Can ethical finance break through to the mainstream?

Written by Lisa Stanley Mann on 4th September 2015

By Bruce Davis, Managing Director, Abundance

This article was first published in The European Financial Review on 18 August 2015

Ethical finance is often seen as an additional niche in the financial system. But this article presents a different point of view and argues that new forms of ethical finance provide a balancing force within the financial system by applying a purpose and mode of governance which is based on social and ethical values and for whom profit is a useful by-product.

The finance industry in Europe is experiencing unprecedented levels of change and disruption. The failure of the financial system in 2008 opened the way for a new generation of financial services providers to step forward whose values and use of technology are more in tune with the changes happening in society and culture at large.

Arguably the failures of 2008 were a symptom of a wider malaise in the system which had seen money increasingly disconnected from the real world; traded instead in ever more complex and fast moving ways between financial institutions. At the same time those institutions were increasingly drawn away from the less profitable business of dealing with customers in the real world towards the bright lights of “quantitative trading” and wholesale markets. Both regulators and institutions were wrapped up in the process of finance and ‘financialisation’, paying insufficient regard to the very real problems in the world upon which their complex products were based.

The effect of this disconnection was a shift in the locus of money away from the morals of society and more towards the abstract rationalities of the financial world. This in itself was seen as an ethical choice, a decision to base investments on the forces of markets, competition and profit as the best way to produce positive outcomes for the economy and society as a whole. The reality was that these motives became subverted by a culture of short termism and greed (which fed on each other in a negative feedback) and which eventually led to the whole system needing to be bailed out by the very society it was supposed to serve and support. The lesson was clear even for a free market guru such as Alan Greenspan that markets cannot operate in a vacuum; they need external regulatory factors to keep them cognizant of their wider purpose and goals.  Market actors need to be assessed as social actors too.

The background of the financial crisis has prompted a resurgence of ethical finance and the creation of numerous alternative models of financial services. These innovations are now beginning to penetrate the broader public consciousness through the use of advertising and more consistent coverage in the finance and money pages of newspapers. As a result, individual investors are no longer content to allow others (i.e. what previously would have been considered financial experts) to decide how their money is invested and instead want to take greater control over those decisions whether via new technologies or seeking out companies and organisations that explicitly share their ethics and values.

In the real world, it transpires, ordinary people are uncomfortable with their returns on investment coming from the disadvantage of others; an ethos runs counter to our sense of shared purpose and community. We have also seen the debunking of the myth that people are driven by short-term goals and returns for their money. The observed behaviour is that they prefer to make decisions that are about securing their long-term future goals for themselves and even across generations.

Opinion seems divided whether “ethical finance” represents a new wave of companies offering choice to consumers, or a more fundamental change within the financial system itself. It is fair to say that the incumbents of the current system prefer to see ethical finance as an additional niche, for investors who are prepared to sacrifice financial returns for the sake of wider social and environmental benefits to be accrued. But this is to miss the bigger opportunity which ethical finance represents in the mainstream market for people investing and managing their money. Conventional ethical investment vehicles still work on the fundamental assumption that the primary purpose of finance is profit, and the activities that capital and money can produce in the world are secondary to that motive. As such, ethical motives are a dilution of that focus adding cost to the management of the investment and limiting choice of assets from which those investments can be made.

New forms of ethical finance see themselves instead as providing a balancing force within the financial system by applying a purpose and mode of governance which is based on social and ethical values and for whom profit is a useful by product which contributes to the sustainability of those activities and incentivises risk.

My own company, Abundance, which is a regulated peer to peer investment company financing UK renewable energy projects, has carried out a social attitudes survey1 for the last 3 years which has examined UK investor attitudes to ethical finance to try to understand better what people mean when they say they would like to invest their money ethically. The UK financial system is perhaps the one which has been most exposed to the forces of globalisation which has left its financial system dangerously lacking in resilience (as highlighted in the recent New Economics Foundation “Financial Resilience Index”2 which compared the relative resilience of the financial sectors of each of the G7 economies).

ethical-finance-mainstream-1UK investors are faced with a relatively undifferentiated choice of very similar institutions when it comes to saving and investing as a result. Perhaps not surprisingly therefore the survey highlights a significant gap between what people say they want and what the market offers in terms of ethical investment.

Whether you frame the question in terms of controlling where your money goes or whether you would be unhappy if your money was being used for unethical or environmentally damaging activities, just over 70% of UK adults agree or strongly agree with the sentiment.

