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Building a Responsible Financial Sector

If Canada’s financial sector wants to compete, it needs a competitive advantage. Responsible investing could be that advantage, argues Brett House.

By: /
26 May, 2014
Brett House
By: Brett House

Deputy chief economist, Scotiabank

As pretty much everyone has heard, Canada’s performance through the 2008 global financial crisis has burnished our reputation for financial probity. The World Economic Forum has named Canada’s banks the world’s soundest for six consecutive years. In relative terms, we have had a very good crisis.

Our “good” crisis has not done much, however, to boost Canada’s standing in financial markets. “The Banker” magazine’s 2013 index of top international financial centres puts Toronto 9th globally—the only top-10 city to drop two rungs from 2012.

Similarly, Long Finance’s Global Financial Centres Index (GFCI) ranked Toronto 14th amongst international financial hubs, down from 11th in 2012. No Canadian city was mentioned in the survey’s list of financial centres that were likely to become more significant.

Instead, our stability has made us into a haven for emerging-market plutocrats looking to stash their cash in Canadian real estate. Sotheby’s found that foreigners accounted for about 40 percent of Vancouver’s luxury-home purchases last year. Similarly, the Conference Board noted that Vancouver’s real estate market is tightly tied to Chinese economic fluctuations. When all of this gets detailed in The New Yorker, as it was last week, we’re vying with Manhattan for honours in the wrong game.

These foreign inflows are combining with domestic capital, pushed by generationally-low interest rates, to create one heck of an asset bubble in urban Canadian real estate. Rather than making Bay Street look like the new Wall Street, foreign capital is making Liberty Village look like pre-crash Phoenix or Las Vegas.

Instead of rewarding Canada for a good crisis, foreign capital is making us more vulnerable to future financial turmoil.

In response—and especially given that this week is “Responsible Investment Week” with its annual conference being held around Toronto by the Responsible Investment Association from May 26-28—Canada needs to work at becoming more than the Avis of second-tier financial centres: it’s not enough to try harder. There’s no point trying to outdo New York at being New York. The relatively small size of Toronto’s securities industry puts Canada at a persistent disadvantage in attracting trading and corporate finance.

We need to try differently. Thomas Friedman argues that “average is over”: when it’s so easy to find better people, companies and even countries to do a job, all of us have to find unique ways to add value.

Responsible investing offers Canada an opportunity to do things differently. It’s both an approach to allocating capital and an asset class in its own right. Responsible investing runs the gamut from efforts to avoid underwriting activities that damage society—tobacco, weapons, pollution—to the active search for investments that produce positive social and environmental impact—reducing poverty, empowering women, reducing crime—in addition to a financial return.

About one in every nine dollars under professional management in the United States, some US$3.74 trillion, is invested in responsible strategies, with double-digit growth in recent years. That’s a little more than twice Canada’s annual GDP and roughly equal to the assets of Canada’s banks.

In surveys, at least a third of North American investors express a strong interest in do-good investing. European and younger investors tend to be even more engaged, which sets up responsible investing for further growth. As Baby Boomers age and begin redeeming their retirement savings, responsible investing will become the way all asset allocation is done.

Returns on responsible investments vary as much as in any other market segment. But what’s clear is that fears of a zero-sum trade-off between financial returns and doing good are overblown: social benefits can go hand-in-hand with satisfying fiduciary responsibilities.

Additionally, responsible investments are broadly uncorrelated with other assets. In a post-crisis world where nearly every market moves in lock-step with the actions of central bankers, responsible investment offers a natural hedge.

Responsible capital tends to be patient capital: dominated by pension funds and endowments, it’s invested for long-run returns, not speculative gains. An enhanced focus on responsible investing could complement the macroprudential measures being implemented in many countries, including Canada, to trim the distortions created by exceptional short-run monetary stimulus.

The United States and UK already have more flexible and supportive regulatory and taxation frameworks for responsible investing. Canada needs to play catch up.

We need clearer and common structures to certify responsible investments, measure their social impact, and report returns. Getting beyond publicly-traded equities and connecting interested investors with responsible private investment opportunities needs to be made easier and due diligence needs to be made simpler. Ontario’s Social Venture Exchange (SVX) represents a nascent start at linking responsible investors with investable private placements. Finally, we need to take impact investing beyond accredited (i.e., institutional, high net worth, sophisticated) investors and support efforts to build retail products and distribution platforms.

At the same time, efforts to create a single national securities regulator must not be allowed to undo the substantial regulatory experimentation and responsible investment product innovation that has been achieved in several provinces.

Getting this right matters for Canada, but even more so for Toronto: 7.6 percent of its workers are employed directly in financial services, a higher share than in either New York or London.

The same report that lauded Canada for its sound banks also called out limited access to financing and insufficient capacity to innovate as the two biggest impediments to doing business in this country. Building Canada into a world leader in responsible investing would address both these challenges in one swift move.

This post was co-written with Salomé Mirigay.

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