|28 July 1998|
PROFITABILITY AND RESPONSIBILITY
IN THE 21ST CENTURY
Concern about the environment is no longer an optional extra for the business community. More and more financial institutionsinvestors, bankers, and insurersare realizing that their future depends on backing the right kind of economic development. If infrastructure, industries and trade are not built on principles of sustainability, it is not just bad for the environment; it is also bad business.
The United Nations Environment Programme, charged with encouraging partnership in caring for the environment, started working with forward-looking organizations in the financial services sector at the beginning of the decade. Since its creation in 1972, UNEP had always had a mandate to encourage economic growth compatible with protection of the environment. But this special element of UNEPs role was considerably enhanced by the Earth Summit in 1992 and placed great emphasis on promoting development that did not compromise the quality of life of future generations.
UNEP was convinced that bankers and investors had a valuable contribution to make in protecting the environment while maintaining the health and profitability of their businesses. Many of the largest and most respected international banks responded to the call, working with UNEP to draw up statements of environmental commitment for the sector; promoting environmental issues and, through workshops, seminars and roundtable discussions, helping disseminate information about best environmental practice throughout the industry.
The financial services sector has an important stake in promoting sustainable development. Investments that take no heed of the future, that destroy or deplete natural resources needed for future development, do not make economic sense. Environmental degradation and man-made ecological catastrophes threaten the very basis of the sector, which depends on being able to calculate and manage risks.
The negative environmental impact of some kinds of industry and some types of development is increasingly covered by international legislative frameworks. Bankers and insurers have to operate within this increasing global regulation.
As we approach the end of the decade and the end of a millennium, the interdependence of environmentalists and business makes itself more and more evident. It is not just a question of what the financial services sector can do for the environment but of what environmental awareness can do for bankers and insurers.
The economic rewards of placing environmental concerns high on the agenda are considerable. Green investment is booming as concerned individuals and organizations look for environmentally sound ways to invest and plan for the future. Sustainable development is good long-term investment.
117 financial institutions have now publicly endorsed the principles of greener banking and investment. More than 70 major insurance or reinsurance concerns have endorsed a similar commitment to the environment for the insurance industry.
Financial Services Initiative
The Financial Services Initiative recognizes the common interest that environmentalists share with financial institutions daily responsible for investment decisions. Both are concerned with halting the degradation of the planet. UNEP formally launched the initiative for banks at the 1992 United Nations Conference on Environment and Development in Rio to agree a programme for sustainable development.
The principal aim of the initiative is to generate a constructive debate between commercial banks, investment banks, venture capitalists, insurance and reinsurance concern, multilateral development agencies and asset managers all those involved in economic development and managing risks and environmentalists. A secondary objective is to foster private sector investment in environmentally sound technologies and services.
The idea was extended to insurance and reinsurance organizations at the end of 1995 with the launch of the Insurance Industry Initiative on the Environment. Why were insurance companies interested? Theyre not polluters. Insurers, like bankers, are major investors and manage large funds for their clients, so they share all the concerns of bankers. But, in addition, they have specific concerns about environmental degradation and catastrophes. Oil spills and chemical pollution, for example, cost huge amounts of money. Unpredictable storms and hurricanes threaten to cost even more. The core business of the insurance industry is to manage and assess risks, including environmental risks. The consequences of environmental catastrophes, particularly weather events arising from climate change for the stability of the industry could be very serious. Loss prevention is better for insurers bottom line than paying out claims for events that could have been avoided.
Major banks and insurance groups from around the world have put their name to the statements. A major plank of both is a commitment to sustainable development and support for the precautionary approach to environmental management that attempts to anticipate and prevent environmental degradation. The signatories also undertake to promote public awareness and communication.
Its more than a promise to be a bit more environmentally aware. The statements commit those who sign it to specific practices, such as energy efficiency, recycling and waste reduction. Signatories recognize the precautionary approach to environmental management, in other words anticipating the consequences of financial management decisions and thus avoiding potential environmental degradation. The statements also acknowledge the need for a continuing dialogue with customers, shareholders and employees.
In all this UNEP has played a catalytic role. The Financial Services Initiative is directed by a steering committee consisting of eleven representatives from member institutions, one representative from UNEP, and a non-voting representative from the International Finance Corporation of the World Bank. The Insurance Initiative has a steering committee of six representatives from leading insurance companies, plus a UNEP representative.
The first task of that small group working with UNEP was to prepare a document that could be given to interested banks and investing organisations to help them focus on environmental issues and consider their possible roles.
The result was the Statement by Banks on the Environment and Sustainable Development that was submitted to the Earth Summit in 1992. More than 30 banks immediately signed at that meeting. The statement promoted environmental management practices, encouraged environmental impact assessment as part of investment decisions and promoted the implementation of the precautionary principle; by mid-1997 the list of signatories had passed the one hundred mark and continues to grow.
