Designing a Better Global Financial System – Why Do Human Rights Matter?
Commentary, 11 February 2016
By Margaret Wachenfeld, Managing Director, Themis Research; Senior Research Fellow, IHRB
How would you design a global financial system that is fit for purpose in the 21st century? What steps are required to ensure more inclusive and sustainable financial decision-making that can serve the needs of economies and societies?
Over the past two years, the United Nations Environmental Programme (UNEP) Inquiry on the Design of a Sustainable Financial System has taken the lead in addressing this critical question, with input from an eminent Advisory Council, a crack team, and extensive international engagement and research.
Its recent flagship report, “The Financial System We Need – Aligning the Financial System with Sustainable Development” suggests that there is now a historic opportunity to shape a financial system that can more effectively finance the development of an inclusive, green economy. This opportunity is based on a growing trend in policy innovation from central banks, financial regulators and standard setters, who are incorporating sustainability factors into the rules that govern the financial system.
The Inquiry Report proposes how to move towards a global financial system that puts sustainable development at its core. The key findings are:
- A 'quiet revolution' is underway as financial policymakers and regulators take steps to integrate sustainable development considerations into financial systems to make them fit for the 21st century.
- Momentum is building and is largely driven by developing and emerging nations including Bangladesh, Brazil, China, Kenya, and Peru, with developed country champions including France and the UK.
- Amplifying these experiences through national and international action could channel private capital to finance the transition to an inclusive, green economy and support the realisation of the Sustainable Development Goals.
The IHRB co-authors, myself and Motoko Aizawa, together with Mary Dowell-Jones, partnered with the Inquiry in developing a working paper that explores the role of human rights in shaping a sustainable finance system. As set out in the paper, there are real opportunities to more closely align the financial system with the vision of social sustainability signalled by the international human rights framework. The experience of the 2008 financial crisis has resulted in a clearer understanding of how the financial system allocates capital, manages risk and impacts the wider economy. However, international human rights principles and standards are only beginning to inform that understanding and help guide reform.
Our working paper analyses the following three levels of the financial system and human rights, highlighting the multi-faceted roles and contributions human rights can make to a more sustainable and more ethical financial system:
At the systemic level
There are key regulatory leverage points for incorporating human rights into regulatory approaches and embedding ethics, informed by human rights, in the culture of financial institutions. The impact of the financial crisis and growing inequality has sparked, if not ignited, an interest among some regulators in considering the need for inclusive capitalism where human rights can play an important role in framing considerations around inequality. The growing attention to unwanted environmental and social externalities of current modes of production and the social tensions this can cause is beginning to register with financial supervision authorities, particularly those in emerging markets.
Equally important, human rights standards provide a benchmark against which to measure the impacts of the modern financial system. For much of our history, financial markets have been reasonably straightforward support services for facilitating economic activity where the economy and finance were seen as part of the social fabric, rather than as a separate, self-governing system. Over the last twenty years, as the financial system has changed beyond recognition, occupying an outsized place in the world economy, this implicit relationship between financial markets and a context of unspoken, broadly accepted social values has broken down. There is a real need to improve the data and the assumptions that go into the mathematical formula and quantitative models that drive many financial transactions so that they better reflect the human reality and social complexity in which financial products are used.
At the same time, more effective regulatory checks on how the financial system operates must be put in place to prevent widespread negative and unsustainable social, economic, and financial consequences as were seen during the 2008 financial crisis. In order to build a more sustainable and resilient financial system for the future, it is essential that the broad range of social impacts of financial activity are included in the debate on the management and regulation of the financial system. A human rights lens can help to integrate these social impacts more deeply into the financial architecture.
At the client level
Human rights considerations are starting to make their way into the lexicon and practice of risk management among large banks, insurance companies and investors in their transactions with corporate and sovereign clients. This can be seen in areas such as project and corporate finance and asset management, but no one has yet addressed in detail the human rights impacts of more complex products and services, such as derivatives. At this level, human rights are most often viewed as risks for financial institutions. Where environmental and social risk management systems are in place, they may work well to reduce risk to the financial institution, should work well to reduce risks to stakeholders, but often fail when it comes to redressing impacts. Where harm is happening, those costs often are externalised -- remaining with those harmed, especially in countries with weak legal regimes. As the scope of human rights covered by regulation expands, attention to human rights should begin to be built into compliance costs around transactions and thus move from being externalised costs to internalised costs.
At the consumer level
Human rights are an expected standard of conduct for financial institutions and provide a benchmark for respecting and treating the interests of consumers fairly and without discrimination. The emerging field of impact investing and the growing world of micro-finance and micro-insurance are obvious entry points to actively support the enjoyment of human rights at the consumer level.
The Inquiry Report points to the need to upgrade the governance architecture of the financial system so it is more sensitised to the need to respond to sustainable development. Broadening and strengthening the voice and participation of stakeholders in international economic decision-making and standard setting will enhance global economic governance, and is a first step toward a governance structure that is consonant with the human rights of participation and engagement, transparency, accountability and rule of law.
For the micro-level financial institutions, the closer alignment between corporate governance and human rights, as seen in the recent G20/OECD Principles for Corporate Governance, could send a strong signal to corporate boards about their responsibility toward stakeholders and the need for internal controls to manage human rights impacts, and to investors about the importance of taking human rights into account in their investment and engagement strategies.
In other words, there are multiple opportunities for improving attention to human rights in the financial sector, but the road ahead is a long one. The UNEP Inquiry is continuing its work on building inclusive and green financial markets with a wide variety of partners, such as the G20, and with a series of working papers across the policy levers that provide crucial opportunities for enhancing sustainability.
For our part, the working paper is part of IHRB’s programme on the financial sector that seeks to highlight the value human rights can bring to financial markets.