Written by Caroline Ashley, Global Programmes Director, Forum for the Future and Emilie Goodall, Affiliate, Forum for the Future, this blog draws on conversations with actors in and beyond finance, and on this new Forum paper on the Role of Finance in systems change.

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COP 27 outputs disappoint in many ways, but for those of us seeking fundamental shifts in finance, it was a significant step.  Beyond the routine calls for trillions of finance, Article 48 of the draft decision includes, for the first time, a recognition of the need for  ‘transformation of the financial systems and its structures and processes’.   It specifies that this is not just about public finance, but involves the full array of financial actors.

Yes, yes and yes again.  At Forum we know that the finance sector is extraordinarily powerful.  And we believe it can be a powerful agent of change. There is the potential for it to actively contribute to a different economic trajectory towards a significantly better future. And how it can do that is an urgent question if we are to shift from  cascading crises of today to a more resilient, just and regenerative future.

We don’t attempt to offer detailed answers about what exactly should be financed, nor the investment costs of the Paris Agreement or the SDGs. Our lens is quite different, focused at the overall system and the process of systems change. And specifically, on how the finance sector can be an agent of systems change.

Our new series of blogs on finance and systems change are based on four assumptions, which we explore: 

1. Finance - meaning investment, banking, insurance, pensions and related services - currently support an economy that is degrading our natural assets and social fabric. This is not just because the aggregation of specific transactions result in harmful outcomes.  It’s because the way the finance system is structured drives these decisions and actions. Or as Steve Waygood (Aviva Investors) reflects: We don’t necessarily do any of this intentionally; we just don’t understand the system we have built or our impact. 
2. An alternative is possible: Finance can drive change in how our economic and social systems work - better reflecting what is valued, what is used, what is generated, who gains, and whether our environmental and social fabric ultimately thrive. 
3. This will require changes within the finance system itself - the rules and incentives as to how finance works plus the mindsets that dominate it.
4. To support these long-term processes of change, we should start by exploring what a ‘systems change lens’ means in finance, and how to develop systemic skills amongst financial players. 

The rapid ascendance of sustainability issues within the finance sector is a recent phenomenon. Indeed it is remarkable that it was only 50 years ago that this year's Nobel prize winners in economics (Sveriges Riksbank Prize in Economic Sciences) posed the breakthrough idea that banking could actually influence the real economy.  The economic theories of Ben Bernanke, Douglas Diamond and Philip Dybvig were met with some resistance, by those who believed banks simply channelled money between savers and borrowers with no effects - or risks - even in the wider economy. Fast forward to 2008 and their work was entrenched and demonstrated.

But as for finance’s influence on the climate, ecology or social fabric, that idea has taken longer to seep into financial circles. Let alone that financial actors have ‘responsibility’ for doing something about it.  The myth that finance is ‘neutral’ stood tall for some years as climate concern rose. 

The breach in that wall has occurred in the last few years, as responsibility for taking action on the climate emergency has finally spilled over from the business sector into the financial sector.  That breach has unleashed a positive but decidedly choppy sea of initiatives, acronyms, and now regulations. 

Most of the current action, debate and backlash focuses on ESG - or the application of ‘environmental, social and governance’ data to financial decisions.  It’s scaling fast, with ESG assets forecast to hit one third of global assets under management (AUM) by 2025, or $53 trillion. Recent debates over the Glasgow Finance Alliance for Net Zero (GFANZ) provide a microcosm of debates about ESG in general, and the duty or responsibility of finance.

We think ESG is a useful but not necessarily transformative step along the way.  A wider lens is needed. The first wave of ESG has served to expand the understanding of a vast range of environmental (in particular) factors among many thousands of financial sector professionals, astonishingly rapidly. But ESG is still maturing, so, naturally, confusion and debate reign. 

Much of the confusion surrounding ESG is linked to its dual heritage in:

• ethical investing, originally focused on the exclusion of sin stocks (such as tobacco or apartheid-era investments), which focused on the ‘inside out’ chain of impact: how does this investment contribute to the outside world?
• integration of risk management, assessing the financial materiality of non-financial factors, focused on ‘outside in’ chain of impact: how does the outside world affect this investment?  This is needed, in the face of looming climate impacts, but is quite simply a different question to how finance can address the causes of climate change.

Lack of clarity between ‘inside-out’ and ‘outside in’ versions of ESG has created misaligned expectations about ESG.  ‘Double materiality’ requires financial professionals to take, and act on, both perspectives. For ESG to be a stronger force driving systemic change, this is essential.

Double materiality is reflected in the raft of regulation from the EU, which has taken a stronger position than other regulators so far, , with measures such as the EU Sustainable Finance Disclosure Regulation (SFDR). The huge flows of information that will result from increased regulation will need to improve in quality, and impact will depend on other actors being able to use the information to drive accountability. 

So the application of ESG data in decision making in the financial system is far from fixed.  This first major wave of ESG, as a voluntary, market-led response, is perhaps best interpreted as ‘the ‘first response’ of a complex system to an abrupt new awareness of context’, in the words of Duncan Austin. He sees this first response, perhaps inevitably, as a ‘fix that fails’ but one which can point us towards fixes that may succeed.

But while ESG attracts the bulk of attention, we think there are exciting shifts happening away from centre-stage, that have great significance for the potential role of finance in driving systems change. The next post in the series explore the potential of 3 innovations:

• System-level investing
• Influencing the rules of the game
• Impact investing.

Change will require leaders in finance who are able to widen the solution space and adopt a systems lens. Our third post explores what good leadership looks like. 

The language and skills of systems change is not common in finance. In our fourth and final post we will share insights from the inaugural course of the School of Systems change for Finance. 

Ideas shared in this blog series draw on a new Forum paper on the role of finance as an agent of system change. 

School of Systems Change in Finance: This is an initiative of the School of Systems Change, Forum for the Future, and Aviva Investors, to develop system-change skills and perspectives amongst players within the finance sector.  It draws on deep systems change skills in the School, perspectives on systems change in finance captured in Forum’s paper (above), and reflected by Aviva in this edition of Aviva Investors Quarterly.