Climate Action

Michael Lewis on the significance of financial markets in the pursuit for sustainability

Ahead of the Sustainable Innovation Forum 2021, Climate Action caught up with Michael Lewis, Head of Research ESG from DWS, on the significance of financial markets in the pursuit for sustainability and why governments must enforce climate and nature-related policies and accounting boards the delivery of full ESG Globally Accepted Accounting Principles.

  • 27 September 2021
  • Rachel Cooper

Ahead of the Sustainable Innovation Forum 2021, Climate Action caught up with Michael Lewis, Head of Research ESG from DWS, on the significance of financial markets in the pursuit for sustainability and why governments must enforce climate and nature-related policies and accounting boards the delivery of full ESG Globally Accepted Accounting Principles.

Why is the financial return first model no longer fit for purpose? 

On the 13th of September 1970, the New York Times Magazine published an article by Milton Friedman1 which concluded that “the social responsibility of business is to increase its profits”. The article became one of the most academically cited newspaper articles of all time.  However, this drive towards sheer profit maximisation has come at a high cost in terms of environmental damage, human rights abuses and greater inequalities.

A better understanding of the importance of ESG factors on corporate performance has meant Friedman’s primacy of shareholders has been replaced with one that recognises the financial materiality of all stakeholders and that the executives who manage the firms create value not only for capital providers, but also for customers, suppliers, employees, and/or communities.

Today, many investors around the world are demanding to know how their capital is used and the impact their capital is having on the world. The problem has been we are still stuck in a world of corporate reporting more reflective of the 1970s than the 21st Century. What is required is a credible set of sustainability reporting standards which are science-based, incorporate double materiality, and go beyond simply climate-related financial risks to broader sustainability issues such as inequality, human rights, water risk and biodiversity loss.

Why is the climate-first approach to addressing sustainability flawed? 

Since the signing of the Paris climate agreement, governments, regulators and supervisors have focused considerable effort in understanding climate risk above all other ESG risks. This climate first approach, which has typically focused on decarbonization in the power generating, buildings, transport, and industrial sectors, needs to be adapted to incorporate nature’s critical role in emission reduction and removal.

In fact, when it comes to addressing climate change, oceans and specifically vegetated coastal habitats as well as forests play a critical role as carbon sinks given their ability to sequester CO2 from the atmosphere. While most heat-trapping emissions stay in the atmosphere, roughly 40% are quickly removed by plants on land or taken up by oceans2.

However, the ability of our oceans and forests to capture and store carbon is being eroded by rising temperatures, plastic and chemical pollution, habitat destruction, overfishing and whaling. In our opinion, addressing these issues therefore should become key priorities for government policy, investor stewardship and developing private market investment opportunities. We are also working to facilitate better coordination amongst the many initiatives and groups active in these areas which should help to meet investors’ expectations.

Do you think we are acting quickly enough to avoid exacerbating further climate-related natural crises, and if not, how can we act faster to prevent future catastrophe? 

The planet is on course to warm by an average of 2.9°C by the end of the century3. This means much more action is required to encourage investment capital into climate mitigation and adaptation strategies to avert a more disastrous climate future. In our view, an important way to unlock investment flows is by redefining the roles along the investment chain.

It starts with governments enforcing stronger climate-related policies. This needs to be accompanied by accounting board providing a full ESG Globally Accepted Accounting Principles (GAAP) with the auditing of countries, companies and investors regarding their entire environmental impact. And it requires investors investing with impact. One idea to mobilise this capital, is that investment products that truly address climate risks as well as other sustainability risks ought to receive a tax credit compared to those investment products that “do less” when it comes to addressing sustainability4

If we fail to address these issues, then it will condemn climate change to a risk that investors simply try and avoid even though it is set to become major challenges for humanity over the coming decade and beyond.

Why aren’t climate-related financial disclosure-compliant scenarios including water, climate and biodiversity more prominent in today’s financial risk assessment conversation?

For the past few years, the investment community has been increasingly focused on the measurement and management of climate-related risk above all else. In part this reflects increasing regulation for example in the area of mandatory climate-related reporting frameworks. When it comes to other sustainability topics such as biodiversity, it looks like investors have been held back by the lack of data. However, the past year has seen progress in this area and the increasing understanding of the nexus between climate, water and nature.

It should also be remembered that investors are faced with increasing burdens when it comes to addressing ESG risks since investors are being pushed into areas which have typically laid outside their normal roles and responsibilities. For example, asset managers are being told to understand and measure the multi-faceted nature of ESG risks across different asset classes with the help of data, but, in the absence of a full ESG Globally Accepted Accounting Principles, asset managers are having to search for and validate ESG data from third-party data providers.

How did you incorporate sustainability into your own career path, and why does this topic hold meaning for you personally?

Since leaving university in 1990, my entire career has been focused on financial research, and specifically in the areas of foreign exchange, global commodities and now sustainability and all of this happening within the same company.

I have therefore had a front-row seat in what have been perhaps three of the most important transformations we have witnessed in financial markets over the past three decades, namely the creation of the European single currency, the emergence of China and India as super-commodity consumers and, since 2015, the rise of ESG investing.

My experience has taught me that while an individuals’ aspirations towards sustainability are important, in my case raising funds for local community conservancy projects around Kenya sits close to my heart, individual actions need the power of public policy behind them. That is why when I joined the sustainability sector in 2015, I saw first-hand how the signing of the UN Sustainable Development Goals, the Paris Climate Agreement, and formal recognition from the central banking and insurance community of the financial stability risks posed by climate change would help to unleash forces that I hope will make for lasting change in the fourth decade of my career.

1. Source: New York Times (September 1970). A Friedman Doctrine
2. Source: Project Drawdown - Drawdown Framework, IPCC (2014) & Global Carbon Project (2019)
3. Source: Carbon Action Tracker (September 2020). Temperatures. Addressing global warming
4. DWS Investment GmbH (November 2020). A transformational framework for water risk

Michael Lewis is speaking at the Sustainable Innovation Forum 2021 on 8th November, you can join him by registering here now.