The road to sustainable finance

The researchers in this project consider that political obstacles to addressing climate change render the question of whether, and how, the financial sector can make a contribution all the more important. They are conducting six sub-projects in which they are studying the importance of ethical investors and financial regulation.

In their view, at least three factors have placed the topic high on the agenda: 

First, the financing requirements for “the green revolution” are now so extensive that private capital is needed to complement government initiatives such as the European Green Deal.

Second, the capital managed by SRI (Socially Responsible Investing) funds has increased twelvefold since the early 2000s. Following this dramatic growth, these funds now have sufficient capital to make a real difference.

Third, central banks like the ECB, Bank of England and the Swedish Riksbank have begun to take account of climate change in their monetary policy and regulations, in order to steer investment decisions in the financial sector in a more sustainable direction.

Notwithstanding the changes in the financial sector, many questions remain unanswered about the sector’s role in fighting climate change. Can SRI effectively reduce companies’ carbon dioxide emissions? What is the best way to influence companies: by selling off holdings in them or by becoming actively involved? How should the limited SRI capital be distributed between companies? How should we evaluate the performance of SRI funds? What is the impact of state initiatives like the EU Commission’s proposal to lower the capital adequacy requirements for bank loans to green businesses? How do financial regulations interact with environmental ones?

The project comprises six sub-projects whose common aim is to create a framework to answer the above questions with the help of advanced tools from corporate finance, agency theory and financial regulation.

The results will consist of descriptive and normative insights that can be utilized by investors, public agencies and legislators.

The first four projects study SRI investors, such as ESG (Environment, Social and Governance) funds and state asset funds with sustainability goals, and will illustrate the importance of a broad mandate in order to make a difference. In other words, it is essential that investors are influenced by Exxon Mobil’s emissions, for instance, whether or not they own stock in the company. This insight creates the basis for a green allocation key, the social profitability index, which the researchers intend to create, with a view to distributing resources to “green” investment projects.

The remaining two projects focus on financial regulation. For example, they are examining the circumstances in which hotly debated legislation governing banks’ capital adequacy requirements for green investments have the desired effect, and the circumstances in which they can lead to unexpected outcomes. These projects also show that the most natural solution to climate change – carbon dioxide taxes – cannot be credibly implemented as long as the financial sector has a major exposure to these assets. This is because tougher environmental laws could lead to a banking crisis due to stranded assets. Effective financial regulation may therefore be essential for the implementation of more effective environmental legislation.

The path towards sustainable finance: socially responsible investors and or financial regulation? 

Principal investigator:
Marcus Opp

Jan Starmans

Stockholm School of Economics

SEK 8 million