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Sustainable Development ~ The Banking & Finance Sector

Author: Ruan Kruger ~ Development Bank of Southern Africa

( Article Type: Sustainable Development )

Background

According to the International Finance Corporation (IFC, 2003), developed countries launched the modern environmental movement during the 1960s. This was followed by the emergence of ‘sustainable development’ in the 1980s, a movement that forced a country to examine its pursuit of economic growth while addressing environmental protection and social development. The 1990s heralded the concept of globalisation and there was a growing awareness that companies had a role to play in sustainable development and that their activities had global ramifications.

By the new millennium, most major companies responded to the call for social responsibility by implementing internal environmental management systems, reporting on their environmental activities, adopting voluntary environmental and social codes/guidelines, and/or joining public-private partnerships. Financial institutions also undertook these efforts, but, as relatively ‘clean’ industries, their internal environmental and social goals were fairly straightforward. All these companies faced a common realisation: they knew that they had to make a choice – be proactive and undertake these voluntary efforts or remain unprepared for the increasingly stringent requirements of globalisation and/or future legislation.

While the financial sector has been dealing with the reality of environmental risk directly affecting its core business practices, it also has had to adapt to the treatment of environmental and social issues in a changing world. According to the International Finance Corporation (IFC) (2003), the 1980 United States Superfund Act forced US banks to quickly become aware of the serious risk that environmental issues posed to their bottom line – it meant that contaminated land might be worth a fraction of its former value or, worse, might represent a major liability. Banks responded by incorporating formal environmental riskmanagement procedures into their lending policies to reduce their lender liability and default rate. Although their potential liability was eventually reduced, banks built on their environmental experience by reducing their internal ecological footprint, undertaking environmental audits and introducing conditions for environmental management into their loan agreements. In turn, this drove the insurance industry to exclude certain types of environmental risk from their standard policies, as well as to introduce new environmental-impairment liability insurance products.

Potential benefits of applying sustainability principles

The IFC (2003) further states that financial institutions have been pursuing efforts that not only reduce environmental risk and improve their ecological footprint, but also add value via new products/services. Their experience demonstrates that adhering to sustainable development allows them to: uncover latent, potentially harmful downstream risks; save money; respond to the increasing call for socially responsible behaviour; upgrade their reputations; strategically position them as market leaders; access new markets; and generate revenue. Most importantly, it has become standard practice for involvement in the international financial community.

Within this community, multilateral/bilateral institutions were the first to include environmental and social requirements as part of the financing terms. The World Bank Group (including the IFC), the European Bank for Reconstruction and Development, the Asian Development Bank, the Inter-American Development Bank and the Development Bank of Southern Africa all have such policies/procedures in place. As the largest financiers in emerging markets, the inclusion of environmental and social loan conditions can significantly influence financial institutions’ contribution to sustainable development.

Whatever the initial motive of financial institutions to incorporate social and environmental aspects into their business operations, numerous benefits typically emerge. Those frequently cited include enhanced management, governance, communications, and stakeholder relations.

Application of sustainable development principles

Private sector banks took the initiative in 2003 and drafted an agreement called the ‘Equator Principles‘. Under the agreement, the banks agree to adopt the IFC’s social and environmental rules for sustainable development. According to the Equator Principles, the banks will agree ‘not [to] provide financing to projects where the borrower will not or is unable to comply with our environmental and social policies and processes’. According to Citigroup bank, as from April 2005, 30 financial institutions, including Citigroup, have agreed to implement the Equator Principles.

In addition to the above-mentioned ground-breaking initiative in the banking and finance sector, the Global Reporting Initiative (GRI) was started approximately four years ago to encourage all business organisations to voluntarily report on their individual success in implementing steps to become sustainable. The GRI (2002) states that ‘accountability, governance, and sustainability are three powerful ideas that are playing a pivotal role in shaping how business and other organisations operate in the 21st century. Together, they reflect the emergence of a new level of societal expectations that view business as a prime mover in determining economic, environmental and social wellbeing. These three ideas also point to the reality that business responsibility extends well beyond the shareholders to people and places both near and distant from a company’s physical facilities. Defining, measuring, and rigorously reporting on these economic, environmental, and social issues lie at the core of the mission of the Global Reporting Initiative’.

