Opinion

Why Finance Should Care

about Ecology
Bert Scholtens1,2,*
Finance ignores ecosystems, which has resulted in a growing list of environ-
Trends
mental and social problems. In this article, the importance of ecology for
Financial institutions and markets have
nance is assessed. We suggest The piece also suggests that the nancial an enormous impact on ecosystems.
intermediation perspective can align nance and ecology for the benet of They require information to perform
their function effectively. However,
society. This requires that nancial institutions account for information about they hardly account for ecological
the impact of nance on the environment and vice versa, and that they are held information in their decision-making
accountable by their supervisors in this domain. processes. The result is that a lot of
harm is being done.

This opinion article argues that nance

Finance Needs Ecology should care about ecology, because
Finance ignores ecology. This has resulted in a growing list of environmental problems such as there is a lot of information, currently
loss of biodiversity, climate change, pollution, and exhaustion of natural resources. Finance untapped, that impacts the value of
nancial services and their value added
plays a crucial role in the Anthropocene and very little has been achieved in terms of integrating
to the society, and vice versa. Financial
ecological concerns in nance. Only recently has ecology begun to appeal to nance scholars. regulators should not only assess
Central banks and nancial market participants (e.g., [1,2]) have now become concerned about nancial performance and report about
the resilience of the nancial system to environmental hazards. Some researchers suggest that how they account for environmental
and social issues, but also provide gui-
green nancial instruments and institutions will achieve global environmental change (e.g., [3 dance and requirements regarding the
6]). However, there is no framework to examine the ways in which nancial and ecological ways in which nancial institutions
systems interact. This paper article assesses recent approaches to examining this interaction. It impact ecosystems. This will advance
suggests an alternative perspective for constructive collaboration between nance and the allocation of scarce resources and
reduce risks to both rms and society.
ecology. Financial institutions and markets
should care about ecology because
Conventional View: Returns and Risks it helps them perform their societal
and economic role in an efcient and
The conventional view in nance is that nancial investors can get higher returns only by taking
effective manner.
on more risk, and that most of this risk can be managed by diversifying investments; it assumes
the presence of complete and perfect information [7]. However, dealing with the risks of climate
change or biodiversity loss is highly problematic as such risks are poorly understood and
cannot be diversied away. Further, it is not clear how, where, and when these risks will affect
economic activity [8]. In addition, the risk of climate change itself constitutes a risk, as policy
responses to mitigate it might result in the so-called stranded assets [9]. This pertains to fossil
fuel reserves that cannot be utilized if the policies required to reduce emissions are enforced.
Thus far, the nance community has mainly focused on increasing disclosure of the carbon
intensity of corporations (nonnancial rms) [1,2,10,11]. The related exposures of nancial rms
could then be stress tested under different climate change scenarios. An example is pre- 1
Department of Economics,
sented by Dietz et al. [12], who calculated a climate value at risk for nancial assets. In the Econometrics and Finance, Faculty of
conventional approach to nance, nature is seen as hazardous. Economics and Business, University
of Groningen, Groningen, The
Netherlands
Instrumentalist View: Green Finance 2
School of Management, University of
This conventional view contrasts with the instrumentalist view of nance advocated by, for Saint Andrews, Scotland, UK
example, Shiller [4]. He argues that the nance industry can reverse the negative perception of
nance. Shiller [4] provides examples, such as social impact funds and social benet corpo- *Correspondence:
rations, that show nance playing a positive societal role. Such innovations can account for l.j.r.scholtens@rug.nl (B. Scholtens).

500 Trends in Ecology & Evolution, July 2017, Vol. 32, No. 7 http://dx.doi.org/10.1016/j.tree.2017.03.013
2017 Elsevier Ltd. All rights reserved.
human nature and social systems, in addition to enabling economic growth and productivity.
Others (e.g., [5,6]) argue that nancial innovation, increased sustainability ambitions, and
changes in international commodity markets create new global connections that make nance
an even more important aspect of global environmental change. Galaz et al. [5] highlight the
advance of green nancial instruments, especially green bonds and commodity derivatives
(see also [13]). They also discuss how nancial actors inuence corporate behavior, by
highlighting the Norwegian Government Pension Fund, The Equator Principles, and the
Principles for Responsible Investment. However, none of these studies [46,13] investigate
the ecological or social impact of these instruments and institutions.

Green Finance Is a Niche

Green instruments and institutions ll tiny niches. Regarding green bonds, the Bank for
International Settlements reports that the total debt securities outstanding at year-end
2015 were US$21.1 trillion (www.bis.org). The Climate Bonds Initiative reports that US$118
billion in green bonds were outstanding for the same period, which is less than 0.6% of the total
market [14] (www.climatebonds.net). Commodity derivatives contracts (excluding precious
metals) had a market value of US$216 billion at year-end 2015; this is about 1.5% of all
derivatives, which had a market value of US$14.5 trillion (www.bis.org). The same holds for
green nancial institutions. For example, the 36 members of the Global Alliance for Banking on
Values, which is a network committed to positive change in their industry, manage US$110
billion (http://www.gabv.org/about-us), whereas the worlds 50 largest banks manage US$70
trillion (https://www.gfmag.com/magazine/november-2015/biggest-global-banks-2015).

