Hub for Sustainable Finance Lack of market ‘plumbing’ holds back sustainable investing

We need standards, benchmarks and derivatives to make this sector take off, argues Axel Weber, Chairman UBS.

by Axel Weber 29 Jul 2018

Originally appeared in the Financial Times

As investors look to do well while also doing good, money has flowed into sustainable and impact investments. SII assets under professional management rose 25 per cent1 in the two years to 2016 to $23tn.

Unlike pure ethical investing, SII assets seek to deliver rates of financial return that are comparable to traditional investments, while also generating positive social and environmental outcomes. Academic research shows that this is more than a pipe dream. A 2015 review2 of more than 2,000 studies found that integrating sustainability measures improves, rather than harms, operating performance. Yet SII funds remain niche within total global wealth, which reached $280tn3 last year.

© AFP

Axel Weber

Axel Weber is the Chairman and Non-executive member of the Board.

Why should that be? The answer lies in a lack of financial “plumbing”.

Three crucial pieces of market infrastructure are incomplete for the sector. If we can find ways to construct and strengthen them, we can propel sustainable investing into the mainstream. 

Simplification and standardisation of terms and products

First, the SII industry needs to agree, simplify and standardise its terms and products. The sector must come up with common definitions for sustainable investment, both to distinguish it from charitable giving and to reassure sceptics that the asset class actually delivers positive social and environmental outcomes. But we must also avoid being too prescriptive, lest it hinder innovation.

At UBS4, as we broaden our offering of sustainable and impact products to private clients, we have discovered that there are gaps in core asset classes. While we have worked with the World Bank to open access to development bank bonds, options are lacking for high-yield debt and alternative investments. Financial experts should develop standards for these products and the sector should adopt them.

Meaningful benchmarks

Second, we need meaningful benchmarks. Institutional investors rely on indices and other measures of whether they are meeting their investment objectives and fiduciary responsibilities. Most traditional bond indices include only a small amount of sustainable debt, which makes fixed income investors wary of allocating sizeable amounts of money to the sector.

Benchmarks can spur the mainstream adoption of SII by offering greater market transparency on pricing and liquidity

Index provider Solactive is working with us to create a new family of sustainable development bank bond indices. We hope that this will encourage more institutional and private investors to put capital into the sector.

More generally, benchmarks can spur the mainstream adoption of SII by offering greater market transparency on pricing and liquidity. Importantly, these benchmarks can also bring in new kinds of investors by allowing the financial sector to build new products based on the indices. The industry should work quickly to fill other SII benchmark gaps.

Development of a fully-fledged derivatives market

Third, sustainable investment would also benefit from the development of a fully-fledged derivatives market. This matters because derivatives allow owners of large pools of capital to hedge their risk and move in and out of markets quickly and efficiently without incurring large transaction costs.

Institutional investment capital will only flow into sustainable markets at scale if large asset managers can use derivatives to navigate them in the same way as traditional ones. Deeper derivatives markets would also make it easier for investors to reduce the volatility of their financial returns. That would encourage institutions to pledge capital to sustainable investment projects for longer periods of time and stay invested even in choppier economic or political circumstances. Patient capital is more likely than “hot money” to achieve financial and societal impact objectives.

Private investment is crucial to meeting ambitious global sustainability targets5, such as the United Nations’ Sustainable Development Goals. It is pleasing to see that central banks and supervisors have started to discuss the wider impact investment market infrastructure through initiatives like the EU action plan6 on sustainable finance.

But these assets will only move into the mainstream if both the public and private sectors work together. They must turn our shared interest in solving social and environmental challenges into concrete actions — like getting the SII market plumbing right.

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