By Rick Bunch, Managing Director, The Erb Institute for Global Sustainable Enterprise, University of Michigan
Sustainable business strategy experts, from economists to NGO executives, tend to agree that the market, and its myriad financial instruments and exchanges, is a powerful force for change when it comes to sustainable business practices. Cap-and-trade policy is high on the Obama administration’s list of environmental priorities, and in recent years, carbon trading markets, alternative energy investment firms and unique “green” financial products like weather derivatives have emerged to redefine the relationship between green strategy and greenbacks.
Amidst this change is an unprecedented level of uncertainly, combined with dismal performance within financial markets. With Wall Street in crisis, what is happening in the newly created environmental markets? And how will those markets change the way companies execute sustainability strategy in the future?
The short answer is, a lot. Green markets and related financial products have continued to thrive, although their growth has been dampened by the global slowdown. The regulatory/political landscape is shifting, and with that shift brings the likelihood of an auction-based cap-and-trade system for carbon being implemented in the near term. With political support for sustainability, demand for corporate transparency and enthusiasm for market-based solutions to climate change at an all-time high, it stands to reason that this should be the Golden Age of Green Markets.
Our research at the Erb Institute tells us that, yes, green financial markets and instruments are strong, but they are also complicated, and without close monitoring and smart regulation, these innovative tools for corporate sustainability risk the same fate as their traditional counterparts.
A complex picture
On the one hand, “green” markets are generating an unprecedented level of interest among institutional investors, companies and the economists, researchers and other academics who study these kinds of things. For example, we’ve counted at least 38 environmental-services markets in the U.S. alone, including exchanges for NOX, Ozone, SO2, CO and particulates. These are all being traded by carbon-credit brokers and other specialized traders, as well as hedge funds, investment banks and some utility companies.
The rise of these markets has been driven by existing regulations and the anticipation of new compliance requirements as the Obama administration comes online. Our estimates tell us that already, the voluntary carbon market may have grown as much as 300 percent last year, from 330 million USD in 2007 to over 1 billion USD in 2008 value traded. At the same time, investors are becoming more interested in projects related to biofuels (especially around methane capture and destruction and manure) and forestry, where a pre-compliance market in the US is drawing attention from private equity firms in the UK and elsewhere. Many of us see this year is a “runway” to regulation that will be implemented around 2012 and will directly impact how companies manage and report their environmental footprints.
On the other hand, we’ve seen anecdotal evidence that green markets are not the Emerald City of Wall Street. Credit Suisse has recently closed its carbon desk in New York, and the price of carbon credits has declined as investors – green or not – scramble to pull money out of uncertain markets. So green markets provide new tools for generating capital to support certain environmental activities, but as part of the capital markets, they are susceptible to the same ups and downs.
Invisible hand, visible impact
In assessing the performance of green markets and assigning dollar values to their performance, we negotiate a slippery slope on the supply-demand curve. As any financial analyst or trader will tell you, miscalculating – or ignoring – the underlying value of an investment can significantly increase your risks. Free market economics tells us that, over time, the invisible hand of the market will guide us back into equilibrium; if you’ve miscalculated the fundamentals, the mistakes will be exposed and the market will make a correction. In the present case, that’s been a very big correction for very big mistakes with mortgage-backed derivatives and other financial products.
But what if the fundamentals are not just numbers? What happens when we take financial risks through green market instruments, but the underlying value is invaluable? How do we put a price on further destruction of the climate if we get the trades wrong? Nature foreclosing on vast real estate in coastal cities worldwide will dwarf the lender foreclosures causing so much pain and uncertainty today.
These scenarios are not just an alarmist rant. We are creating and using tools of the free market to help us solve, literally, life or death issues. For example, on the commodities side of things, pricing has changed because in a recession we buy less stuff, like paper. Paper prices have gone down, which might mean that paper companies are “selling” their trees as carbon sinks for other companies, rather than turning them into reams of paper. Ultimately, this translates into less deforestation, cleaner air and a healthier planet – in theory. In practice, carbon markets are vulnerable to exploitation similar to that faced by other capital markets, such as when developers of carbon ‚Äòoffset’ projects get carbon money from activities they would have undertaken anyway. In these cases, there is no net climate benefit.
When it comes to green markets and financial instruments, the environmental impact of the invisible hand is unmistakable, though measuring it is extremely complicated. On an individual level, we can afford to lose 30 percent of our 401(k)’s value in a market downturn because we can always earn that money back – even if it’s a long and painful process. Collectively, the stakes of planetary threats are higher: how do you measure the loss of 30 percent of our ozone layer or the loss of 30 percent of the world’s wildlife species or a 30 percent rise in ocean levels over 15 years? These changes are more than a hardship; they are irreversible and directly threaten our lives.
The rising tide of support for pro-sustainability market regulation in Congress and the administration is promising for responsible, successful management of green markets in the future. Getting it right involves considerably higher stakes than our current struggles with financial markets. Let’s make sure to ask the tough questions in advance this time – lest the bailout of our coastal cities become more than a metaphor.
Rick Bunch Biography:
Rick Bunch is managing director of the Erb Institute for Global Sustainable Business at the University of Michigan. Bunch comes to the Erb Institute from The Aspen Institute, where he launched the Chinese CSR Business Education Initiative. Prior to that, Bunch was executive director of the groundbreaking Bainbridge Graduate Institute in Washington state, the first independent business school focused on sustainable business in the U.S. Bunch also has served as director of business education at the World Resources Institute (WRI), where he created the biennial Beyond Grey Pinstripes ranking, published jointly by WRI and The Aspen Institute starting in 1999.