In addition, the greenness of the nancial institutions remains to be seen. The Norwegian
Pension Fund has an ethical council that screens those rms in which it holds ownership. Firms
are excluded from the investment universe if they engage in particular activities and/or refrain
from changing course in a direction that is desired by the council. The fund excludes 120
companies but invests in about 9000 rms. The rationale for exclusion is often ad hoc and it is
not clear whether the ecological footprint of the rms invested in is signicantly smaller than that
of those being excluded [15,16]. For example, Exxon, Royal Dutch Shell, and other oil majors
are not excluded, despite their enormous greenhouse gas emissions [17]. Similar arguments
hold in relation to the Equator Principles and the Principles for Responsible Investing [18,19].

Information Is Key to Finance

Both the conventional and instrumental approaches suggest the need for more information to
assess ecological implications and risks for investors. As such, this is not sufcient, as one
should also assess the ecological and social impact of nance itself [1619]. However,
information is not going to be sufcient if accountability, governance, and enforcement are
left unaccounted for [16]. Concerning commodity markets, the instrumentalists seem unaware
of the long-standing debate regarding the interaction between prices and volatility in spot and
future commodity markets, which establishes that it is very case specic as to the impact of
commodity derivatives on prices, returns, and price volatility in spot markets, as well as on
production and income of agents involved (e.g., see [2023]). Both the conventional and
instrumental perspectives ignore that, in fact, all aspects of nance have substantial effects on
society and ecosystems, and that this has been the case since time immemorial. From a purely
nancial perspective, the relevance of such impact is absent, as the externalities by denition
are unpriced and it is hard to assess how and to what extent nancing in fact contributes to
changes in ecosystems and which institutions can be held accountable for these changes (see
also [10,24,25]). The social and environmental impact of nancial institutions services and
operations are not being reported on the basis of validated and reliable data and metrics [16].
There are preliminary estimates about which companies are responsible to what extent for
global greenhouse gas emissions [17]. However, such information does not result in the

Trends in Ecology & Evolution, July 2017, Vol. 32, No. 7 501
transformation of the business model of these companies or their nanciers [6,9,10]. Trans-
parency, accountability, and governance of the nancial industry are notoriously poor [26]. The
(unintended) consequence of the focus on green nance is that it ignores the overwhelming
majority of nance operations.

Financial Intermediation Approach

The nancial intermediation perspective holds that the business of nancial institutions does not
offer end products that can be used or consumed, but provide advisory and intermediary
nancial services. They mediate between agents that have surpluses and decits and between
agents that want to reduce nancial risks and those that are willing to take them on [27].
Compared to nancial markets, banks have superior ability to grant credit on the basis of private
information. To perform their role, nancial institutions specialize in producing and processing
information, managing risks, and reducing transaction costs. Further, they make do with
agency problems, moral hazard, and adverse selection [28]. By engaging in this transformation
function, nancial institutions incur myriad risks that must be managed to assure that the value
of their business is sustained [2931]. Banks specialize in gathering and processing information
on borrowers and their projects to carry out screening and monitoring to reduce information
problems. This intermediation view of nance does not go uncontested. For example, the
experience of recurrent crisis, fraud, myopia, and social and environmental degradation that
relates to mainstream nance is being heavily criticized (e.g., [4,6,31]). After the global nancial
crisis, this has resulted in some regulatory changes, such as the DoddFrank Act in the United
States, but so far supervisors and regulators have ignored the ecological impact of nance.

Financial institutions facilitate the transfer of risks and deal with an increasingly complex maze of
international relations, regulations, institutions, products, and markets [30,31]. As such, they
play an important role in the structure and development of social and economic systems, and
their role and importance change over time [32]. The crucial input for all intermediation services
is information [27]. However, in most cases, information is incomplete or missing and there are
information asymmetries. Financial intermediation adds value by reducing these problems
related to information [28]. Further, it drives changes in the nancial and economic landscape
[32]. If it goes untampered, its actions can result in crises with huge economic and social costs.
In this respect, the global nancial crisis has acted as a wake-up call [31], but only to some
extent as climate change and biodiversity loss are still being ignored by nancial regulators and
supervisors.

