regulators have argued in favour of considerable privileges for government bonds in order to mitigate the euro and sovereign debt crises with the help of the financial sector. A gradual change in course would be desirable here, so that investors with a clear focus on sustainability can have more leeway to invest in assets other than government bonds and Pfandbriefe, such as investments in infrastructure and education.

Another key issue that policymakers must address with urgency is the internalisation of external costs. At present, there is no price to pay for the exploitation of land, for restoration of brownfield land and exhausted mines, for the remediation of environmental catastrophes and deforestation; there are virtually no prices on CO₂ emissions and no price is paid for ensuring adequate wages in many parts of our globalised economy. Many of the modern conveniences of daily life (closets full of clothes, flights to weekend getaways, wine from California and avocados from Costa Rica) can only be enjoyed in such excess because no price is paid to offset the social and environmental impacts within global value chains.

When it comes to this, everyone is more than happy to implicitly deny the mantra so often repeated throughout the financial industry of "rational markets". The markets are not rational! If a tonne of CO2 were to cost EUR 180 – a price the German Environment Agency considers fair¹² – and not only EUR 22.30 (as at 31 January 2019), this would have a significant incentive effect. Sustainable business would sell itself.

Of course, we must also address mechanisms of social compensatory measures and how the impact on low-income earners can be mitigated, as called for by leading economists and Nobel laureates from the United States in January 2019.¹³ Yet the upper third of the highest-earning in this country can certainly be asked to pay the real prices.

It's up to all of us.

Whether as a banker, a member of the board of directors of a pension fund or a department head in the Ministry of Finance: all of us – both private persons and officials – will have to face the fact that our consumer habits need to change and familiar processes have to be questioned. For decades, players in Germany's sustainability debate have focused on efficiency and consistency as guiding strategies for success. Preaching sufficiency was bad for business, kept the Green Party out of the German government and does not fit with the German economy's growth paradigm at all. For many years, the hope – particularly in technophile Germany – had been that only technological advancements such as the 3-litre engine or energy-saving light bulbs would be the solution. No constraints on consumption, just a whiff of efficiency or a green tinge would save the day.

Yet events of recent years have made it clear that the rebound effect negates all gains in efficiency and has caught up to all of us. While individual devices have become much more efficient and require less electricity, almost everyone has not only a landline telephone but also at least one mobile phone, a tablet, a PC and maybe even a gaming console – meaning that any gain in efficiency is eroded. Electricity use is rising, not falling, with a similar trend for general consumption of materials and resources.

However, if a true socio-environmental transformation is to succeed, we have to reduce our massive use of resources – significantly. Researchers at the Wuppertal-Institut have calculated this in their environmental footprint model, and have concluded that everyone needs to reduce their average annual environmental consumption from the current 30 tonnes to approximately eight.¹⁴ For the financial industry this can (or should) mean: no more company cars, as these create the wrong incentives – instead, everyone should receive discounted rail tickets; no more flights between German cities, but instead conference calls and videoconferences; fewer pointless meetings where attendance is required but no effective decisions are taken.

What has to change in the financial industry?

Having asked around in various segments of the financial industry, my impression is that much responsibility has been surrendered in the context of this debate. One argument I have often heard is that financial market players cannot save the world and are merely actors without any major agency to shape the debate. And many are wholly uncomfortable with the idea of taking on the central role in restructuring our economy. Why is that? And in what way must those responsible within the financial industry change their thinking and actions?

Pioneers of change are needed!

The far-reaching changes within the financial sector – brought about by increasing digitalisation, the rising number of fintech companies and the persistent low interest rate environment with the associated slow erosion of the interest rate business – pose the risk of over-straining the sector, yet also represent an opportunity for institutions. They have to leave their comfort zones and think outside the box. But this is not something they have been taught to do. Account openings, overdraft fees and derivative hedging transactions are part of their daily routine, but they often have too little interest in social issues and the role their institutions play.

Now more than ever, banks, insurance companies and asset management companies need people who question the existing order, who are prepared to leave the mainstream path, to consolidate different points of view and to test out new ways of solving problems. We need sustainable leaders – especially in the financial sector.

