Moneycation Newsletter: Vol. 2. #1, March 2014; Investigating sustainable finance

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Information about Moneycation Newsletter: Vol. 2. #1, March 2014; Investigating...

Published on March 5, 2014

Author: Moneycation



A look at the meaning of sustainable finance and the use of financial models when implementing sustainable financial practices.

Published by Moneycation™ Newsletter: March 2014 Investigating sustainable finance “Anyone who believes in indefinite growth on a physically finite planet is either mad, or an economist” David Attenborough How long can we live a lie, bury the financial truth and hide from the fact that many of our existing financial models are less than perfect, and in a substantially serious or significant way? Design flaws in any model eventually cause larger complications to a machine, financial operation or infrastructure. The failure of institutions such as Lehman Brothers and the controlled revitalization of firms such as AIG, General Motors and the mortgage giants Freddie Mac and Fannie Mae demonstrate how financial models can and do fail, and that repairs are made to stem the negative impact of the problems. What if even better financial models had existed in the first place? If by better, one means sustainability for the benefit of the greater system and core model strength while still maintaining at least some of the ethical principles associated with profiteering, then why not pursue that objective? That is what this newsletter seeks to explore, extrapolate and elaborate upon. What is sustainable finance? According to the University of California at Berkeley's Center For Responsible Business, sustainable finance is “...the practice of creating economic and social value through financial models, products and markets that are sustainable over time.” This means in order for finance to be “sustainable”, most, if not all of the financial system must create economic and social value. Economic and social value themselves are terms that should also be understood as these may be defined differently depending on what organization, political entity, business etc. thinks it is and how they benefit from that meaning. A good place to begin understanding the notion of sustainable finance is with a simple visual display of the aforementioned definition. Moreover, when social value is extended to include environmental impact, three core areas of sustainability emerge. These three areas are economics, social responsibility and environmental safety. They must interact together in a way that allows for a functional societal eco-system. Financial sustainability is only a part of the greater system, but before looking at it more closely, the Venn diagram below demonstrates the basic principles behind sustainability and serves as a good introductory graphic to the topic:

Sustainability is a measure of social, environmental and economic worth Image license: Johann Dréo , GFDL What is economic value? There are several ways to interpret economic value. One such method is the concept of economic value added. According to the New York Stern School of Business, economic value added or EVA “ a measure of surplus value created on an investment.” Their calculation for such is below: EVA = (Return on Capital - Cost of Capital) (Capital Invested in Project) According to Investopedia, economic worth rather than economic value is. “The worth of a good or service as determined by people’s preferences and the tradeoffs they choose to make given their scarce resources, or the value the market places on an item” In light of the above two definitions or meanings, economic value is a measure of worth as created by market forces and perceived by market participants whether they be corporations or individuals. Sustainable economic value So what then, is sustainable economic value? Given that sustainable finance involves social responsibility and long-term renewable benefits, sustainable economic value would be the market worth of something as understood in terms of social responsibility or long-term renewable benefits. For example, an energy producing wind turbine may have more sustainable economic value than non-sustainable economic value due to the socially responsible benefits it is capable of providing. Thus, financial models by necessity, must involve sustainable economic value instead of the opposite. Crudely, the addition of the word sustainable is all that is needed to the aforementioned equation:

SEVA = (Sustainable return on capital – Sustainable cost of capital) (Sustainable capital invested in project) What is social value? The notions of sustainable finance can be whittled down even further if one attempts to conceptualize what social value is. Social value depends on individuals, organizations and even regulations. In a broad sense, social value is the net perception of the value of sustainable products and services as determined by market forces, which kind of begs the question. Essentially, the more people and entities believe in such value, the greater its prevalence and impact on total value becomes. If total value is equal to sustainable economic value plus non-sustainable value as a weighted average of the two, as the former becomes larger, its influence on valuation rises. An example of this is the value of solar panels as measured by demand. Over time, as technological advancements are made, as non-renewable resources deplete and as consciousness of environmental responsibility expands, the sustainable economic value of solar panels increases. Whether or not sustainable economic value is in and of itself a sustainable metric depends on what culture values in the first place. The image below provides one interpretation of how sustainable models incorporate social, environmental and economic interests to varying degrees. It also illustrates the complexity of balancing a complex and interrelated system of organizations, industry, culture etc. Image license: Saint George IV, GFDL

