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Mick McAteer of the Financial Inclusion Centre considers issues and solutions from his report against the backdrop of the Covid ‘new normal’

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Systems change

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Time for Action – the impact of Covid-19

Sustained record low interest rates, the driving down of bond yields, quantitative easing following the 2008 financial crisis and now the economic impacts of Covid-19 distort the behaviours of financial markets, financial institutions, and households. It will be some time, if ever, before market conditions are ‘normalised’ – before interest rates and bond yields return to typical pre-crisis levels. The ‘new normal’ will be with us for some time.

This environment creates opportunities for the change in the financial markets so they can work better for the economy and society.  There is a chance that investments can be directed towards ‘finance for good’ (sustainable, responsible, and social impact activities, collectively SRI). But there are also risks – of greenwashing, mis-selling and more – if it’s not handled well.

Time for Action set out to answer two main questions:

  • Post 2008, in the ‘new normal’ of low interest rates and low bond yields, how much finance has been directed to economic activities that: have a positive environmental impact; promote responsible corporate behaviours; or have a positive social impact? We term this Sustainable, Responsible, and social Impact, or SRI finance.
  • Despite encouraging growth rates, there is clearly a long way to go before SRI is mainstreamed into the behaviours of financial institutions and households. So, we asked: what factors limit the amount of financial resources going into SRI activities?

We then set out policy recommendations designed to channel greater public and private resources into SRI activities.

While producing the report, two key events were uppermost in our minds – the 2008 financial crisis and Brexit. The 2008 crisis was still exerting its baleful influence on the UK economy. Brexit was expected to constrain the economy and influence UK financial services policy and regulation.  What we didn’t know was that the Covid-19 pandemic was about to hit.

The shock of Covid-19

The analysis and recommendations in the report still stand. If anything, channeling greater resources into SRI activities is even more of a priority due to Covid-19. The current state of the economy and financial markets could create even greater opportunities.

But, dealing with Covid-19, economic recovery, and Brexit are uppermost in the minds of government policymakers and regulators. We will have to fight even harder to ensure SRI is a top priority for decision makers.

UK GDP fell by a record 20 percent in the second quarter of 2020. The economy bounced back but remained over nine percent below its February 2020 level. The full impact of Covid-19 on the number and nature of jobs is unknown but will be significant.

There are two main points to consider with regards to Time for Action:

  • the continuation of the low rate/ low bond yield era; and
  • the need to respond to the scale and nature of the economic crisis the country faces.

The continuation of the low rate/ low bond yield era

As with 2008, Covid-19 has forced policymakers to mount huge interventions to stave off even more devastating economic shocks. Ten year government bonds (gilts) now yield just 0.22%. Five years ago, they yielded 2.41%. In 2007, on the eve of the financial crisis, 5.46%. Even longer term 30 year bonds yield just 0.79%. The Bank of England base rate now stands at just 0.1% with speculation that we might see negative base rates.

This is an incredible position to be in. How well the financial system allocates resources in this new normal of low rates/ bond yields is one of the most important financial issues of our time.

It presents opportunities and threats for SRI finance. Firstly, financial institutions and households will need to find alternative opportunities to generate decent returns (as well as being driven by other motives). SRI finance, if structured properly, should represent attractive opportunities for institutions and households. Moreover, the unprecedented low cost of borrowing presents a golden opportunity for the state to fund much needed SRI infrastructure.

We see two main threats. As we explain in Time for Action, financial institutions invested more in alternatives such as private equity, hedge funds, property, and infrastructure funds than in SRI. Supporters of SRI will have a battle on their hands to compete with those alternatives.

The second threat comes from detrimental market behaviours that will occur if SRI finance continues to grow at a high rate. Market failure and detriment inexorably ‘follows the money’. Financial institutions and households could end up taking on risks they do not grasp. There will be misselling, there will be costly failures, and there will be significant green/ impact washing as financial institutions seek to repackage their activities as SRI complaint. If this happens, this will undermine trust and confidence in the sector.

Responding to the scale and nature of the Covid-19 economic crisis

Post Covid-19, the prospects for the economy and households are bleak unless we can ‘build back better’ and create skilled jobs. Greening our economy and building up our social and physical infrastructure should play a major role in that challenge.

This means reforming and reconfiguring our financial system so that the necessary financial resources are deployed to support the growth in SRI economic activities.

So, to conclude, even without the Covid-19 pandemic, reforming the financial system so it supported the development of SRI activities was already a priority. But, the economic shocks created by the pandemic means that this challenge has taken on an even higher priority and sense of urgency. The current state of the economy and financial markets could create even greater opportunities for the sector – if the all too obvious risks to the development of the sector can be managed.

There is crossover with the commonly used ESG category which stands for environmental, social, and corporate governance. We do not include governance in our definition. Corporate governance refers to how companies are run including the structure and role of company boards, management structures, the relationship between boards and executives, and executive remuneration.

To find out more watch our webinar “Time for Action – a chance for high impact investment”  chaired by Friends Provident Foundation Trustee, Stephanie Maier and panelists Mick McAteer; Catherine Howarth, ShareAction; Bruce Davis, Abundance; Mark Campagnale, Carbon Tracker; discussing issues and solutions from the report against the backdrop of the Covid ‘new normal’.

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