20 May 2019, 16:29
Benjamin Wehrmann

Markets still bet Paris Agreement will not be honoured, German finance researcher says

Oil platform by Norwegian energy company Equinor in the northern Atlantic. Photo - Equinor / Øyvind Hagen
Oil platform by Norwegian energy company Equinor in the northern Atlantic. Photo - Equinor / Øyvind Hagen

Financial markets are excellent processors of information - and they currently don't seem to expect that the global economy will be geared towards respecting the Paris Climate Agreement's goals and give up fossil fuel investments, says sustainable finance researcher Christian Klein. The economist from the University of Kassel told Clean Energy Wire what is needed to bring about a change of heart on financial markets regarding climate action, why many Germans are particularly hard to convince of putting their money to a productive use and why green and sustainable investments should be a "no-brainer" for any true capitalist. 

Christian Klein is chairholder at the Institute for Business Economics at the University of Kassel.

When trying to identify how the financial sector can become a driving force in sustainable policymaking, the subject’s enormous scope can make it seem like a daunting task. Finance permeates virtually all levels of the economy and is often a decisive factor in political decision making. Where should one begin to look when trying to get a grip on sustainable finance?

Christian Klein: Sustainable finance to me means to simply add sustainability to the classic “triangle of investment”, namely return, risk and liquidity, when assessing whether or not to put money into any given business venture. And the scope of this principle may indeed seem unlimited. It concerns the state when it sets aside reserves for state employees’ pension funds, it affects people’s private retirement provisions, modernising a company’s equipment and so on. Every single capital owner has to decide whether the classic triangle is all they care about when making an investment decision, or if they take into account that these decisions can affect future generations.

When thinking of how to best ensure a secure financial future, it can be worthwhile considering if you want to do it with investments that make the future less secure for others. The Paris Climate Agreement has helped a great deal in promoting this more wary approach to investing, since it has shown that getting global warming under control will be very, very expensive and require more investments than the state alone could shoulder. This means we also need private capital to fund the necessary decarbonisation measures, both from big multinational companies and from individual citizens looking for a way to invest their savings.

What is currently standing in the way of investors taking these aspects into consideration more?

I think one of the biggest problems we’re facing in this respect is a lack of communication. People need to be explained what’s at stake and what they can do about it. Surveys conducted by us [University of Kassel] have shown that a clear majority of about 70 percent of people say sustainability criteria are important to them when pondering an investment – but just as many also answered that they never applied them when they invested in something. If you ask them why this is so they are likely to answer that they simply don’t know enough about it or that their bank adviser could not give them any substantial information on sustainability.

Others may say that they don’t invest at all and simply keep their money in a savings account – but in that case, it’s the bank that does as it pleases with the money and the saver has no influence on it. All the while, many and especially young people would love to make sure their savings are put to a sustainable use.

So, there’s a lot of idle potential in the sector because people lack the means to take advantage of it?

No, they’re not lacking the means, but rather the knowledge. There’s money and liquidity in abundance here in Germany.

"Some say they don’t invest at all and simply keep their money in a savings account – but in that case, it’s the bank that does as it pleases with the money"

Christian Klein, University of Kassel

Is this lack of knowledge in financial matters something that applies to all industrialised countries or rather a German problem?

There is definitely something peculiar about Germany in this case. The four preferred options of Germans for what to do with their money are either putting it into a savings account, into a fixed-deposit account, into an overnight money account or into a building loan contract. The savings account has to be one of the most silly inventions in finance ever since it pays little interest and doesn’t allow you access to your savings at all times. The fact that it is the most popular investment choice for Germans tells us that something is not going the way it should here – and like the other options, it shows us just how conservative and risk-averse Germans are when it comes to money.

Sustainable finance, on the other hand, mostly relies on investment funds. So it’s not surprising that the share of sustainable investments in private investments in Germany is so small, curently at about five percent. In my opinion, this is due to the fact that we simply offer the wrong kind of financial products. There should be much more sustainable investment models with fixed interest rates here.

And who could offer these products?

Well, there already are a few banks that specialise in sustainability and we currently see that the issue is slowly sipping from its niche into the mainstream. Bigger banks have started to develop products that fit into this category and I’m confident that we will see a major shift of funds soon. The EU Commission’s Directive on Markets in Financial Instruments (MiFID) could soon make it mandatory for bank advisors to advise their customers on sustainable finance alternatives. If this happens, it could give the topic a huge boost as it simply makes sure that those ready to invest cannot stay unaware of it. But it will certainly require a lot of on-the-job training for bank staff to make it work.

How come the EU is tackling this issue only now?

The EU is working on a set of measures in parallel - and the pace in which they carry it out is staggering. The Commission has lumped together the efforts to create a common taxonomy for sustainable investments, the directive on bank counsellors and other activities under the label sustainable finance – even though it does not necessarily touch upon all of the classic ESG criteria of sustainable finance – environmental, social, and governance – but rather is largely confined to carbon emissions reduction. The EU argues it needs to start somewhere to make progress in other areas and, if you ask me, that’s acceptable for now.

