Paper Title: The Value of Societal Values in Finance

Author:        Carolin Schellhorn

Publisher:    International Journal of Ethics and Systems, Vol. 40, No. 4, 699 – 710.

Author explains that quantitative finance models and empirical tests with observable data were developed to help managers and investors achieve goal of returns maximization while providing support for an expectation of objectivity, consistent with the traditional claim of science as being value-free. However, the financial crisis of 2007–2009 raised profound questions regarding the stability of the financial system that had been built on this new discipline and the discipline’s ability to benefit society.

Since then, concerns about financial system stability have been compounded by growing concerns about the sustainability of other societal systems, such as the energy system, the food system and the transportation system. Because societal systems are interdependent and collectively depend on the stability of planetary systems, crossing Earth system boundaries compromises safety and social justice.

As human activity continues to generate large amounts of greenhouse gases, causing average global temperatures to keep rising, and as the degradation of ecosystems and the destruction of biodiversity proceed, growing systemic risks are magnifying existing uncertainties.

Author argues that finance professionals need to recognize that their practice cannot be value-free, and it cannot operate in a policy vacuum, if the finance discipline is to benefit society.

Standardization and a narrow focus on financial objectives, models, tools and data has long been one of the strengths of traditional finance because it provides focus and facilitates comparisons and benchmarking. However, by focusing on observable asset prices and rates, traditional financial decision-making in theory and practice is ignoring important nonfinancial information, which is allowing negative environmental and social externalities to grow unabated, thus contributing to the global systemic threats rather than mitigating them.

The finance profession is attempting to correct these problems with greater attention being directed to environmental, social and governance (ESG) factors, and management practices focused on corporate social responsibility (CSR) including social diversity, equity and inclusion as well as the abatement of greenhouse gas emissions.

However, these largely uncoordinated efforts by some individual investors, managers and institutions risk weakening financial performance, at least in the short run, and therefore require comprehensive policy support to level the playing field and scale the efforts.

The author urges that deep and rapid decarbonization must become a global priority because climate tipping points will likely be reached much sooner than previously expected as greenhouse gas emissions continue to rise. To safeguard humanity and its societal systems, it is not only important to consider the time it takes to achieve decarbonization, but to ensure that we avoid reaching the climate tipping points.

Many themes that fall in the category of ESG investing are also represented on the business management side in the CSR category.  Examples  include  reducing food waste, water and energy use, moving from industrial to regenerative agriculture and transitioning to low- carbon transportation. Sustainable finance encompasses both the ESG and CSR categories as well as climate-related and sustainability-related market innovations, such as green bonds, social bonds and debt-for-nature swaps.

Investors interested in sustainable finance exhibit a range of financial return expectations. Philanthropists, at one end of the spectrum, provide funding with no expectation of financial return, while investors at the other extreme are unwilling to give up any financial return in exchange for intangible societal or corporate benefits.

Just as investors differ with respect to their degree of risk aversion, they also have different preferences regarding expected outcomes in the form of societal impact and financial return. Some impact investors aim directly for achieving certain SDGs.

Other investors participate in public– private partnerships or sustainability- related projects funded with blended finance at costs below market rates to accelerate the transition to a more sustainable economy. SDG-related investing may be faith-based, ethically or morally motivated or driven by concern for the stability of societal systems and the prosperity of humanity and civilization.

Author contends that managers must be motivated by societal values to acquire the science-based information relevant to address SDG-related issues such as living wages, the values of ecosystems and biodiversity and use this information to guide their fund allocations and decision-making.

Author also envisions multidisciplinary collaborations among researchers and industry experts to create systemic change. This approach requires professionals in all industries and governments and all finance-related functions to cultivate a holistic mind-set informed by societal values.

Author thinks that comprehensive reform of economies and social systems is necessary to ensure that humanity remains within multiple Earth system boundaries.

Author recommends that training to become a finance professional should only be possible after an individual has received a solid foundational education in societal values and the 17 SDGs. Young finance professionals will be tasked with adapting or reforming existing models, concepts and tools so they can be used to achieve outcomes consistent with the SDGs.

Author discusses that innovations in financial practice could include, for example, loan or bond covenants that require corporate borrowers to refrain from engaging in anti-ESG activism or anti-SDG lobbying. Not only would this reduce the obstruction of climate and prosocial legislation, but it would also increase shareholder value by reducing lobbying expenses.

Author also suggests that compensation in the financial services industry must be aligned with the desired SDG-related outcomes to incentivize large-scale innovation and reform, not only for executives but for professionals at all levels of an organization’s hierarchy. Once inertia and aversion to change are overcome, market participants may find that systemic change is not as prohibitively difficult as it may currently appear.

Author feels that educational reforms are needed to prepare young people for these challenges. Households, businesses and governments will be called upon, planet-wide, to collaborate in deep decarbonisation efforts to avoid reaching climate tipping points, which would have catastrophic consequences involving massive destruction well beyond financial wealth. For value creation to last, it must be based on the societal values of each individual market participant, and these must be anchored in the 17 SDGs.