The fact that a majority of UK adults feel that their money should be used ethically, as well as generating a financial return, also begs the question what constitutes unethical business activity. It is hardly surprising that most people consider child labour and human rights abuses to be unethical, however, far more surprising was the that third in the list was corporate tax avoidance (ahead of pornography and arms dealing). This is unfortunate when research by the UK national newspaper, the Guardian in 2012 showed that 99 out of 100 FTSE 100 companies engaged in some form of corporate tax avoidance and the majority of our pension provision in the UK will have some exposure to the FTSE 100 in its investment mix.

So if the majority of people think ethics are important when it comes to investing, why isn’t more of our money invested in companies and organisations that present themselves as an ethical alternative?

Part of the reason is no doubt the natural inertia and conservatism we have when it comes to money.  People often lack the confidence and the means to get the information they need to make ethical investment decisions. Our ethical principles may leave us conflicted when it comes to an audit of the impact of our money in the world, but it is not sufficient to overcome the dominant narrative of the market which is that it is somehow ‘safe and sensible’ to put your money with a large, well established financial institution. Our money has to perform some serious tasks in terms of our own and our family’s financial wellbeing and no one wants to compromise that too far in the pursuit of their ethical agenda. In essence, people are looking for a ‘win win’, a combination of financial and ethical return that aligns personal and social outcomes. The popularity of investments in renewable energy directly benefits from this ‘win win’ thinking. The development of other sectors, such as social impact, will have to juggle with the same equation if they are to break through to the mainstream investor and not just appeal to the wealthy philanthropist.

We also need to look at the nature of ethical investments themselves and how they differ from conventional financial products. Ethical investments require different approaches to due diligence and don’t necessarily lend themselves to the industrial scale and process needed to achieving a listing on a modern stock exchange. Ethical investments also often lack the infrastructure of research and secondary markets that allow larger or institutional investors to deal in the assets. As such, ethical investments don’t conform to the norms of conventional investments where there is often little interest in the underlying assets and the activities from which the profits and returns are generated and which also may be at some remove from the investment product being purchased.

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The result is that most peoples’ experience of ‘ethical investment’ is diluted by the structures and layers of information and reporting required of investments in the modern world.

Regulators too need to be educated in the value of ethical investment institutions and assets in providing much needed diversity in the financial system. Too often ethical investment companies are constrained by regulatory requirements that are applied without attention to the unique nature and social value of the underlying assets. It may be simpler for regulators but the lessons of 2008 are very clear about the dangers of groupthink when it comes to assessing risk within a complex, multifaceted system. Andy Haldane, head of financial stability at the Bank of England makes a distinction between diversification and diversity in the financial system but it is often disregarded when it comes to the development of regulatory policy.

One success on regulatory policy in this regard is the implementation of the crowdfunding regulations in the UK that provided a clear framework for the development of new and innovative models of investment based on the simple premise of democratizing finance. The regulator implemented a proportionate regime that was able to balance investor protection with the need for entrepreneurialism and innovation that is now being looked at closely by other European regulators to accommodate the development of their own crowdfunding sectors. Customers can navigate the sector and make their own decisions about how their money is invested directly, without need for layers of intermediation between their ethics and their money.

The result is a sector in the UK, which offers a wider range of choice for individuals to invest, in terms of risk, rewards and importantly ethics. Rather than dictate to the market and define ethics by what it is not, the market allows innovators to develop uses of money that are in tune with the value of the public at large. If people don’t believe in what the project is trying to achieve (and that its wider benefits to the community, society or environment are insufficient or poorly communicated) then it won’t get the funding it needs to make it happen. Ethical investment becomes an intrinsic part of the conversation about what makes a good society and what we need to do to preserve the environment for future generations as well as our own needs in the present. And that in essence will be what brings ethical finance out of the niche and into the mainstream.

About the Author
Bruce Davis is cofounder and Joint Managing Director of Abundance, the first regulated peer to peer investment platform.  He is also a Visiting Research Fellow of the Bauman Institute, Leeds University and a fellow of the Finance Innovation Lab.

References
1. Abundance Great British Money Survey data available under creative commons http://blog.abundancegeneration.com/2015/05/results-of-the-great-british-money-surveys/
2. http://www.neweconomics.org/publications/entry/financial-system-resilience-index