Carbon Finance & Socially Responsible Investing: How financial innovation reflects our society
Line BreakAuthor: Eli Magid (17 Articles)
Eli currently works in business development and strategic planning for Israel Corp. Prior to joining Israel Corp., Eli held capital markets and corporate finance positions at Credit Suisse and Morgan Stanley. In addition, he is a former financial markets entrepreneur and co-founder of a green carbon finance start-up. Eli has a BSc in Applied Economics & Management from Cornell University.
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In the recent bestseller The Ascent of Money: A Financial History of the World, renowned British historian Niall Ferguson introduces his book by remarking that
“financial innovation has been an indispensable factor in man’s advance from wretched subsistence to the giddy heights of material prosperity that so many people know today. The evolution of credit and debt was as important as any technological innovation in the rise of civilization, from ancient Babylon to present-day Hong Kong. Banks and the bond market provided the material basis for the splendours of the Italian Renaissance. Corporate finance was the indispensable foundation of both the Dutch and British empires, just as the triumph of the United States in the twentieth century was inseparable from advances in insurance, mortgage finance and consumer credit.”
One can take issue with the strength of the above statement, as well as the tendency of finance to solve certain social problems at the expense of creating others. However the point is that by attempting either successfully or unsuccessfully to solve our wants and needs, financial innovation reflects strongly on who we are as a society. After all, don’t mortgage backed securities, credit cards and tech IPOs reflect the human desire for home ownership, the tendency to spend more than we earn and our hope in newfound technologies?
If so, what picture do current financial innovations paint of our society? And like in Oscar Wilde’s Picture of Dorian Gray, what insights can we glimpse into the current soul of society?
I may be an optimist but I think the present trajectory of financial innovation is extremely positive and reflects well on us. In the past when we’ve talked of finance creating “value” we’ve almost always meant financial value. However we’re now discovering that finance has the capability of creating social value as well. There is a heightened interest in products and stategies which seek to both maximize financial returns and do social good. Is this nothing more than a passing trend, or are we learning from past mistakes and evolving?
Some examples off the top of my head: microfinance in the developing world, renewable energy certificates (RECs), socially responsible VCs like Gray Matters Capital and biodiversity species banking. Maybe in a future blogpost I’ll write about Canopy Capital’s €80 million, 10-year tradable bond, the interest from which will pay for the protection and maintenance of 350,000 hectares of the Guyana rainforest.
Perhaps the best example of socially responsible financial innovation is the $126 billion global carbon market. In this Cap and Trade system companies must meet certain pollution reduction targets. Companies are rewarded financially for reducing their pollution below a target level through selling the surplus pollution allowances that they are now too “green” to utilize. Companies polluting above their target levels are penalized; they must either buy these allowances or purchase credits derived from projects which reduce pollution in the developing world.
Carbon has created lots of recent buzz recently and rightfully so. The American Clean Energy and Security Act (read “US Cap & Trade Bill”) currently being passed by the US House of Representatives and the UN climate change convention in Copenhagen this December will grow the carbon market significantly. If predictions by the US Commodities Futures Trading Commission global are correct, the global carbon market (including the value of its derivatives) will top $2 Trillion by 2020 making it the largest commodities market on earth.
Wall Street, and modern finance for that matter, has been knocked down hard – nearly K.O.ed. However we’re giving some very talented people very little credit if we think they’re out for the count. Rumors abound of lobbyists scurrying around Capitol Hill pushing not TARP, but oddly enough – climate change. Fixed income trading floors are beginning to quietly ramp up their commodities trading desks in anticipation of carbon trading. The capital markets machine remains intact and there’s an army of traders eagerly waiting to sell and trade the next hot financial product – global greenhouse gases.
Eras of financial innovation have been defined by identifying a human aspiration and financing it through financial innovation. Only this time the aspiration is for something remarkably positive: protecting the global environment.
I think in the not so distant future Fortune 500 companies will each have their own “social responsibility portfolios.” Why? Because their shareholders, consumers and employees will demand it. A future social responsibility portfolio may be composed of tradable social responsibility certificates verifying that the owner has made certain contributions from everything from protecting an endangered species to funding a healthcare initiative in a developing country.
In this vision of the future Fortune 500 companies will have a new executive position: the Chief Responsibility Officer (CRO). On a typical day the CRO will be sitting at her desk monitoring the trading of Social Responsibility Certificates(SRCs) on Bloomberg screens when the phone rings. It’s Morgan Stanley’s senior Environmental Capital Markets sales person on the line. The Bid: 50,000 high-quality third-party accredited carbon credits originated from a privately funded conservation project that reduces deforestation in a heavily threatened biodiversity hotspot in the Brazilian Amazon. The Ask: $2.5 million. The CRO looking at the screens in front of her sees how this environmental product complements her company’s social responsibility portfolio perfectly. Our shareholders and customers are going to love what this trade does, she thinks to herself. She smiles as she hits his bid.
