Ten years ago, in August 2007, global financial markets faced catastrophe. It started when BNP Paribas hit a wall—it had to freeze cash withdrawals from three hedge funds because the bank could not value fund holdings in the US subprime mortgage market. BNP could not pay out cash, because it could not find a price signal for the holdings: its statement said, “The complete evaporation of liquidity in certain market segments of the US securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating.” Soon enough, the disease spread and the world learned that those esoteric mortgage instruments were the same as quicksand—there was no basis and no bottom. The popular film “The Big Short,” based on the book of the same name, compared the financial crisis to a phony fish market, showing a chef dicing up old fish and wrapping it in new paper, over and over again. It is hard to think of a product with lower value than old fish resold.
Value, of course, as in the art market, can be in the eye of the beholder, but absence of a credible pricing ten years ago sent the financial world to the brink of collapse.
So what about absence of price signals for natural resources? The world still has not found a credible way to value the increasing scarcity of clean water, and the tightening budget of space in the atmosphere to accommodate the noxious greenhouse gases (ghgs), including carbon dioxide, that are causing climate change due to the combustion of fossil fuels. So far, only “carbon markets” have begun to price the cost of ghg pollution, but carbon markets continue to be hampered by political uncertainty, the pullout of the US from the Paris agreement on climate change, and mis-alignment of rules and baselines among countries. Meanwhile, the emergence of China’s carbon market is sure to influence carbon pricing throughout the world.
So how to truly value scarce resources? Surely their value is more than the cost of using them? There will never be another drop of freshwater on earth—so how to value that scarcity?
That is a philosophical question at its heart, but we do need to answer it in concrete terms that make financial sense? One way is through the promising trends in ESG investing—that investing that takes into objective account environmental, social and governance (esg) factors by attempting to price the hidden financial risk if those factors are ignored. Investors scour portfolios for holdings that carry those risks—factoring in carbon market prices, but also adding costs such as disruption of supply chains from extreme weather, labor strikes due to unsafe factory conditions, even a company’s staff turnover rate as a gauge of fair wage and labor practices. This so-called non-financial information has begun to carry financial meaning, making pricing risk more viable and, indirectly, illuminating the value of what is, in theory, “non-financial.”
Globally, esg investing is only growing—according to the 2016 Global Sustainable Investment Review, “there are now $22.89 trillion of assets being professionally managed under responsible investment strategies, an increase of 25 percent since 2014.” However, in Asia ex Japan, the report notes, “the overall market for sustainable investment in Asia has been growing more slowly than in previous periods…sustainable investment has grown 16 percent since 2014, compared to 32 percent from 2012-2014.” This slowdown could represent prudence, or it could represent isolation. Investors may be having trouble securing credible ESG information from publicly-listed firms. In Hong Kong alone, according to a report in the South China Morning Post on a survey conducted by BDO in August 2017, “more than 80 percent of the respondent firms said they do not have a comprehensive strategy, an ESG committee or dedicated personnel to deal with ESG matters.”
Standing outside the ESG circle is no longer good for business, if global trends are any indication. But also, standardized ESG participation helps assign credible value to non-priced assets, namely natural resources, to which all investors can refer.
Ten years ago, BNP found it had built funds on quicksand and world financial chaos followed. It could be true that the global economy has also become dangerously dependent on quicksand of another type—the grossly undervalued input of scare and irreplaceable natural resources. Perhaps this is an impending “earth bubble”? Ten years after the financial markets wrapped up old fish as new, that question is worth asking. BM