Linking the financial system together
A company accessing debt or equity capital is at the end of a four-link chain. Here's how the financial system is linked together.
Guest blog written by Roger Lewis, Director, Intelligent Sustainability
The money chain
A company accessing debt or equity capital is at the end of a four-link chain. Each link is closely connected, and each link integrates sustainability and climate as a material risk, but also an opportunity.
Link one: Asset owners
At the start of the chain are asset owners. These institutional investors deploy trillions of dollars. They are pension schemes (defined benefit and defined contribution), insurers, family offices, endowments and foundations. They all have idiosyncratic aims and time horizons, from funding retirement in 50 years’ time for a 20-year-old starting to work today, to enabling a charity’s operations from return and short-term cash flows for insurance claims.
But in common is their long-term perspective. If a pension is underfunded and liabilities exceed assets, a funding ratio of less than one in actuarial-speak, then how will retirement obligations be met? If insurance claims exceed inflows from the premiums paid by customers – think homeowners in California after the wildfires at the start of this year – then how financially viable is the insurance provider, without government intervention?
Link two: Investment consultants
Investment consultants, the second link, help to answer asset owners’ investment objectives and the future outcome that is needed from deferring spending today. Through investment policy statements and strategic asset allocations, they give mandates, or ‘buy-rate’ in the language here, to the third link, asset managers.
One hundred years ago, all allocations were to bonds (tradeable debt) only; then it was all to equities, or part of a company and a claim on its earnings in return; a period of 60:40 equities and bonds followed, but the recent rise of illiquids (real estate, infrastructure, private equity and private credit) makes common an allocation of one third to each asset class, across regions and fund structures.
Link three: Asset managers
Massive varieties and combinations are possible. Outcomes vary massively too. The bankruptcy of First Brands, an auto parts retailer in the US, will drive down returns for private credit. Equities are sensitive to geopolitics, as the 20% dip in the S&P500 in April showed, from the tariff war.
If a period of deflation and falling interest rates comes, then bond yields, and therefore prices, will rise. But two things are constant. First, the fiduciary duty of asset managers to show loyalty and care to their asset owner clients. This leads to the second constant: sustainability is core in long term investment decisions by asset managers to generate outcomes for asset owners.
Link four: Companies
This takes us to the company perspective and the final link. Not being left behind as the world decarbonises – the future is solar, according to the IEA, an energy forecaster.
Attracting talented staff that care about their employer managing externalities like emissions, pollution or waste. Offering products that customers – young and old – want to buy, like circular fashion and electronics or ethical chocolate and meat. And not having to pay fines for bad behaviour – read: Exxon Valdez and BP Deepwater, where damage is still felt and the companies have reported increased earnings since.
Value creation through sustainability
These are factors investors consider in ESG analysis and stewardship activity. Companies that perform well are rewarded with reduced interest rates for debt or improved valuations for equity, and a lower cost of capital. They generate return and dividends, and positively impact the environment, nature, labour and communities, and are well governed.
The asset managers’ funds perform well versus benchmarks, the investment consultants are thanked for good allocations, and the asset owners’ beneficiaries meet their aim. Thus, the whole chain is pleased. And green.
Guest blog written by Roger Lewis, Director, Intelligent Sustainability.
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