IFoA review on the link between environmental sustainability and the financial system finds three key areas which need addressing

Posted on Jul 9 2015 - 8:05pm by John Peters
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  • sustainability of the policy of pursuing growth without limit within a finite ecosystem
  • implications if GDP were to be replaced as the key measure of economic success
  • limitations of using discount factors for long term capital allocation and investment decisions

    The review found a consistent pessimism on the role traditional economics plays in promoting behaviours that contribute to resource depletion and the inability of the current system to reform these behaviours.

    The review found a consistent pessimism on the role traditional economics plays in promoting behaviours that contribute to resource depletion and the inability of the current system to reform these behaviours.

The Institute and Faculty of Actuaries (IFoA) has released a review of existing research on the potential risks to long term environmental sustainability the financial system could pose and found a number of issues that need to be addressed.  Leading experts Lord Adair Turner and Professor Richard Werner spoke at the event on the impact of monetary policy on the economy and the environment.

The IFoA review, entitled Sustainability and the Financial System, consisted of a systematic search of 125 top rated journals and 355,000 articles and found that surprisingly only 40 research papers addressed how the financial sector related to the issue of sustainability.

The review found a consistent pessimism on the role traditional economics plays in promoting behaviours that contribute to resource depletion and the inability of the current system to reform these behaviours.  Three key themes were identified where further research is needed in order to understand the implications for anyone working with long term financial institutions:

  • The policy aim of pursuing growth without limit within a finite ecosystem
  • The potential replacement of GDP as the key metric of economic activity and success. GDP has received much criticism. In environmental terms it does not capture the depletion of existing natural or human capital and so promotes capital erosion.
  • The limitations of discount rates for making financial decisions needs to be better understood as it may have unintended consequences for sustainability. With the current approach the far future may appear worthless (having negligible capital value).

Nico Aspinall, one of the authors of the report and the incoming chair of the IFoA’s Resource and Environment Board comments,

“We found that current research shares the general view that the growth-oriented economic model we currently use results in an increasingly fragile financial system and that the current system does not provide any incentive to fully recognise natural environment and resource constraints. In addition, there is little analysis of the wider impact of the natural environment on the financial system and economy.

“We found that the solutions offered in the existing research are relatively limited and small-scale in their outlook.  There is a vital need for further research, particularly for actuaries and others who are required to take a longer term outlook, to ensure our financial system is sustainable in the long term.”

At the event, Lord Turner said:

“If you discount the far future at the sort of rates of return that private sector participants believe they are going to get, or even very low estimates of that, you will do nothing about climate change whatsoever.

“In essence I think we have, in the relationship between finance and the real economy, a set of major problems that even if we didn’t have a problem of sustainability we couldn’t necessarily rely on free financial markets to achieve optimal results.  And when we introduce the exponalities of the environment and climate change we can rely on it even less.   And that’s why I think it’s very valuable that actuaries are thinking carefully about what is the link between sustainability and the financial system and what is their role in that.”

Professor Werner, lead author of the paper, said at the event:

“The literature review is the necessary and important first stage of a research programme.  What we’ve now demonstrated is that the so called leading journals have failed dismally covering this, in addressing the question let alone the solutions.

“The literature review itself is very important to demonstrate this and I am grateful to the actuarial profession for putting together resources to support it.  Much more research is required that must be done empirically, grounded in research, with statistical analysis to back it.”

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