The house is burning but we’re quibbling on the size of the water pipes

“It’s madness, it’s collective suicide! »

It is in these terms that the Secretary General of the United Nations Antonio Guterres described the situation of our world, on September 10, during his visit to Pakistan, a country devastated by monster floods.

While the house is burning, in the literal sense of the word in France as in many other countries in the world, the self-declared firefighters of the financial sector are still negotiating the dimensions of the pipes in order to save water for the swimming pool and the jacuzzi.

We have already seen the devastating effects of the over-financed economy on the environment and people.

The real and profound transformation of the finance sector towards the inclusion of environmental and societal considerations in investment decisions is no longer an option, but an emergency that requires an intervention far beyond what the current state of ESG is able to accomplish.

Should we rejoice in the effervescence of responsible finance ?

At first glance, the uninitiated might believe that finance is moving in the right direction.

Indeed, if we look at the figures, the growth of green/responsible/sustainable finance has been phenomenal in recent years! It is estimated that more than $41 trillion of assets will be invested in ESG funds in 2022.

All the while, regulators and standardization bodies are busy planning, consulting and announcing “improved and reinforced” directives: TCFD, SFDR, European Taxonomy, CSRD, and even the birth of the ISSB within the IFRS.

Unfortunately, those who really want to change their business approach are too few.

So what do financial players do ?

Despite this apparent effervescence, on the whole, financial players are not up to speed: the measures taken are not, and far from it, up to the challenges.

ESG ratings, widely used in recent years to identify green investments, mainly only consider the influence of ESG factors on a company’s financial performance (simple materiality). They do not take into account the effects of the company on the environment and society (double materiality).

This last point on materiality is crucial: it is a matter of whether we only require the disclosure of risks that environmental and social degradation poses to a company’s business model (financial materiality), or we also require disclosure of the company’s impacts on the environment and society. This is called the double materiality approach. Which we believe is the only way to provide a clear and factual vision of the real impact that each company has on our world.

The solution to be implemented is known

What needs to be done to bring about the systemic change that will address the environmental and societal impact on our economy is well known to insiders and proven to be effective. Companies and financial institutions must be compelled to report on the effects of their activity on the environment and our society, with a reporting standard as high as those observed for financial data.

It was in 1933, following the Great Depression of 1929, that the international desire to stabilize the markets took hold. Market players were imposed a standard that provided rigor and uniformity in the reporting of financial data, as well as the obligation of an annual verification by trusted third parties.

The same is needed for the disclosure of extra-financial data: a common standard based on a double materiality approach, giving a complete picture of negative impacts and their mitigation, as well as positive impacts and how they are generated, with contextualized indicators, using SDGs as a common language, and verified by trusted third parties.

The players in the financial sector will have to relearn their trade.

Since they must play a leading role if we are to succeed in our transition to a positive impact economy, financial sector players must relearn how to invest and lend.

Indeed, the integration of extra-financial data in their business processes requires change management at all levels of the organization. And taking these new data into account, whether for risk management, credit analysis, reporting, the production of new products or portfolio management, requires training for a lot of people.

Become a leader of the financial sector revolution

Some financial institutions, too few in number, already see this as a business opportunity and are investing in ways to obtain much more complete, rigorous and verified extra-financial data to accomplish their transformation.

It is indeed up to executives of all financial institutions to set the tone and lead this change. It cannot take place without their massive and unreserved commitment. Because one thing is certain, given the magnitude of the challenge, small gestures will not be enough.

Who will be, within the financial community, the ones with enough vision and courage to close the chapter on the over-financed economy ?

Article co-authored by : 

Paul Allard, CEO impak Ratings Inc 

Thierry Sibieude, Professor at ESSEC business school and Founder of the Innovation and Social Entrepreneurship Chair.