Value Chain Analysis

How can the nancial intermediation approach be amended in such a way that it accounts for
the impact of nance on ecological (and social) systems, and vice versa? In principle, the
approach allows for accounting for nonnancial information. For example, traditionally, it
already includes the assessment of the borrowers character in the decision to grant credit,
next to nancial ratios, collateral, and project prospects [29]. Leaving out this judgment of
character has been regarded as one of the main drivers of the nancial frenzy that was at the
root of the global nancial crisis [4,19,31]. Further, there is both theoretical and empirical
evidence that rms environmental and social conduct interacts with their nancial performance
in a complicated manner [3335]. So far, only few intermediaries integrate this perspective into
their business model, but those who do seem to be more resilient to nancial shocks [19,36
38]. The nancial intermediation approach might be used to help bridge the gap between
nance and ecology as it opens the way to include information that might be value relevant and
reduce their risks and those for society. For example, the analysis of the vulnerability or
resilience of ecosystems to climate change is of crucial importance to agricultural production
[12,20]. Financing decisions of institutions affect companies decisions as to the way in which to
exploit and manage natural resources [6,9].

502 Trends in Ecology & Evolution, July 2017, Vol. 32, No. 7
The intermediation approach contrasts with the instrumental perspective, which sees
green instruments as the ultimate objective of nancial institutions. It reveals that the
conventional perspective ignores the existence of information problems and might miss the
upside potential associated with, for example, climate change; in addition to nancing
mitigation and adaptation, new businesses and business models will emerge that require
nancial services. From the intermediation perspective, the instruments and their pricing are
regarded as a means to an end, namely, providing risk management and information
services, both of which are being appreciated by their clientele. Where the instrumental
perspective gives rise to telecoupling of good and bad nancial instruments [4,5] and
the conventional view regards ecosystems as hazard prone [10,12], the intermediation
approach relates to the complete nancial and ecological value chain and can account for
their interaction.

Using information on the impact of nancial activities on ecosystems and by being held
responsible and accountable for such impact, nancial institutions could very much improve
the management of scarce resources. This would require that nancial supervisors broaden
their perspective regarding the social and ecological impact of nance. That is, they should be
open for the consequences of nance for society as these impact the license to operate of
nancial institutions [4,34]. Therefore, nancial institutions should no longer be assessed only
on the basis of their nancial performance, but held accountable for their societal impact too.
This would complement the initiatives by the Bank of England and the Dutch central bank
regarding the vulnerability of nancial institutions and the nancial system to climate change
[1,2,11], as it would reveal how the behavior of nancial institutions plays a role in this respect.
Many European pension funds have to report how they account for environmental and social
issues. The next step would be to set requirements regarding these.

How to Align Ecology and Finance?

Reviews of the literature on environmental and ecological economics (see, e.g., [3945]) reveal
that the nance perspective is underdeveloped. However, several nancial intermediation
approaches emerge that try to integrate the nancial and ecological perspective. For example,
the discount rate has been hotly debated in the context of economic appraisal. Discount rates
are the minimum rates of return required from an investment project to make it desirable to
implement. Gollier [46] provides a theoretical foundation for amending the discount rates
currently used for project analysis to account for the social and environmental aspects of
business operations and investments (see also [47,48]). It would be very helpful if supervisors
provide guidelines for banks regarding their appraisal of projects that improve or degrade the
environment.

Another line of research relates the nancial conduct and performance of nancial institutions to
their corporate social responsibility (e.g., see [4955]). This literature establishes that nancial
institutions show much variety as to their environmental and social policies and performance.
Further, this translates into both positive and negative association with nancial performance,
which highly depends on the types of indicators (both environmental and nancial) being used
[19,34,56,57]. However, a drawback of this type of studies is that they rely on ratings that
combine a very large number of indicators, which are predominantly policy related. The material
impact of corporate conduct is not part of such ratings though (see [16,58,59]). As such, it
seems that this type of analysis is not sufcient to gauge the value relevance of the interaction
between nance and ecology. More sophisticated information is required and ecology can
prove indispensable to achieve this. In this respect, it could be promising to link up with the
nascent literature that addresses biophysical issues from the business perspective
[17,24,25,60]. This would also help regulators set requirements regarding the societal and
ecological impacts of nancial institutions.

Trends in Ecology & Evolution, July 2017, Vol. 32, No. 7 503
Concluding Remarks Outstanding Questions
Ecologists should care about nancial markets and institutions, because they have an enor- How to assess the impact of nancial
mous impact on society and ecosystems. They should not concentrate solely on green institutions and markets on ecosystems?

nancial instruments and institutions, as this will misguide them regarding the real game
changers. We argue This article argues that a thorough understanding of nancial intermedia-
tion would help ecologists see the nancial forest beyond the trees (see Outstanding Ques-
tions). This will help the nancial industry and its regulators and supervisors recognize and
govern the interactions between nancial and ecological systems, which should help to arrive at
a wise, efcient, and effective allocation of both nancial and natural resources for the benet of
the society. Financial institutions and markets should care about ecology because it helps them
perform their societal and economic role in an efcient and effective manner.
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