The statement, since revised on the basis of the complexities involved in describing the entire world of finance, proved a useful tool for generating debate and discussion within the industry. It quickly led to the formation of the Advisory Group on Banking and the Environment and to the first of several international round table meetings aimed at bringing together bankers and investors from different commercial backgrounds and regional perspectives. Many of the issues discussed at that first international event held in Geneva in September 1994 still top the agenda at workshops and seminars. They included environmental risk assessment in relation to credit procedures; opportunities in environmental financing and internal operations and environmental performance.
Within a year of formation, the Advisory Group on Banking and the Environment set out to discover how the wider financial services industry was looking at environmental issues. With financial support from Salomon Inc of New York, UNEP commissioned a survey on current environmental policies and practices.
Of 177 investment and commercial banks contacted, 90 responded. The results were highly informative and included the following:
The results of that survey suggested a growing eagerness within the financial sector to learn more about environmental management and its relation to debt financing. In particular, it demonstrated that an increasing number of banks and investors saw the need to incorporate environmental awareness into their businesses. Issues such as sustainability, future ecological risks, environmental impact and conservation and recycling are all now firmly on the banking agenda, driven by the increasing complexity of national and international regulations, and the steady growth in consumer demand world-wide.
There is evidence of deep public concern about degradation of the environment in both developed and developing countries. An international opinion poll in the mid-Nineties demonstrated that consumers in countries as diverse as Denmark, South Korea and Switzerland were all prepared to pay higher prices for better environmental quality. These trends are of direct significance to lenders. They are also informing the development of new international standards that bankers have to adhere to in their investment policies. More rigorous pollution control standards are the future.
The Way Ahead
The third Roundtable held in New York in mid-1997 attracted more than 350 leading bankers and financial experts from around the world. The agenda also covered detailed issues of practical daily use to participants such as new International Standards legislation and methods for making financial assessments of environmental initiatives. The New York roundtable marked five years of informal UNEP involvement in the financial services sector. There was ample evidence that the cooperation had been beneficial to both partners, providing a debating forum for the sector. UNEPs stewardship had been the catalyst for the emergence of a far more self-regulated organization. There was clearly the energy and expertise within the financial services sector to take a more directive role and to move from a small advisory group acting under the leadership of UNEP to an industry led and driven programme that could operate in partnership with UNEP. The financial sector was also beginning to get its voice heard in international fora.
A more formal structure was needed. On the eve of the New York roundtable, the Financial Institutions Initiative was formally launched and its first Steering Group meeting was held. The new Initiative formally adopted terms of reference along with a revised and fuller Statement. Until then, promotion of the Statement and organization of the annual roundtable meetings had been the responsibility of UNEP and the Advisory Group. Now the structure included a formal steering group and specific sub groups dealing with implementation, outreach and a technical committee. Awareness and interest among financial services providers had grown to the extent where there was a significant demand for an active Initiative, undertaking a wider range of activities, for example production of a quarterly newsletter to keep the sector fully informed of developments.
The Initiatives terms of reference also underline how far the process has come. As well as promoting the revised statement, the Financial Institutions Initiative aims to promote education, research and information programmes and projects, share best practices and information, identify relevant principles and effective environmental tools and collaborate with other UN organizations, universities and institutions relevant to the industry.
Questions About the Initiative
Do these initiatives do anything, or are they just talking shops?
Talking is very powerful if the right people are doing it. When the worlds biggest investors and insurers discuss the future of the environment, everyone has to listen. Their investment and insurance strategies can literally change the world. The two initiatives organize international and regional meetings and workshops and collaborate with relevant institutions, government and non-governmental organizations.
In addition, the insurance sector has taken a prominent role in discussions on the framework convention on climate change. The two sectors also disseminate information through newsletters and special seminars about policies and approaches that have worked in practice. So the practical implementation of investment policies on the ground can encourage other companies. International roundtable meetings such as the New York meeting in May 1997 or the Moscow workshop in 1996 give companies in different circumstances around the world the chance to discuss different approaches and initiatives with each other.
Can big investors really afford to worry about the environment in today competitive marketplace?
More and more major corporations and financial institutions are asking whether they can afford not to. Of course, they have to work strictly within the framework of market mechanisms, but it is becoming clearer to the banking and insuring world that unsustainable development is bad business.