The Guidelines complement and strengthen traditional financial reporting by providing critical non-financial information that helps users assess the current and future performance of the reporting organisation. Whereas financial reporting primarily targets one key stakeholder (the shareholder), sustainability reports have a wide audience, reflecting the diverse groups and individuals with a stake in high-quality information. Financial analysts, employees, customers, advocacy groups, trade unions, communities and others are all part of GRI’s audience.

Performance indicators, both qualitative and quantitative, are the core of a sustainability report. The performance indicators are grouped under three sections covering the economic, environmental, and social dimensions of sustainability. In each area, GRI identifies core indicators (required for reporting in accordance with the Guidelines) as well as additional indicators (used at the discretion of the reporter to enrich a report).

GRI in collaboration with the United Nations launched the United Nations Environment Program – Financial Institutions (UNEP FI) and GRI initiative, and followed up the work with a finance sector working group. This group was tasked to develop indicators that will be specifically applicable to the finance sector. The work started in September 2003 and the final version of environmental indicators was published in March 2005. The guidelines can be accessed at www.globalreporting.org

Potential difficulties in implementing sustainable development principles

The main difficulty is that the implementation of sustainable development principles remains a voluntary option to all businesses. But the positive angle to this issue is that ‘big business’ is increasingly forcing the implementation of this approach by not doing business with organisations that do not subscribe to the same philosophy. This power, which business can use in their trading and financing operations, is an immense force that can change the future of sustainable development dramatically.

A problem being experienced in the developing countries/ emerging markets is that these governments are often so eager to attract foreign direct investment that environmental and social legal requirements are not made strict enough. This situation is referred to in the IFC document, and emphasises the important role that international financial institutions should play in the emerging markets.

Emerging markets are often faced with such pressure from their electorate to provide basic infrastructure, such as housing, water and sanitation, as well as the creation of job opportunities, that the required attention is not given to long-term strategies such as implementing sustainable development principles. These problematic situations can only be solved through consistent awareness-raising campaigns at global summits and active involvement by developed world financial institutions in the developing economies.

Additional opportunities are being created for international financial institutions to play a positive role in the emerging markets by financing and participating in initiatives such as the Prototype Carbon Fund, launched recently in South Africa through a partnership between the World Bank and the Development Bank of Southern Africa. This will enable ‘cleaner technologies’ to be transferred from the developed world to the developing countries, and will include a financial benefit for the developing countries for using the cleaner technology. Difficulties experienced include the cost associated with the preparation of baseline information and the monitoring of environmental information to claim the required credits from the Fund.

Anticipated trends that will affect the application of sustainable development principles

Financial institutions have until recently largely escaped the wrath of environmental groups, which have tended to shower their criticism on international institutions, such as the International Monetary Fund and World Bank, or manufacturers accused of operating sweat shops in developing countries (Financial Times, 7 April 2003). But at the 2004 World Economic Forum in Davos, over 100 advocacy groups signed the so-called Colleveccio Declaration, which called on financial institutions to implement more socially and environmentally responsible lending policies.

According to the IFC (2003), financial institutions in developed countries have undertaken most of the sustainable development efforts in emerging markets – the emerging market financial institutions are lagging behind. There are several exceptions, but embracing even basic environmental and social efforts has yet to reach a critical mass. Most emerging market financial institutions still do not believe that these issues are their problem to solve, but perversely, it is in their marketplaces that environmental and social challenges for business and society as a whole are most profound. Another problem is a dearth of in-country capacity. In recent years, development agencies such as the IFC have begun to bridge this knowledge gap by training financial institutions on environmental and social issues.

Trends that are starting to influence financial institutions and will increasingly do so in the future are:

  • ’No place to hide‘– NGOs will continue to expose financial institutions’ activities.
  • Investors will increasingly scrutinise companies for their transparency, governance, and environmental and social efforts.
  • International financial institutions will continue to include environmental and social conditionality for emerging market projects.
  • Weak emerging market regulations/enforcement will spawn more informal environmental and social ‘regulators’.
  • Best practices will become more documented.
  • Financial institutions will be pressured to apply environmental and social standards to their entire operations.