The above diagram also illustrates sustainability is not as simple as social, economic and environmental harmonization. There are many more factors and disciplines that influence each other with varying levels of sustainability. Sustainable financial models Since market forces vary, organizational objectives differ and social values change, the idea of one sustainable financial model seems naïve. If economic value is not calculated using a single formula or method, then it should not be surprising if multiple models of sustainable finance exist, nor is it necessarily required that they do. Each of these models should generally seek to measure some method for developing anything from business financial models to fiscal regulations. Non-profit organizations have been practicing sustainable or socially responsible finance for some time, and many of the models are effective. Yet, a world without profit seems fantastical, so adaptation of not-for-profit financial models in to sustainable for-profit models is a possible alternative. According to a USAID and Nature Conservancy report on sustainable finance, the four pillars or key areas of sustainability include: Financial and strategic planning, income diversification, sound administration and finance and in-house income generation or self-sourced revenue. These are not new concepts and are applicable to many legal entities. They are important in maintaining organizational continuity, which is not necessarily sustainable. Thus, additional elements of managerial finance are needed to add economic opportunity that allows for individual wealth creation. Financial models are designed for numerous levels and types of administration. For example, fiscal policy creates taxation, budgetary and operational models. Moreover, monetary policy uses economic models that incorporate econometric equations to assess optimal outcomes via various policy initiatives. If every organization has its own model that functions symbiotically with other models, then creating fundamental framework that allows systemic sustainable integration possible is beneficial. An important understanding behind sustainable finance is that profit, whether it be shareholder earnings or profit margin, is not necessarily the most important factor in modeling. As long as profit is the pinnacle motive, social values, economic sustainability and environmental equilibrium become secondary. It is that simple, but the broader implications are not. Nations seek power through economic growth because it is in the best interest of the nation. Money pays for defense programs, improves educational funding, stimulates commercial innovation etc. These are all legitimate reasons to seek economic growth, but not necessarily the best ones. The financial model on the next page details the following attributes of financing the renewability of product sourcing and the sustainability of funding the organization process. • Flexibility • Functionality • Cost effective • Buoyant capacity • Balanced revenue generation

Convention Biological Diversity: Funding model Source: Convention on Biological Diversity; License: Fair Use Problems of sustainable financial models Since sustainable finance is an ideal, and is not currently common practice, obstacles that challenge financial models today may not be problems in the future if more sustainable models are adopted. However, at present, corporations and legal entities have expenses, shareholders and operations that do not necessarily allow them to become fully sustainable. A few obstacles to sustainability of financial models are listed below: • • • • • Profit interest Competitiveness Functionality Capitalization Marketability

Overcoming these obstacles is possible, although not necessarily right away. Forward thinking is all that is needed to begin the process of creating or developing sustainable financial models. Possible ways to do this and objectives to consider are listed as follows: • • • • • Partial re-structuring Progressive implementation Re-designed marketing Profitable methods within a sustainable model Commercial and economic viability of the new model Sustainable finance within industry Financial sustainability is dynamic and interlinked within business models. In other words, since sustainability is thought to take more than simply one business division in to account in order to function, it more often than not, must work within a broader system by necessity. Moreover, isolated operations that only take departmental functionality in to account is generally not as sustainable due to the lack of integration with a broader system. For this reason, financial sustainability should be considered as part of broader business models in addition to the financial models themselves. The different types of sustainable business protect resources while simultaneously meeting the goals and objectives of business interests. According to the International Institution for Sustainable Development (IISA), different types of sustainable business require business strategies that define, implement, change, design and enhance aspects of business that affect sustainability. Attributes of sustainable businesses include profitability and compliance with both environmental regulations and credible scientific knowledge regarding the impact of business practice on the environment. The IISA also states protecting, sustaining and enhancing human resources while not degrading those resources is a characteristic of business sustainability. This is interpreted to mean, keeping the work force alive and healthy, but not too wealthy to ensure ongoing or sustainable labor. • Agriculture Agricultural businesses necessitate sustainability as without it, crops management is susceptible to failure. Without renewable resources such as the sun, rain and fertilizer agriculture would not exist. Since these types of businesses rely so heavily on sustainable resources it follows that proper management of those resources helps ensure sustainability of the business. Organic farmers nationwide have embraced sustainable business models that are health for the environment and people. What's more, according to a report from Inc. com's, businesses such as Frog’s Leap Winery, the upfront cost of becoming a sustainable business are indeed profitable. • Green energy

The green energy movement has been gaining momentum for some time now. Green energy businesses are in the business of sustainability. Businesses that create, build and install equipment that harness, store and distribute renewable energy are as sustainable as the resources that fuel these types of businesses are. Green energy businesses that utilize renewable parts and equipment that are environmentally safe naturally follow suit with the green energy sustainability they help promote. • Waste management Recycling, reuse, and re-integration are methods used by green waste management companies such as Waste Management Inc. This is one of largest waste management companies in the United States and has begun reusing the garbage it collects to fuel its trucks in addition to running and enhancing its traditionally earth friendly recycling programs. This type of sustainable business demonstrates how costs can actually be reduced by going green. • Construction materials Companies that recognize environmental and financial pitfalls of harvesting and wasting construction materials are green friendly and thus sustainable at some level. According to Inc. Magazine, a business called Hycrete has found a way to waterproof concrete with earth friendly chemicals that make it more efficient to reuse old concrete than costly to recondition. Green friendly businesses such as lumber supply companies that rotate crops to ensure a constant supply of wood without having to acquire additional land have also grasped the concept of sustainable business. • Automotive Auto manufacturers are on the sustainable business wagon as well. Increasingly energy efficient vehicle models are being designed, tested and marketed in an effort to meet earth friendly standards that test business models sustainability. Renewable energy news reports design concepts that support automotive business sustainability include fold up cars, self-repairing cars, plastic cars and even plastic roads. Different types of sustainable businesses span multiple industries among which there may also be unsustainable businesses. However, some industries are more apt to sustainability than others. To identify what the different types of sustainable business are it is helpful to understand what makes a business sustainable, and then match those attributes of sustainability with businesses and business models that have them. provides an outline of qualities that business on the road to sustainability or that are already sustainable possess. These factors can be referred to as a qualitative measure of business sustainability.

