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Policies and regulatory frameworks to better align business and finance with global goals

Policies and regulatory frameworks are an important complement to voluntary actions. There are two sets of issues covered in this section: regulatory frameworks for the financial sector and international standards and agreements on labour rights and environmental and health standards, which are also well-covered in the SDGs, particularly in SDG 8.

Short-termism

The Addis Ababa Action Agenda emphasizes that sustainability and stability of the financial system are mutually reinforcing. Yet, to date, capital markets remain short-term oriented. As shown in the figure, in the USA, for example, the average holding period for stocks fell from 8 years in the 1960s to under a year in 2016.

Corporations also increasingly focus on short-term indicators, such as stock price fluctuations and quarterly profits, with many business executives reporting they feel pressured to demonstrate short-term performance. A McKinsey index of corporate performance found that short-termism has been rising since the turn of the century, despite a fall prior to the 2007 global financial and economic crisis.

Although the exact causes are not known, the Task Force has identified several factors behind this short-term investment horizon of many assets managers: 1) Prudential regulations and capital requirements; 2) Insufficient capacity to invest directly in infrastructure and other illiquid assets; 3) Accounting measures such as mark-to-market accounting, which mean that relatively short-term changes in market prices impact performance measurements; 4) Benchmarks; 5) Compensation tied to short-term performance measures; and 6) Institutional issues and firm culture. 

As shown in the figure, the majority of pension and insurance assets are primarily invested in liquid assets, such as listed equities and bonds in developed countries. While investment in “other” assets increased somewhat over the past decade, investment in infrastructure still represents less than 3 per cent of pension fund assets, with the majority in advanced economies.

Finally, there is a range of other actors, such as investment consultants, rating agencies, brokers, and regulators that help guide investment decisions and set incentives within the system. The incentives and impediments faced by all the actors in the financial chain will determine the magnitude, time horizon and quality of investment, with implications for incomes, employment, and social and environmental outcomes. While the ultimate beneficiaries (e.g., pensioners) may have a long-term outlook, the intermediaries often have progressively shorter-term incentives that are ultimately not aligned with the owners of capital. 

Financial Institutions

In recent years, the international community has taken important steps to strengthen the resilience of the financial sector through regulatory reforms, such as the Basel III capital and liquidity requirements. While these measures have been aimed at reducing systemic risks and enhancing the stability of the financial system, the Addis Agenda also points out the possibility of unintended consequences including adverse effects on the cost of finance to smaller enterprises and a reduction in the availability of long-term financing or financing for the higher risk investment often necessary for sustainable development.

 

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