If the required legislation is really going to be adjusted to anchor sustainability as a guiding principle in the financial sector, what do companies do to avoid getting caught off-guard by this systemic change in strategy?

Capital market investors have debated the issue of the so-called carbon bubble already for a long time. The bubble basically consists of companies’ fossil fuel assets that cannot be monetised if the Paris Agreement’s minimum goal of keeping global warming below 2 degrees Celsius is to be achieved. For some companies and capital holders who have invested a lot in mining these assets, this means that they would see them turned into sunk costs and possibly face existential problems. US oil and gas giant Exxon Mobile, for example, would lose about half of its current value under this scenario.

But if you look at these companies’ shares there has maybe been a little twitch here and there but no real breakdown anywhere. For me, this is a clear sign that capital markets so far are still betting that the Paris Agreement will not be honoured and that lawmakers are not ready to implement it. There’s no other explanation. But this doesn’t mean that they are bad guys, they simply turn available information into prices, as is their function.

Do you expect the current activities at EU level to cause any change to the current market wisdom?

The German government’s announcement that it wants to turn the country into a leading sustainable finance hub shows that it has acknowledged soul-searching no longer is an option and that it needs to act now if it wants to stay abreast of changes. Administrations like the Federal Environment Agency (UBA) or the German central bank (Bundesbank) have hastily set up sustainable finance departments only now, but at least the staffing with experienced people from the financial industry suggests that they are serious about it. Yet, if you compare it to what has already happened elsewhere, there’s still a long way ahead before Germany can lead on anything in this regard.

But the announcement still appeared quite vague on key points for getting the financial industry in line with sustainable policy and, to a large extent, relied on recommendations rather than concrete duties put into legislation. What needs to happen that market actors have no other choice but to comply?

I read the announcement as a truthful testimony that they are trying to get into gear. The idea to set up a council is a good starting point – if it is staffed in the right way, that is. And I also fully support the idea of improving public communication. Sustainable investment concepts have to be distributed more in the media, be taught in schools, in banker apprenticeships and so on. And the idea to include sustainability criteria in investment criteria for large public funds, such as for pensions, is far from being innovative but nevertheless very welcome as it lets Germany catch up with others in this respect.

Could the council work in a way similar to the coal exit commission and develop concrete proposals for further action?

No one I’ve spoken with really knows how the council is supposed to work yet, even though some of these people will likely end up being in it. This just shows how quickly the decision has been made. I suppose it will be working under the aegis of the German Council for Sustainable Development (Nachhaltigkeitsrat), but in that case it will definitely have to be given greater sway than the latter, which so far - despite the good work it does - has mostly been a toothless tiger that submits its recommendations to the Chancellor once a year and disappears again without visible consequences. The government has to make it credible that it actually intends to get things done, otherwise the markets will simply conclude that fossil fuels continue to be valuable assets for a long time to come.

So communication in two ways is necessary? First, to make the broader public aware that the possibility to invest in sustainability exists and second, to make it clear to market actors that lawmakers are intent on making it the new standard?

That’s right. There has to be a clear signal that policymakers are committed to the 2-degree goal. Forthcoming EU legislation could provide leverage for national progress in the sector, as it has already been the case in other sectors before. And signals could also come from other sides, for example by civil society as in the form of the Fridays for Future school student protests for more rapid climate action. These young people show the world that they know it’s going to be them who will be affected most by environmental damages caused by decision makers today.

"From a capitalist perspective, opting for sustainable investments should be a no-brainer"

Christian Klein, University of Kassel

But even with all the public pressure in the world, capital market actors’ very reason for existing is, and will continue to be, to operate at a profit. How can this basic requirement be reconciled with sustainability principles?

Empirical evidence tells us that there is no disadvantage in sustainable investments compared to ‘conventional’ ones as far as returns are concerned. They even appear to perform slightly better, regardless of their duration. So, from a capitalist perspective, opting for sustainable investments should be a no-brainer. You will not lose money with sustainability. Scientific findings really are surprisingly clear on this.

When evaluating an investment’s performance, you have to factor in risk and returns, the more risk you take the more returns you can get. If you simply look at the returns side, taking big risks should be the norm for everyone, which obviously isn’t the case. That’s why performance indicators exist. And they are saying that sustainable investments are not a disadvantage, period. It used to be common wisdom to pension funds and other big investors that considering sustainability criteria would violate their duty to seek maximum returns, but this logic is now being reversed. If sustainability is no worse and even likely to offer better performance, the duty would then be to consider them right from the start. But this still has to sink in within the mainstream.

And what about industry experts?

Things are different if you look at institutional investors, the share of sustainable investments here is growing much quicker than in consumer retail, and it is unlikely that this is because institutional investors act in a more ethical way than small investors. They simply follow the evidence available to them. If anything, it illustrates that the lack of sustainability standards is not due to unpopularity with professionals but rather due to the inexperience of non-professionals.

All texts created by the Clean Energy Wire are available under a “Creative Commons Attribution 4.0 International Licence (CC BY 4.0)” . They can be copied, shared and made publicly accessible by users so long as they give appropriate credit, provide a link to the license, and indicate if changes were made.
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