Pathway to Cop26: How can finance professionals actively encourage changes in consumer behaviour to achieve society's goal on climate change?
Featured in this collection as winner of the Chartered Banker Institute Green Finance Essay Competition 2020.
The overwhelming majority of people see climate change as a serious issue that threatens the environment, economies, and life. The primary cause of climate change has been human behaviour, particularly through investment decisions made into fossil fuels and other unsustainable projects. Human behaviour and investment will also prevent climate change from becoming even worse, in line with the UN Sustainable Development Goals and Paris Climate Agreement to keep global warming below 2°C.
Finance professionals need to take the lead to do their part in adjusting consumer behaviour in the fight against climate change. This adjustment must lead to tangible results on climate and investment, whilst still allowing consumers agency to choose and access effective financial services. The approach detailed builds on concepts in behavioural economics to suggest a solution to encourage sustainable investment, whilst preserving the freedom and rights of the individual.
For retail consumers, financial professionals must provide access to sustainable products for consumers to access. These products could be in the form of savings accounts, pension funds or other more exotic investment vehicles.
By investing in ‘green finance,’ consumers are directly supporting businesses, infrastructure and projects that provide tangible benefits to the climate, in addition to yielding a rate of return which matches their financial needs. In fact, market reports show that green portfolios outperform those who opt for a less sustainable investment strategy. 1 This may be due to changing consumer desires, more growth potential or more beneficial regulation.
I propose that given Green Financial products have similar yields to conventional products, but provide significant environmental impact, green should become the default option provided to future consumers.
Under this system, when a consumer selects a savings account or pension plan, the green option which meets their risk/reward ratio will be the default one selected. This means that by default, consumers choose the option which works towards climate objectives.
This is not to say that consumers are forced to go green; if for whatever reason they decide not to, they are welcome to make the decision to switch to an alternative plan. Yet by opting out, the consumer not only has to exert mental effort in order to make the switch, they actively have to make the choice not to support climate action, with no clear benefit to themselves.
This approach is heavily inspired by Nobel Laureate Richard Thaler and Cass Sunstein, and their concept of Libertarian Paternalism.2 Under this approach, freedom of choice is preserved, whilst the socially beneficial outcome is still favoured.
The default effect has consistently been seen to increase the socially desired outcome, whether it be in investment, pensions or organ donation, consumers are overwhelmingly more likely to stick to the default than opt out. In the case of organ donation, donations increased two times under a default approach than they were before, saving numerous lives. 3 Likewise, a green finance default may help save our planet.
The effectiveness of this scheme can further be improved through clear communication of climate impact that an investment makes. This metric could be based on CO2 emissions, energy usage or any other “agreed upon” metric. What is important is that the metric is consistent and easily attributable to investment decisions and translates the abstract into something concrete that consumers can factor into financial decisions.
Such a metric could be influenced by the Human Development Index (HDI), 4 which factors in literacy, life expectancy and per capita income to assess the development and quality of life within a country. Despite the difficulties in environmental accounting that surrounds this issue, such a system would provide clear comparables to be used by consumers and investment professionals to be implemented in decisions, such as default choice architecture.
Furthermore, by creating a clear metric, more focused attention can be given towards the issue. Whether causal or a correlation, many of the UN’s Social Development Goals were either inspired or based around the HDI, leading to the view that such a metric could incentivise consumers to act quantitatively in an environmentally conscious way to set further goals on climate change.
An appealing aspect of the green default initiative is how such a seemingly simple change in the way that financial products are promoted can lead to significant structural change within investment, the economy and the environment.
By focusing consumers towards assets with proven green and climate benefits, the total value of green assets under management would be expected to grow. Whilst in the past decade, Environmental, Social and Corporate Governance (ESG) assets have grown dramatically in market share, they still only make up 1.2% of global Assets Under Management (AUM).5 By implementing the green default, more money will be invested in sustainable projects, helping bring about innovations and technology to reduce global temperature increases.
Moreover, and perhaps more impactful for the long term, a shift to the default investment becoming the sustainable investment may lead to an exponential growth in efforts to combat climate change. The reasons for this are two-fold.
First, as financial institutions realise that sustainable investing is the norm, the transformation may be sector-wide, as opposed to being isolated to a single firm. In a hypothetical case, were all asset managers, banks and pension funds to adopt a green default initiative for all future investment, it would be reasonable to expect the total of green investments to increase by trillions of dollars in the next decade. Additionally, sustainable specialists and knowledge of green finance fundamentals will continue to develop, as firms become more committed to the environment, based on the will of their clients.
Second, as firms realise the paradigm shift occurring within the investor community, ESG and climate focused initiatives will become strategic priorities for firms seeking investment or entering into a complex financial transaction like an Initial public offering (IPO) or share issue. This is because, if firms know that the default response of financial professionals is to create sustainable portfolios, the firm must become sustainable to achieve other objectives, such as expansion or future profitability.
Essentially, what this means is that consumers investing with the purpose of achieving climate objectives alongside achieving a positive return can directly influence societies’ progress in the fight against climate change, thanks to the support and “choice architecture” created by financial professionals.
The implementation of the green default strategy is also feasible, with potential competitive advantages geared towards the financial professionals and institutions that implement it first.
It is evident that the younger generations of “millennials” and “gen Z” are even more climate conscious than their parents. We can base this on reports of younger generations suffering greater climate anxiety, and the rise of activists such as Greta Thunberg representing the youth of today.6
As a result, these groups are more willing to engage in green finance and may place a premium on ensuring that their investment yields a positive societal or environmental impact. We can infer this from how many brands adapt to fit the millennial view through taking social, environmental or even political stances on current events.
This increase in propensity for sustainability amongst younger consumers means that climate- friendly financial products will be highly attractive to them. For the financial firm that chooses to innovate within this space first, a unique selling point will be established, creating immensely strong marketing and public relations, backed by tangible real-world benefit.
The marketability aspect is especially important here, as consumer grade products like savings accounts and pension funds are far more familiar to consumers than bonds and other instruments. Consequently, public awareness of the firm’s green investments towards climate change will grow to an even greater extent than complex instruments, leading to more consumers investing in sustainability and an increase in total AUM for the firm, providing greater revenue for the firm.
Of course, in an efficient market, this advantage will likely be competed away by other financial providers offering climate focused products. However, the total amount of sustainable investment would overall dramatically increase and may even become the norm amongst finance professionals. From this, we would expect to see a similarly dramatic increase in climate related projects receiving funding, - thereby, hopefully mitigating future climate risk.
This would still be an incredible outcome for the climate.
In summary, by changing the default products that we present consumers, we can dramatically influence the behaviour of investment.
We can also provide consumers greater purpose in investment, facilitating future green initiatives. And, together finance professionals and consumers can beat climate change.
2 Thaler, R., & Sunstein, C. (2003). Libertarian Paternalism. The American Economic Review, 93(2), 175-179. Retrieved September 12, 2020, from http://www.jstor.org/stable/3132220
3 Johnson, Eric J. and Goldstein, Daniel G., Do Defaults Save Lives? (Nov 21, 2003). Science, Vol. 302, pp. 1338-1339, 2003, Available at SSRN: https://ssrn.com/abstract=1324774 Note: the study indicated donors were twice as likely to donate under a default than otherwise, though significantly greater rates of donation are present in countries where a default is introduced.
4 Anand, S., & Sen, A. (1994). Human Development Index: Methodology and Measurement.
5 https://www.ftadviser.com/equities/2017/07/10/fund-review-interest-in-sustainablestrategies-soars/ 6 https://www.reuters.com/article/climate-change-children-idUSL1N2AV1FF