Can Private Finance Really Serve Humanity?

By Jomo Kwame Sundaram and Anis Chowdhury
KUALA LUMPUR and SYDNEY, Jul 14 2020 (IPS)

The recent explosion of private finance has
nursed the hope
, dream or illusion that it can be mobilized for
the public good, e.g., to achieve the Sustainable Development
Goals, associated with Agenda 2030. However, such hopes ignore how
changes in financial investing have deeply transformed
corporations, national economies and prospects for the world
economy and social progress.

Jomo Kwame Sundaram

Private finance boom
Private capital has exploded with financial deregulation from the
late 20th century. Global finance
increased 53% from 2000 to 2010
, reaching some US$600 trillion
(ten times annual world output), and was projected to reach US$900
trillion by the end of this year.

In its 2018
annual report
, Principles for Responsible Investment (PRI) –
an investor initiative in partnership with UN offices – estimated
that investors with over US$80 trillion in combined assets had
committed to integrate ‘environmental, social and governance’
(ESG) criteria into their investment decisions.

According to the
, between US$3 trillion and US$31 trillion in assets are
managed by ESG funds, depending on the definition used.
also notes problems in evaluating ESG criteria, such as
reducing emissions or raising labour standards, and hence fears
‘greenwashing’ financial investments with false claims of ESG

From active to passive investing
From 2006 to 2018, almost US$3,200 billion left
actively managed
equity funds globally, while over US$3,100
billion has gone into equity
index funds
, constituting “an
unprecedented money mass-migration from active to passive
”. The shift has given index providers considerable
private authority and influence in global capital markets.

Mutual index funds have been available since the late 1970s,
while the first exchange traded funds (ETFs) were launched in the
early 1990s. The growth of passive or index funds has greatly
accelerated in the decade since the global financial crisis

Anis Chowdhury

Attracted by the much lower fees charged, passive funds had
US$11.4 trillion globally by November 2019, five times more than in
2007. Jan Fichtner, Eelke Heemskerk and Johannes Petry
some implications of this money mass-migration to index
funds for corporate governance, market competition and investment

Wall Street’s new titans
Consequently, corporate ownership is increasingly
concentrated and largely held
by the ‘big three’ passive
asset managers: BlackRock, Vanguard and State Street, already the
largest owners of US corporations. In 2019, actively managed US
funds were overtaken by passive funds.
Some estimate
that index funds will have over half the US
capital market by 2024.

Describing passive investors as the true “titans
of Wall Street
”, Jill Fisch, Assaf Hamdani and Steven Solomon
fear that passive investing’s rise raises new concerns about
conflicts of interest due to ownership concentration and common
of rival firms, thus undermining competition.

In traditional investment funds, managers decide how and where
to invest, e.g., which shares to buy. Instead of depending on fund
managers, passive funds track selected constructed indices. This is
increasingly done algorithmically,
instead of reflecting or responding to price and other

Index providers set standards
When investors invest via index funds, their decisions are
effectively shaped by the indices the passive funds track. The
three most influential index providers are the MSCI (Morgan Stanley
Capital International), the FTSE (Financial Times Stock Exchange)
Russell and the S&P (Standard and Poor) Dow Jones.

The main emerging markets indices have tremendous influence,
particularly the MSCI Emerging Markets Index, which includes large
and medium-sized companies in 26 countries, including China, India
and Mexico. Thus, MSCI effectively sets criteria for countries
aspiring to qualify as emerging markets, requiring financial
authorities to ensure free access to and exit from national stock
markets for foreign investors.

Deciding what to include in indices is not just an objective or
technical matter, but inherently political and subjectively
discretionary, typically benefiting some over others. Setting
criteria for inclusion thus
endows index providers with the authority and power to
influence regulation and policies.

Indices influence capital flows
In the past, index providers only supplied information to financial
markets. But with passive funds, index providers have considerably
more authority in markets. With trillions of dollars invested
worldwide, capital has been reallocated by index providers’
decisions, as innocuous as they may seem.

These often influence international capital flows
much more than economic fundamentals
. Massive portfolio
investments typically flow into the financial markets of countries
chosen for inclusion.

When China was added to key emerging market indices in 2018,
reportedly after heavy lobbying, it was expected to attract
portfolio capital inflows of up to
US$400 billion

Adding Saudi Arabia to the benchmark MSCI emerging markets index
in 2018 was expected to bring up to
US$40 billion
into its stock market. This
did not materialize
, perhaps due to the Jamal Khashoggi murder
scandal, treated by financial markets as a ‘reputational

Thus, the big three’s indices greatly influence global
investment flows. Meanwhile, investors may unwittingly acquire
controversial or problematic investments, either by investing in
index funds, or by choosing options heavily invested in such

Divesting for progress?
Clearly, the three biggest passive fund managers and three major
index providers greatly influence portfolio investment choices,
while the world remains largely oblivious of their biases,
influence and impacts, wishfully hoping for the best possible

BlackRock, the world’s largest investor, with US$7 trillion in
funds under its management, gained approving attention by
announcing divestment of its actively managed funds from firms
making more than a quarter of their revenue from coal.

But, as most BlackRock funds passively track indices, these
continue to invest in coal until such stocks are removed from the
indices. Moreover, its CEO has
made clear
that it will continue to invest in controversial
assets, including coal.

Following BlackRock,
State Street
have also announced they will increase their ESG
funds. But ESG criteria are defined, interpreted and acted upon by
the index providers, who use different, often problematic and

methods and data.

UN ‘blue-washing’?
ESG-rating firms disagree about which companies qualify, producing
different sets of ostensibly ESG compliant stocks. Meanwhile, the

has not found any consistent differences in rates of return
between the investment portfolios of ESG funds compared to
conventional ones.

In August 2019, Vanguard
dropped 29 stock
s, noting they had been ‘erroneously’
classified as ESG by FTSE Russell. The rejected stocks included a
gun manufacturer, a private prison operator, a restaurant and a
pharmaceutical company.

Neither Vanguard nor FTSE Russell explained
how and why the ‘error’ had happened
, or the criteria
involved. Most ESG indices include ‘industry leaders’ in almost
all, including the most controversial sectors, only excluding the
very worst offenders, which are quite subjectively, if not
arbitrarily determined.

The Economist
has noted, “Tobacco and alcohol companies
feature near the top of many ESG rankings. And many funds marketed
on their green credentials invest in Big Oil…the scoring systems
sometimes measure the wrong things and rely on patchy, out-of-date
figures. Only half the 1,700-odd companies in the MSCI world index
reveal their carbon emissions”.

Unless there are more meaningful and effective means to ensure
that private finance equitably and appropriately serves public
needs, indiscriminate UN endorsement of ostensible efforts to
mobilise private finance for sustainable development runs the
serious risk of legitimising a massive fraudulent exercise in
financial ‘blue-washing’, referring to the colour of the UN

The post
Can Private Finance Really Serve Humanity?
appeared first on
Inter Press Service.

Source: FS – All – Ecology – News
Can Private Finance Really Serve Humanity?