Sustainable finance ended 2018 on a high. Never before has so much capital been committed to integrating environmental, social and governance (ESG) factors. But financial markets also entered an unnerving cycle. If we are not careful, growing financial turbulence could divert attention away from the urgent need to scale up investment in climate action and sustainable development. Instead of being knocked off course, we need to identify ways not just of surviving potential shocks in 2019, but also of making financing sustainable development the way of avoiding another crisis.
First, the good news. In market after market, responsible practices and sustainability factors are being embedded into finance. Investors have led the way and institutions with over US$80 trillion in assets have backed the Principles for Responsible Investment. The banking sector, however, is the largest segment of the global financial system and in November 2018, it finally stepped forward with the launch of its own set of Principles for Responsible Banking. Central banks and regulators have come in from the sidelines, formed their own club – the Network for Greening the Financial System (NGFS) – and are raising their expectations on how banks, pension funds, insurers and capital markets more generally manage sustainability risks, most notably climate change.
Yet 2018 was the year of synchronised volatility for the financial system. Major equity and bond markets both ended the year down. Many equity markets had their worst year since 2008, with China leading the way – the Shanghai composite fell by a quarter, the MSCI All Country World Index down by 11 per cent, and Wall Street’s S&P 500 dropping 6 per cent. In the debt markets, the Bloomberg Barclays Global Aggregate Bond Index also fell – by a modest 1 per cent.
Brewing storm clouds
Ten years after the global financial crisis, a powerful set of structural, cyclical and circumstantial fault lines are being revealed, all against the backdrop of the continuing destruction of natural systems and rising social instability. Three concerns stand out in particular.
- The growing debt burden of the global economy. Debt per unit of output is continuing to rise. According to the International Monetary Fund, total non-financial sector debt in major economies stands at $167 trillion, up from $113 trillion in 2008, a rise from more than 200 per cent of gross domestic product to close to 250 per cent. This shift was strongly enabled by the era of ultra-low interest rates engineered by central banks since the crisis. As monetary tightening gets underway, this increased debt dependency creates new fragilities.
- The removal of monetary support – which could further impact equity markets and reveal a host of corporate, national and household borrowers exposed to rising interest rates. Already 2018’s G20 president, Argentina, has been forced to seek help from the IMF, while one analyst at the Financial Times has described “the woes at General Electric as a harbinger of a major reckoning, just as the downgrading of US carmarkers Ford and GM in 2005 triggered a credit spasm. One duly forgotten until 2008 dawned.”