It has been clear from the beginning of the decade that governments alone could not protect the environment. The private sector had a particular perspective on environmental issues and its expertise was needed if a radical shift in public attitudes about the compatibility of an ecological outlook and ordinary commercial and industrial life was to be achieved. Bankers and investors have crucial links with commercial activity including activity that degrades the natural environment. Furthermore, as enlightened banks were already aware; the sector has a long-term interest in sustainable development and in backing commercial and industrial practices that safeguard future resources. Quick profit with no thought for tomorrow is not in the interests of a sector that has to invest in the future. The banks that embarked on the Financial Services Initiative with UNEP in the first years of the decade had realized that they needed to take more account of future risks and the long-term opportunities offered by sustainable development. It was also becoming clear that it was possible to persuade other financial institutions that there could also be short-term benefits in working with environmentalists: first, so that both could keep up with the fast-changing national and international agendas, in particular the increasingly complex legal obligations covering finance and the environment; second, to satisfy the steadily growing demand from the financial sectors clients for greener banking and investment.
The recent past provides plenty of examples to demonstrate why banks need to be in the forefront of the ecological debate: The cost of cleaning up past mistakes is escalating, with major issues of lender liability remaining to be resolved. In the US alone an estimated 5,000 - 7,000 hazardous waste sites have been identified with an average clean-up cost per site of $31 million per site. In the Netherlands, clean-up estimates into the next millennium are estimated at $5.6 billion. A study by the University of Chile estimated in 1994 that $435 million was lost to the economy each year through health problems linked to air pollution. As governments continue negotiations on policy instruments to reduce greenhouse gas emissions, the demand for energy is increasing at a phenomenal rate requiring rapid development of clean technologies: new power generation capacity needed in developing countries and economies in transition is estimated at $1 trillion for the period 1997-2000. The market for environmental services in Western Europe was estimated at $94 billion in 1992; the global market in waste management is predicted to reach $500 billion by the year 2000
Isnt this just about the banks trying to avoid becoming liable within environmental regulations?
Most industrialized countries began introducing pollution controls in the 1970s. The early wave of legislation tended to look at clean-up and end-of-pipe solutions in other words, dealing with pollutants produced by traditional manufacturing methods only at the end of a process. By the 1980s, the emphasis had begun to shift to pollution prevention, and to incorporating the latest environmental technology and resources at every stage of manufacturing or engineering processes. More recently still, many of the areas covered by national legislation air and water contamination, land use, toxic waste management, transportation of hazardous wastes, mandatory labeling, etc., have become the subject of regional or international conventions or standards. At the regional level, there are other factors that lenders have to be aware of. Organisations such as the North American Free Trade Agreement grouping are attempting to standardize a range of environmental provisions. The European Union is harmonizing air quality standards for its member countries. Legislation covering lender liability for past environmental damage is emerging and developing in different directions in various countries. The European Union, for example, is establishing an integrated Union approach to environmental liability. During the Fifth Environmental Action Programme (1993- 2000) it intends to establish Union-wide rules to implement the Polluter Pays Principle. With the legal debates on lender liability far from resolved, lenders and financial institutions will necessarily be heavily affected. As we enter a new millennium the international approach to environmental regulation is becoming more comprehensive.
The trend now is to see the market as a friend rather than a negative unmanageable force. More emphasis is placed on the importance of market mechanisms than on strict governmental or international control mechanisms. The Organization of Economic Co-operation and Development (OECD), for example, has estimated that economic instruments to help environmental objectives doubled or tripled in the first half of the Nineties. A market mechanism that lending institutions increasingly have to take into account is the enthusiasm of consumers for green products. With a greater number of people claiming that they are willing to pay more for ecologically sound products, the opportunities for supplying that gap in the market become clear. Eco-labeling schemes have also become a force for change. If concerned consumers demand information about the environmental characteristics of products, then greener goods and services begin to have an explicit value.
The bottom line
The short-term costs to investors of enforcing higher environmental standards in industry have been widely debated. It has been argued by some industry lobbies in some countries that unilateral introduction of high standards would lead to industrialized countries losing their competitive edge: that high standards in the United States, for example, would drive polluting industries south of the border. It has been as forcefully argued by developing countries that, with no economies of scale, the cost of cleaner technologies hits their infant industries even harder. But there is growing evidence that neither of these pessimistic lobbies have reason on their side.
The World Resources Institute has argued and demonstrated that higher standards are linked to stronger, not weaker, economic performance. Japan and Germany, with strict environment standards, are highly competitive. Countries with ineffective environmental legislation can be shown to be strikingly uncompetitive in world markets.
Some multinational groups may indeed seek out countries with weak legislative frameworks but the overwhelming evidence is that countries that have high environmental standards attract the greatest amount of direct foreign investment. At company level, many of the case studies discussed at UNEP/Financial Services Initiative roundtable meetings demonstrate that higher standards, including in developing countries, bring positive economic benefits.
Information on the Financial Services Initiative can be found at http://www.unep.ch/eteu/envr-fin.htm.