Financial resilience is defined by sustainability, not deregulation

Inclusive Economy24 May 2016Megan MacInnes

The European Union’s apparently reignited love affair with the financial sector carries with it not only perils associated with the re-introduction of securitization and financialization, but also signifies a potential divorce of Europe’s financial sector from the EU’s social and environmental commitments, as well as from the urgent need to transition to long-term and sustainable growth.

This expert opinion was written in response to our research article on the European Capital Markets Union: Europe and the financial sector: a continuing love affair.

Announced on 30 September 2015, the Capital Markets Union (CMU) Action Plan, launched five days after the new globally-agreed Sustainable Development Goals and two months before the Paris climate change conference (COP 21). Given Europe’s deep involvement in both of these global agreements and its internal commitment to so-called ‘policy alignment’, we would expect these to be reflected in important financial initiatives such as the CMU.

And we are not the only ones expecting joined-up thinking about the financial sector and the systemic risks involved in economic models that are based on the false premise of unlimited natural resources. Earlier this year the Bank of England and European Systemic Risk Board emphasized the impact of climate change on the economy. In a speech made the day before the CMU was launched, Mark Carney, Governor of the Bank of England, criticized short-termism in the financial sector and welcomed moves by the G20 finance ministers and Financial Stability Board to consider how the financial sector could take account of climate-associated risks.

The work of Global Witness, Friends of the Earth Europe and others highlights another threat to Europe’s financial institutions: of not adequately considering environmental, social and governance factors. In other words, there are financial and reputational risks for investors who become financially involved in projects overseas that result in human rights violations, deforestation and land grabbing.

Does the CMU side line and deregulate environmental, social and governance factors?

Disappointingly, the growing recognition among global investors of the urgent need to change direction appears to have been disregarded by a Europe holding on to an anachronistic perception of the financial sector. For example, despite early recommendations by the European Council that environmental, social and governance considerations should play a central role in the CMU, the inclusion of such concerns has been limited to Green Bonds – a specialized and so-far poorly-defined vehicle which side lines the importance of these considerations.

Not only does the CMU fail to strengthen regulations governing Europe’s financial sector, the initiative introduces several deregulatory measures. As Finance Commissioner Jonathan Hill announced in his April 2016 speech, Europe should not “over-regulate” but “work for a regulatory framework that delivers financial stability but which also recognises that without risk, we will not have growth”.

Europe has lessons to learn from progress to ensure that the global financial system is sustainable

Global Witness supports the idea that the negotiations about the future of the CMU need to move from technical to political fora. The Commission, Parliament and other European institutions could do well to learn from the international experience. The global ‘Inquiry: Design of a Sustainable Financial System’ by UNEP concludes that “In the wake of the global financial crisis, recognition has grown that the financial system must not be only sound and stable, but also sustainable in the way it enables the transition to a low-carbon, green economy”, while noting that “A ‘quiet revolution’ is taking place as policy makers and regulators address the need to forge robust and sustainable financial systems for 21st century needs”.

The Commission’s current review of the EU’s regulatory framework for financial services and 2017 mid-term review of the CMU, therefore, should not be seen as opportunities to re-introduce risky financial products and mechanisms (like securitization) and further deregulate the sector. Measures to mitigate the risk for European investors of becoming involved in projects that cause harm (e.g. involving land grabbing overseas, climate change-associated risks and impacting on other environmental, social and governance factors) must be urgently mainstreamed into initiatives such as the CMU. Silo’s between Europe’s financial sector and the EU 2020 Strategy, the Roadmap to a Resource Efficient Europe, the 7th Environment Action Programme, as well as global commitments to sustainable development, climate change and human rights, need to be broken down, rather than reinforced. Efforts to achieve this are inherently political, and rightly so.

In its assessment of the EU, the UNEP’s Inquiry optimistically concludes that “the debate [in Europe] is now advancing to the system level and the need for a strategic reset, seeking to link previously un-connected initiatives and to enhance the capacity of the financial system to support renewed economic competitiveness and improved sustainability performance”. In conclusion, the Inquiry calls for an EU-wide strategy for sustainable finance. It is now up to the Commission to demonstrate if it is up to the task of ensuring that Europe remains competitive in a world where financial resilience is defined by sustainability.