Figure 1: Changes in society and companies within the context of sustainability

Source: own data

The Sustainable Leadership concept, which was forged primarily at the University of Cambridge and in Germany at the Leuphana University of Lüneburg¹⁵, includes not only current leadership and organisational theories but also relevant sustainability strategies (consistency, sufficiency and efficiency). It comprises the following view of leadership: "Sustainable leadership seeks to find a long-term balance between economic and social objectives by steering employees' behaviour so as to fulfil the company's purpose, while at the same time ensuring that the required human resources – tangible (workforce of employees) as well as intangible (knowledge, skills and competencies) – are preserved for the long term."¹⁶

This very general definition is expanded upon by the seven core characteristics of sustainability leaders¹⁷ at the Cambridge Institute for Sustainability Leadership:

1. Systemic understanding
2. Emotional intelligence
3. Values orientation
4. Compelling vision
5. Inclusive style
6. Innovative approach
7. Long-term perspective

These demands represent a high bar against which to measure leaders. For two of these characteristics in particular, the ideal and the reality often diverge greatly: systemic understanding and long-term perspective. Very few leaders, especially in the financial industry, understand systems theory. Although they deal with a highly complex system such as the financial system on a daily basis and operate within highly regulated organisations (primarily banks and insurance companies), the predominant attitude is highly monocausal and marked by homo oeconomicus in the ideal market. They only have a below-average understanding of the interdependencies between the players, the different motives that guide bank customers and knowledge of the management of complex systems. They therefore require insight and a deeper understanding of the systemic outcome: the success of interventions in organised complexity is often slight.

The same goes for the requisite long-term perspective: in times of quarterly reporting, constant observation and commentary through social networks and remuneration systems with a focus on the short term, a long-term approach is left by the wayside, as is open, creative thinking for the future and deliberately testing out different possibilities.

Team diversity is also in demand – as far as gender, experience, academic background, cultural heritage and problem-solving skills are concerned. Bankers, exit your (environmental) bubbles! What the financial institutions of this Republic urgently need is people with an entrepreneurial spirit, self-efficacy, motivation and stamina, as well as respect for other people's ideas. We need change agents – especially in the financial industry.

Knowledge and audacity required!

Transformation research aims to discover just what it is that change agents have to be able to offer. "The art of conceiving another reality and translating it into change requires a special mixture of knowledge, attitude and specific skills."¹⁸

If we first consider the aspect of knowledge, we may at this point critically ask where and in what quantity and quality the topic of sustainable investment has been part of training courses, economic studies or special training programmes for board members in the financial industry in recent years.
One would have to look very hard to find it! Tomorrow's leadership elite is being educated at various institutions and the topic of sustainability does not appear on a single PowerPoint chart. Perhaps as a voluntary element for a fraction of students and bankers – at most.¹⁹ It's a good thing that regulation will be setting out new requirements in this regard. The EU's Action Plan²⁰ envisages giving greater priority to the issue of sustainability in financial advisory services than in the past and making it an integral part of advice, similarly to how risk appetite and expectations for returns are gauged. This will entail comprehensive training for all bank advisors to ensure that they are prepared to offer advice.

In addition to knowledge, specific skills are required to bring about change in conventional industries – including the financial sector. The expertise required is not so much the standard business administration and financial market theories but rather competences in organisational development, moderation skills and theories covering new, forward-facing forms of organisation, be it holocracy or reinventing organisations.²¹ It is not so much the traditional skillsets that will be required from future banking and insurance executives, since these skills can always form only a foundation; rather, future executives will have to work with employees to establish new, agile, and resilient organisations that render financial services for people and enterprises.

However, the key matter in sustainability is not only expertise and skills, but also attitude.

Attitude is everything

Over the past 20 years in many expert panels with executive boards and workshops with representatives of conventional banks, I have seen a lot of apprehension about sustainability in investing. A few quotes from a workshop with pension funds' CFOs last year illustrate the widely-held defensive attitudes:

• "The financial industry is not here to solve climate change."
• "Sustainability ratings are costly, time-consuming and highly individual."
• "We only invest in democratically run states."
• "We only want a little bit of sustainability."

Or as the investment policy of a major pension fund for one DAX company puts it: "When investing, the pension fund assumes that the state enacts laws and creates regulatory frameworks that lead to securities issuers and companies generally conducting themselves in an ethical, social and ecological manner that promotes the common good."²²

Concealed behind this is the attitude that responsibility as a major trustee for funds is completely in the hands of the state. It pretends that money is neutral, a merely objective, purely logical means of payment. As if the investor has no power or agency whatsoever and need only worry about the wondrous creation of more money. They act as if financial investment were simply following quantitative mathematical principles in a black-and-white world. But this is not the case.

Anyone who has sat around a table with colleagues to determine the best, safest, most profitable investment for a defined time knows that this is anything but logical, unambiguous and clear. This is a rather discursive process, whereby various arguments are weighed against each other – there is no sense of certainty that one is right. When we make investment decisions – even conventional ones – we always make assumptions about the future and the uncertain development of the markets.

Therefore, I would like to call on all members of executives and employees at the banks, insurers, Pensionskassen, fund companies, rating agencies, foundations, supervisory authorities and ministries to decide on an attitude for themselves: What sort of a world do you want to live in? And how can you personally steer money in a sustainable direction?