Sources: 1. “University of California at Berkeley”; Sustainable Finance; Haas School of Business 2. “Journal of Sustainable Finance and Investment”; Corporate governance and sustainable thinking: new and old models of thinking; Eleanor Bloxham; June 16, 2001. 3. “World Wildlife Fund”; Sustainable Finance. 4. “Nasdaq”; Financial Model. 5. “MarketWatch”; Shutdown has taken $24 billion out of the economy; S&P; Steve Goldstein; October 16, 2013. 6. “U.S. Treasury”; Growth Calculator 7. “Bureau of Labor Statistics”; Inflation Calculator 8. “WikiCommons”; Money Creation; Akokkone; February 17, 2012. 9. “WikiCommons”; Components of US money supply; Autopilot, December 12, 2010. 10. “Federal Reserve Board”; What is money supply? Is it important? 11. “Zero Hedge”; Charting The Fed's Across The Board Fail; “Tyler Durden”; October 18, 2013. 12. “Zero Hedge”; Lacy Hunt Warns Federal Reserve Policy Failures Are Mounting; October 18, 2013. 13. “Zero Hedge”; Things That Make You Go Hmmm...Like the Freaking Fed; “Tyler Durden”; October 18, 2013. 14. “Zero Hedge”; Ron Paul Knows The Longer QE Lasts, The Worse It Will End; “Tyler Durden”; October 19, 2013. 15. “Department of Commerce”; GDP data; Bureau of Economic Analysis 16. “CATO Institute”; Greenspan's Monetary Policy In Retrospect, Discretion Or Rules?; David R. Henderson and Jeffry Rogers Hummel. 17. “Business Insider”: Central Bankers Have Gone Wild, And The World Is In Code Red; John Mauldin; October 27, 2013. 18. “Federal Reserve Board”; Does the Fed get audited? 19. “Bloomberg”; Fed Bubble Agonistes Persists As Zero Rates Prompt Debate; Craig Torres and Caroline Salas Gage October 28, 2013. 20. “Moneycation”; Impacts and purpose of Federal Reserve Monetary Policy; “A.W. Berry & Best Accounting Schools, July 25, 2012. 21. “Zero Hedge”; Fromer Fed Quantitative Easer Confesses, Apologizes: “I Can Only Say: I Am Sorry, America”; Andrew Huszar; October 12, 2013. 22. “Zero Hedge”; You Are Here; “Tyler Durden; November 11, 2013. 23. “Moneycation”; What the Federal Reserve Bank's Debt Monetization Means For You; “A.W. Berry”; September 13, 2012. 24. “Stockhouse”; U.S. Federal Reserve Official Apologizes. Goldman Sees More Downside For Gold; Clif Droke; November 15, 2013. 25. “Option Queen”: Archive For October 2013; J.A. Schwartz-Market Analytics. 26. Federal Reserve Board”; Does Monetary Policy Affect Stock Prices And Treasury Yields? An Error Correction And Simultaneous Equation Approach J. Benson Durham; Division Of Monetary Affairs; Board Of Governors Of The Federal Reserve System. 27. “GMO LLC Quarterly Letter”; Ignoble Prizes And Appointments; Jeremy Grantham; November 2013. 28. “New York Times”; Volcker Rule On Bank Risk Approaches Its Final Edits; Ben Protess; December 3. 2013. 29. “University of California Berkeley: Haas School of Business”; Sustainable Finance; Center for Responsible Business. 30. “Ecosystem Valuation”; Basic concepts of economic value; Essentials Section I. 31. “New York Stern School of Business”; Economic Value Added 32. “Investopedia”; Economic Value. 33. “RSA Action and Research Centre”; The Understandable Madness of Economic Growth; Jonathan Rowson; March 26, 2012. 34. “USAID & The Nature Conservancy”; Four pillars of financial sustainability”; Patricia Leon; 2001. 35. “Center on Biological Diversity”; Sustainable Finance. 36. “Inc. Magazine”; The Eco-Advantage. 37. “”; U.S. Small Business Administration. 38. “Green Energy News”; 39. “International Institute for Sustainable Development”; Business Strategies for Sustainable Development.

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