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Sustainable Finance

Our Philosophy and Method of Elaboration

1.1. Principle of Sustainable Finance

What is Sustainability?

Having to do something good for the environment or the society due to the external pressures? Compliance with environmental/social responsibility regulations? Engaging in costly but environmental-friendly activities? Or is it the good old conservative view? NO, not exactly! We believe that sustainability is simply the ability to sustain a business in the long-run. You may ask ‘Where is the concern for the environment or the society in this definition?’ They are hidden in it. A business cannot survive without considering the society or the environment it operates in. Hence, to continue its existence and improve its performance in the long run, every business has to take into account its impact on the environment and the society. Here there are 3 main questions a business needs to answer: for whom, what is the time horızon, and to what degree? To answer the first question the business should determine all the stakeholders it has an impact on and should choose the ones that are crucial and it will take into account while making its sustainability strategy. The second question, ‘time horizon’, on the other hand, refers to time dimension: how long does the company want to sustain its business? Time dimension is important because Finally, the third question asks for the target performance goal of the company in sustainability.

Clearly, these dimensions are not independent and there are also to some extend trade-offs between them. For instance, the more stakeholders are taken into account the more difficult for it to set higher performance targets in sustainability which might save the business e.g. against to unpleasant surprises and reputational risk. Similarly, long run business strategies changes the risk profile of the business and the longer the time horizon specified the more difficult it might become to achieve higher performance targets in the short run. A bit higher investment at the beginning might ensure lower costs, better risk profile and also higher quality in the long run. The choice of attributes for these dimensions reflect a consensus in society and they can be specified to some extent with some degree of uncertainty.

Given these, sustainable finance can be defined as managing financial activities in such a way that the survival ability of the firm is maximized.

Here the relation between financial sustainability and sustainable finance is important, These terms are strongly interrelated. Without financial sustainability, majority of the stakeholders cannot be convinced to embark on whatever sustainable finance means. However, a company with financial sustainability but without any efforts to contribute to an improved environmental and social impact, may become less attractive for investors and lose favour with its important stakeholders. Therefore, financial sustainability will also suffer in the mid- or long-term. Hence, we pursue an integrated approach that assumes financial sustainability as an indispensable part of sustainable finance.

An important principle that may guide sustainable development is based on the awareness that there is no system which is able to select all the favourable outcomes while ruling out the unfavourable ones. Hence, every system evolves towards a “degenerated” state over time [1] unless this principle itself is an integral part of the system. This suggests a model approach which must take into account dynamic risk management, innovation, a learning spirit and the courage to embark on change that hopefully leads to system adjustments with positive net impact.

As proof of concept, we suggest a pragmatic win-win impact analysis that takes into account the concerns and interests of stakeholders and their interactions/dependencies with other stakeholders. The more win-win impact the more successful and sustainable will be the underlying financial mode

[1] If the opposite claimed with a counter example the claimer is very welcome to wait longer.


1.2. Holistic Economic Valuation and Risk Management

A sound sustainability management requires a sound risk management which after all requires a sound valuation framework.

All the markets are inefficient to a certain degree, but they are very capable of learning and can get continuously more and more efficient if certain conditions for the exchange of information between the market players are satisfied. For a holistic economic valuation of any product, not only its best estimate cash flow but also its risk profile counts. The external effects that many of these goods and services generate for society along their value chains are not priced by the markets and therefore the monetary value of these effects remain unobserved and consequently, cannot be determined in a broad consensus. However, there are increasing efforts to measure environmental and social hand & foot prints of products. We believe that the free markets are highly efficient in learning and an “arbitrage”,(e.g. the gains of the market players at expense of other players) tends to diminish rapidly with the growing availability of information and the increased of stakeholder awareness. This development has become more and more observable and causes that “no free lunch” assumption is increasingly enforced in monetary terms. Hence, it makes sense that the companies assess the net impact of their products and pursue a comprehensive valuation of their product portfolios.

We thus suggest a holistic economic valuation of tradable goods, which takes into account the “market compatible” valuation of financial factors and, also with a forward looking spirit also “non-financial” factors within the main areas of E (environmental) , S (social) and governmental (G) factors should be incorporated .

There is quite a long history of sophisticated models and satisfactory amount of data leading to a satisfactory and “market compatible” valuation of financial factors and they serve as valuation methods for the financial part of the balance sheet. However, for the valuation of the non-financial part, we have to deal with significant uncertainties due to global developments, power constellations, lack of consensus in politics & science, insufficiency of the available data and the know how gap among the market players. With no intend of inflationary effects, we suggest a reserving strategy and liability reserves on the balance sheet leading to allowances as part of valuation of non-financial uncertainties of their products and balance sheet.

Once a sound and flexible valuation framework is in place, a risk management framework can be built which takes into account the macro economic factors and, depending on the nature of the business, also the market risk, insurance risk, credit risk, operational, and other risk drivers. It makes sense that these two frameworks go hand in hand since they both have a huge potential to learn from each other and enhance themselves accordingly.


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