Time for a global financial makeover

Not enough has been done to leverage our financial systems in pursuit of the SDGs, as financing still flows to short-term investment projects, writes UN under-secretary-general for economic and social affairs, Liu Zhenmin.

hong kong airport
The city of Hong Kong at night. Incentives toward long-term infrastructure projects like bridges, roads, and water and sewage systems should be created in order to make a major contribution to both development and stability, says Liu. Image: Christian Junker Photogrpahy,CC BY-SA 2.0, via IFPRI Flicker

In 2015, United Nations member states came together and committed to achieving a comprehensive and universal set of 17 Sustainable Development Goals (SDGs) spanning all dimensions of economic and social development.

Investment will be indispensable to achieving the SDGs, which aim to eliminate poverty, end hunger, combat climate change, build resilient infrastructure, and promote inclusive and sustainable economic growth. Yet, three years on, we still have not done nearly enough to leverage our financial systems in pursuit of the SDGs.

The UN, in coordination with almost 60 agencies and international institutions, recently published an assessment of the world’s progress toward changing financing, policies, and regulations to achieve the SDGs. It finds that, despite positive momentum on sustainable investment, the goals will not be met unless we shift the entire financial system toward long-term investment horizons, and make sustainability a central concern. Without a long-term perspective, certain risks, especially those associated with climate change, will not be priced into private investment decisions.

Global financial flows are vast, yet the quality of investment matters. Currently, short-term investment patterns are driving capital-market and exchange-rate volatility, and significantly raising the costs and risks of sustainable investment, particularly for developing countries. If we create incentives to steer the flow of financing toward long-term infrastructure projects like bridges, roads, and water and sewage systems, we would be making a major contribution to both development and stability.

And those investment projects must be more environmentally and socially sustainable. Because today’s investments, particularly in energy systems, will lock in development paths for decades to come, more must be done to ensure that investments now, and in the future, do not undermine our efforts to address climate change. Moreover, as with all economic policies, gender equality needs to become a central consideration. 

Despite positive momentum on sustainable investment, the goals will not be met unless we shift the entire financial system toward long-term investment horizons, and make sustainability a central concern.

Transforming finance will not be easy. Today’s capital markets are highly oriented toward short-termism, as evidenced by capital-flow volatility and the short holding period of stocks in some developed markets, which has fallen from an average of eight years in the 1960s to eight months today. And while long-term institutional investors hold around $80 trillion in assets, with about half of these representing long-term liabilities, nearly 75 per cent are held in liquid instruments, whereas just 3 per cent are in infrastructure.

The same tendency is prevalent in the real economy. In 2016, S&P 500 companies spent more than 100 per cent of their earnings on dividends and share buybacks, which boost stock prices in the short run, rather than raising long-term value through investment. A February 2017 McKinsey Global Institute survey found that 87 per cent of corporate executives and directors feel “pressured to demonstrate strong financial performance within two years or less,” while 65 per cent say that “short-term pressure has increased over the past five years.” Moreover, 55 per cent said they would delay investments in projects with positive returns in order to hit quarterly balance-sheet targets.

Shifting investors from short-termism toward long-term thinking is a prerequisite for achieving all of our economic, social, and environmental goals. But the private sector will not make this transition by itself. Policymakers must step in and provide leadership. Markets do not operate fairly and in the public interest without well-considered and well-enforced rules set by governments. Aside from public investment, this is one of the state’s most essential functions.

Specifically, transforming global finance will require changes in prudential regulations, capital requirements, investment-firm culture, and executive compensation, which will require new and more appropriate longer-term benchmarks. Reforms to accounting practices, especially for illiquid investments, will also be necessary, for example, to reduce the short-term bias introduced by mark-to-market accounting. And institutional investors must adopt a broader interpretation of fiduciary duty, which should focus on the long term and incorporate all factors that have a material impact on returns, be they financial, environmental, social, or governance-related.

With 12 years to go, it may seem like the world has plenty of time to make progress toward the SDGs. But the UN’s past experiences with goal-oriented initiatives show that it is important to take decisive action early on in the process. Making matters worse, escalating geopolitical and trade tensions threaten to set us back, rather than take us forward. Such disagreements must not stand in the way of reaching the SDGs and building a sustainable future.

Above all, that future needs to be financed. Though many public and private institutions at various levels of international finance have already started to change, the overall financial system has yet to experience the sort of transformation that is needed. We have all agreed on what we need to do; now we must do it.

Liu Zhenmin is United Nations Under-Secretary-General for Economic and Social Affairs. 

Copyright: Project Syndicate, 2018.

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