Sustainable Finance News from the Grantham Research Institute, LSE – June 2019

In this month’s update Dirk Schoenmaker outlines a novel approach to teaching the new generation of sustainable financiers. Meanwhile Nick Robins reflects on a resurgence in efforts over the past few months to confront the climate crisis and what implications this might have for Europe’s financial system. We also have a new paper which applies a newly developed insurance pricing model to two catastrophe model data sets relating to hurricane risk.

 Why sustainability means leaving behind old approaches to teaching finance
By Dirk Schoenmaker, Professor of Banking and Finance, Rotterdam School of Management, Erasmus University Rotterdam

Dirk Schoenmaker presents a four-stage framework for sustainable finance in which his favoured configuration, Sustainable Finance 2.0, monetises the social and environmental aspects, placing them on a par with the financial dimension. Part of our Sustainable Finance Leadership Series.

Finance plays a crucial function in our economies. Asset managers and bankers take decisions daily on where to allocate their funds and where not. But they are operating in flawed markets that do not price natural capital or human wellbeing fully. In addition, they are rewarded by incentive systems that largely ignore long-term environmental and social factors. The result is a systematic misallocation of capital to activities that degrade the ecological and societal foundations of economic development.
This is not a problem only for today’s finance practitioners but for the next generation too. Finance textbooks tell students – the asset managers and bankers of the future – that profit maximisation is the guiding principle for these allocation decisions. Sustainability does not figure in this neoclassical environment, one that is still commonplace in most business schools and universities. In many respects, the talent of the future is also being misallocated through these obsolete assumptions.

The good news is that there is agreement that we have to integrate the financial, social and environmental aspects. But the question is how we do this. A key insight from my research in sustainable finance is there are ‘varieties’ of sustainable finance.

Figure 1 summarises a new framework for sustainable finance involving four stages. In finance-as-usual, we just maximise profits (the F-dimension). In a more refined version of the shareholder value model, we pay some attention to social and environmental factors (the S- and E-dimensions), because that is instrumental to future profitmaking. It may be bad for the reputation of an investment fund to invest in so-called ‘sin’ companies that sell tobacco or cluster bombs.

Sustainable Finance event with Dirk Schoenmaker, 10 July, LSE Professor Schoenmaker is taking part in a seminar at the Grantham Research Institute on Wednesday 10 July 2019, 12.30-2.00pm, in which he will discuss his new book Principles of Sustainable Finance (co-authored with Willem Schramade). Professor-in-Practice Nick Robins will offer an LSE view as a respondent. Principles of Sustainable Finance covers key topics in the area, including sustainability, externalities, governance, strategy and integrated reporting. It provides an integrated view on investing, banking and insurance.

We would welcome your attendance at the seminar: please email William Irwin [email protected] to register your interest The ‘Climate Spring’ of 2019: what it means for finance
Nick Robins explores what the recent upsurge in commitment to a net-zero economy could mean for Europe’s financial system.
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Pricing ambiguity in catastrophe risk insurance This paper by Simon Dietz (pictured) and Falk Niehörster applies a newly developed insurance pricing model to two catastrophe model data sets relating to hurricane risk in two locations in the Atlantic basin, estimating ambiguity loads – the extra insurance premium due to ambiguity – and showing how these depend on the insurer’s attitude to ambiguity.
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