Financial market players should not pretend that they have nothing to do with real life! They finance the economy and thus play a crucial role in deciding the direction in which the economy and society will develop! "Those who finance the economy help to decide whether our economy and way of life will be sustainable." ²³

According to a current study by Kommalpha²⁴ the total financial assets held by insurance undertakings and institutions for occupational retirement provision in Germany amounted to approximately EUR 2,802 billion as at 30 June 2018. This represents more than eight times the German federal budget for 2018 (EUR 335.5 billion)²⁵ and an increase by EUR 1,170 billion in just under 13 years. From a purely quantitative perspective, an attitude and assumption of responsibility for shaping investment is essential: money makes the world go round. At the same time, these dimensions beg the question: who legitimises the investments of insurers? And who controls the power that comes with this?

A small cog in a large machine

I myself am a member of the Board of Directors of Hannoversche Kassen, where I am responsible for investment. We are a relatively small player with total assets of EUR 422 million. Nevertheless, for many years we have had a clear sustainability strategy. This began with defined social, ecological and ethical selection criteria for all asset classes and investments. At the beginning of 2019, we became the first pension fund in Germany to publish a Transparency and Investment Report²⁶, in which we report how and where we invest our funds for policyholders.

We at Hannoversche Kassen have taken this first step towards increased transparency with the aim of promoting discussion of responsible and sustainable investing, as well as to disclose the conflicting objectives which shape our actions every day when it comes to sustainable investment in the low interest rate environment. For one thing is clear: however ambitious we already are, our approach still has considerable room to grow because a truly sustainable portfolio should have much greater social impact than does our current (for the most part) highly conventional bond portfolio. Recent years of preferential legal treatment for government bonds have (unfortunately) slowed us down significantly in this respect.

We aim to continue carefully reallocating our portfolio towards greater high-impact sustainability in the coming years. We do so in close cooperation with our members and policyholders, because ultimately we manage their future pension claims as a trustee.

We are often asked how such a small institution as ourselves manages to bear the significant effort and additional expenses for sustainability research. Certainly, there are additional costs, but we consider them part and parcel of risk provisioning. Good, critical sustainability ratings provide us with a 360-degree view of our investments and warn us off from certain ones that do not qualify due to a poor ESG performance.²⁷ In addition, we do not experience any cuts in net interest, but rather are well within the averages for all Pensionskassen. What is currently making our lives difficult is not strict sustainability criteria limiting the pool of available assets for the portfolio. Rather, it is the long-persisting low interest rate environment and the preferential treatment for presumably safe government bonds.

Our aim is to network with other committed Pensionskassen and institutions for occupational retirement provision to enable us to exchange ideas and learn from each other, and to be open about investments which currently still do not fulfil our own standards. Hannoversche Kassen is but a small cog. And yet we believe that our special mix of attitude, expertise and skills enables us to make our contribution to change. The coming years – if not decades – will be challenging for us all.

Conclusion

"The worst thing we can do is nothing, and to allow things to continue along the currently dangerous path. The necessary changes must be aimed at a new paradigm with respect to our relationship with the earth and nature, as well as the way we produce and consume. […] More than ever before, the word revolution in its true meaning would be fitting here."²⁸

So, to paraphrase Leonardo Boff, do we need a revolution in the financial markets or a revolution in the thinking of those responsible for finance?

As I have argued in this article, three things need to change fundamentally: we need to systematically divert invested funds into transformative enterprises, we need a coherent political framework for regulation, and we need a new attitude and a clear will to shape change within the financial sector.
Policymakers have clearly stated their commitment to the UN's Sustainable Development Goals (SDGs) discussed above, and clearly defined the framework for future development paths; in the day-to-day business it is now more important than ever to further define and implement this framework through focused, verifiable and knowledge-based approaches in the respective policy fields. To achieve this, we need politicians to show some backbone and take on lobbyists from powerful traditional industries. This is because the truths that they have to legislate and enforce will result in profound changes in every aspect of our lives.

Regulation follows politics. It brings policy to life and measures performance against set targets. And certainly, the entire regulatory framework for the financial markets has to be constantly monitored to ensure it is fit for purpose and guarantees proportionality.²⁹ But specifically with respect to achieving ambitious sustainability targets, it can and must continually raise the bar, because it is no longer possible to ignore the fact that ecological boundaries are being irreversibly crossed.

Financial market players themselves must take action. In this era of momentous global change, in times of uncertain future prospects, in times of populism and nationalism, those responsible in the financial industry often tend to bury their heads in the sand and structure their investments as inconspicuously as possible.

But waiting is not an option. It is vital that we take responsibility for our own actions, which can sometimes lead to poor decisions, to take responsibility for our own role as investors in this world and to acknowledge the incentives money offers. This is the attitude that financial market players must have in the 21st century.

It requires responsible people in the financial industry who want to shape this world, who want to engage in debate to find the right solutions and who want to develop new, sustainable financial institutions. After all, money is never neutral; it does what we tell it to do.

Footnotes: