1st October 2019
“We demand rigidly defined areas of doubt and uncertainty!”
― The Hitchhiker’s Guide to the Galaxy
Much of the discussion of environmentally-focused investing (green bonds, sustainable finance, ESG etc.) often focuses around the lack of a common definition of green finance [1, 2]. The argument is that having a fixed definition will increase people’s understanding, allow common rule sets to be established, and enable the green finance sector to grow much quicker. However, many people also believe that an accepted fixed definition will not be easy to achieve.
One of the most significant attempts to create a common definition of green and sustainable finance has been by the EU, who last week delayed the implementation of its new rules governing sustainable finance and the definition of what is ‘green’ [3]. The idea behind these rules is to promote green finance and investment in climate change mitigation by providing industry with a stable framework and common definitions. The primary way in which they are looking to do this is by providing a list of industries and activities (a ‘taxonomy’) which, “make a substantial contribution to climate change mitigation and … do no significant harm to other environmental objectives” [4].
These proposals have been scrutinized and commented on by industry, and looked to be almost ready for release, but their implementation was recently delayed to 2022 as EU diplomats tried to square the competing interests of member nations. The primary reason given was due to concerns by Germany, Austria, and Luxembourg over whether nuclear should be seen as a sustainable option – it is after all low carbon, but not environmentally friendly.
Comparisons with other financial concepts
The EU’s attempt at defining green finance is well meaning but it must be noted that there are many concepts and areas of finance which still do not have rigorous definitions. This is primarily due to two reasons:
- Their scope is very wide-ranging, and there are many ‘sub-definitions’
- They are continually evolving so pinning down a definition is only temporarily relevant.
Green finance seems to fit both these criteria very neatly, thus explaining a large part of the challenge in coming to a consensus definition.
Another example of a less well defined concept in the financial industry is the notion of investment banking, especially when compared to retail banking. In its simplest form retail banking involves customers depositing money with a bank, the bank then takes that money and loans it out, earning interest on that money of which some is returned to their customers as interest on the money deposited. Investment banking, however, is much less well defined and in some cases seemingly contradictory. Traditionally merchant banks (as they were known) would earn their money through client services, offering advice and banking services for a fee. However, over the past 30-40 years investment banks have expanded their services greatly [8]:
- Wealth management – managing clients’ money
- Trading – using capital (their own and others) to ‘gamble’ on the markets
- Trading services – connecting sellers and buyers
- Banking services – fee paid services to advice clients on handling and raising money
In some cases these services can be contradictory within a single firm, e.g. one department could be advising a client on how to improve its financial position, whilst the trading department could be unknowingly betting against that same client. There are legal mechanisms to prevent fraud and information exchange in these cases [5], but the activities are still contradictory – not too dissimilar from the idea of reconciling nuclear energy as a climate-friendly, but not environmentally-friendly form of energy.
The investment banking industry can also be very flexible (maybe too flexible), especially when it comes to trading. The ability to invent new financial products to trade (for example, cryptocurrency futures [6] and collateralized debt obligations [7]) means that the sector is constantly evolving and changing and therefore its definition is evolving and changing too. Climate change mitigation technology will also evolve overtime, some new technologies may appear or existing technology may become more or less relevant.
There are many ways to define the concept of ‘investment banking’, but crucially the term has been clarified through its use. As people use the word more and more they create their own definition, but they also create a communal and cultural definition. The evolution of the definition of green finance will most likely continue in this manner by continually ‘interacting’ with the phrase and concept green finance. This doesn’t just include using it in conversation but writing about it, researching it, and listening to others talk about it. (NB – Legal definitions of financial concepts exist and have a place but these are long-winded and technical, and crucially not fit for everyday use).
Summary
The key to creating a cultural definition of green finance will be people actively researching the environmental effects of finance bonds and investments and then communicating those findings to others. The more clearly that environmental and financial data flows between people, the clearer and more widely accepted our cultural definition of green finance will be, and the more green finance will become part of our day-to-day language. There will still be a need for a technical and legal definition, but that will be a too cumbersome definition for day-to-day purposes and almost becomes a different issue entirely. This cultural defining our green finance will take time but through continual engagement we can create something which can be a tour-de-force in the continuing climate fight.
References
- https://medium.com/whub/importance-of-green-finance-the-expert-opinion-daf754926a9a
- http://climatemundial.com/whatisgreenfinance/
- https://uk.reuters.com/article/uk-eu-finance-climate/eu-states-delay-green-finance-guide-leave-it-open-to-nuclear-power-idUKKBN1WA0UV
- https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/190618-sustainable-finance-teg-report-taxonomy_en.pdf
- https://www.investopedia.com/terms/c/chinesewall.asp
- https://www.cnbc.com/2019/02/13/jp-morgan-is-rolling-out-the-first-us-bank-backed-cryptocurrency-to-transform-payments–.html
- https://www.investopedia.com/terms/c/cdo.asp
- Philip Coggan, The Money Machine: How the City Works, 2015, Penguin Books, 7th Edition