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Book review: ‘Principles of sustainable finance’ by Dirk Schoenmaker and Willem Schramade

Published: 23 November 2021

Much more than a textbook, ‘Principles of sustainable finance’ is more a ‘call to arms.’ This fascinating take on the world of sustainable finance pulls no punches for the financial sector.

Book: Principles of Sustainable Finance

The relationship between the financial institution and the company is crucial. Companies must be stopped from causing social and environmental damage and be made to have a positive impact, contributing to achieving the UN’s Sustainable Development Goals (SDGs).

The authors of ‘Principles of sustainable finance’ have a new vision for the financial sector. One where financial institutions are reoriented from the short to the long term. One where the financial sector invests in, lends to, and engages “with corporates that aim for long-term value creation (LTVC).”

Dirk Schoenmaker is Professor of Banking and Finance at Rotterdam School of Management, Erasmus University, where he met fellow author Willem Schramade. “Sustainability should become part of mainstream finance,” the pair advocates.

In the 2016–17 academic year they introduced a sustainability finance course at their university. No wonder then that this is a textbook: packed with information, including excellent graphs and tables, and aimed at “third-year undergraduate, graduate, and executive courses.”

With an eye on executives, Schramade has gone on to found the Sustainable Finance Factory, which helps companies and investors “create long term value.” They might baulk, however, at some of the more complex algebra in the book such as “q+w =F(K,L,N,S,H;r,e).”

More than just a textbook

But this work is more than just a textbook. It warns: “The challenge for the transition of the financial sector is to change the dominant culture embedded in financial risk-return thinking. It is about a change of mindset of the people in the financial industry,” who “tend to think and work in separate silos.”

Breaking this mould is necessary because we are stuck in a pre-climate change world. “Our economic models were developed in the age of resource abundance….No environmental concerns were factored into these models.”

Likewise, “financial theory does not account value to natural resources beyond their near-term cash flows (CFs).” These “models are still widely used, but no longer tenable.”

Urgent need for finance to intervene

The urgency of change is communicated well, depressingly so. As the authors say, “Things are getting worse on so many fronts simultaneously – climate change, biosphere loss, land system uses, freshwater use, biochemical flows, ocean acidification, air pollution.”

I was particularly impressed, indeed shocked, by the detailed material on the effect of rising sea levels, squirrelled away in a chapter looking at the insurance industry.

If we were to see a one-metre rise in sea levels later this century, one currently once-in-a-hundred-years flooding event would happen every six months in New York, and about once a month in Kolkata in India. In Wellington, New Zealand, it would happen with every single tide.

In a wonderfully deadpan, academic summing up the authors observe: “Translating flooding risk to financial losses, Hallegate and colleagues (2013) …(estimate) global losses could approach $1trn or more per year if flood defences are not upgraded.”

The urgency on the social front is equally well documented in this book. I learnt that 39% of people globally have a life expectancy below 70, that for 46% one in forty of their children will not reach their fifth birthday, and that 85% of us live in countries with a corruption score below 50/100.

A guide for financiers

To arms, to arms! And for any revolutionaries feeling lazy, the authors point out: “To guide the transition towards a sustainable and inclusive economy, the UN has (handily) developed the 2030 Agenda for Sustainable Development (UN, 2015).”

“The 17 UN SDGs stimulate action over the 2015–30 period in areas of critical importance for humanity and the planet.” It’s easy.

The finance industry just needs to get on with it and is well placed to do so for three reasons, according to the authors. Firstly, because “the allocation of funding to its most productive use is a key role of finance.”

And: “If the financial sector chooses to finance sustainable companies and projects, they can accelerate the transition.” Secondly, because “investors can also influence the companies through their governance role and a rising trend in sustainable investment is engagement with companies.”

Finally, “finance is good at pricing the risk of future CFs for valuation purposes,” and “scenario analysis is increasingly used to assess the risk and valuation under different (climate) scenarios,” the authors write.

‘Fossil fuel stocks should be priced at zero’

Here the discussion of net present value (NPV) pricing models is interesting, with the authors pulling a ‘rabbit out of the hat’ by suggesting one fossil fuel stock currently priced at $126 should in fact be priced at zero. These arguments reminded me of Thierry Philipponnat’s research at Finance Watch.

Ranting against “the bias towards short-termism,” the authors argue “there is a widely felt need to reorient finance from the short term to the long term.” They touch on the extent to which companies are pushed by shareholders demanding quarterly reporting as investors worship quarterly performance returns. But I fear, while alluded to, this puzzle remains unsolved by this book.

Still, this is compulsory reading for anyone entering the impact industry to understand “the role finance (investors and lenders) can play in shaping this future and making production and consumption more sustainable.”

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