Avoiding the most perilous consequences of a warming planet requires rapid and unprecedented transformations in energy, land, urban infrastructure and industrial systems. As financial capital is an important lever in all socio-technical systems, the way capital accumulates and flows within such systems has a significant impact on our ability to reduce greenhouse gas emissions and build a resilient society in line with the Paris Agreement.
So far, efforts at reforming our financial systems have focused on building a new steady-state orthodoxy — developing the regulations, information architectures, decision-making frameworks and behaviours necessary to make capital markets future-proof. Given how little time the world has left to reverse its emissions trajectory, there is now an urgent need to also rethink the way we deploy capital in service of starting and accelerating the transformation of socio-technical systems — such as national economies, international supply chains and urban communities — over the next decade.
Traditional investors are currently ill-equipped to fuel such systems transformations. This is also true for those investors specifically tasked with enabling sustainability pathways, such as multilateral institutions and ESG and impact investors. This is because the axioms, mathematics, and structures of today’s financial industry nurture a set of paradigms that sit at odds with these required transformations. We, therefore, need a new type of investment logic, deployed with a different intent and mindset and using different methodologies, structures, capabilities, and decision-making frameworks: Transformation Capital.
How the financial meta-regime drives self-perpetuating status quo dependency
Today’s capital markets are operating under a set of axioms that severely inhibit their transformative capacity. Axioms are propositions seen as widely accepted and self-evident, much like first principles in science.
One important axiom currently operative in the financial industry is that everything of value must be measurable in monetary terms. So capital markets cannot relate to—or engage with—sources of value outside our narrow definition of money. Another important axiom is an epistemological one, namely, that the future can be predicted. Investors engage with probabilistic models to forecast the evolution of the economy and of individual financial assets, neglecting that the world at large behaves as a complex adaptive system and thus, by definition, possesses non-deterministic characteristics.
There are other axioms worth highlighting: Nation-states as the guarantors of the rule of law, financial statements as the principal accountability ledger in the economy, the acceptance of the efficient market hypothesis and the rational economic agent theory, and the existence of markets operating on the principles of open access, supply/demand balancing and anti-trust protection.
All of these axioms are social constructs and thus contingent and fragile, yet investors take them for granted and assume that they will exist into perpetuity. As a consequence, these axioms set rigid boundaries around the inner workings of capital markets and strip them of the capacity to adapt in the face of exogenous pressures and discontinuous change.