Sustainable Finance: An Emerging Imperative

As climate change and social inequities intensify worldwide, there is a growing recognition that the global economy needs to transition towards greater environmental and social sustainability. While public funds alone are insufficient, sustainable finance (SF) offers a means to mobilize vast private capital towards financing this transition. By systematically integrating environmental, social and governance (ESG) factors into investment decisions, sustainable finance aims to align economic activity with long-term sustainability imperatives.

Our aim is to showcase the growing role of SF in catalyzing the shift towards a greener, more equitable and inclusive economic model. It explores the key drivers and opportunities presented by this emerging paradigm. The report also outlines policy and regulatory developments supporting its mainstreaming. Overall, the adoption of sustainable finance approaches presents strategic opportunities for businesses and investors seeking to future-proof operations amidst rising sustainability challenges.

Historically, normal business activity has concentrated on for-profit enterprises striving to maximise profit at the expense of society and the environment. For instance- just 9% of all plastics produced are actually reused or recycled.

It’s true that everyone on Earth depends on the production, distribution and exchange of goods and services, as well as the enforcement of contracts, to survive and prosper. Increased ESG reporting rules will be implemented by the SEC in the near future.

What is Sustainable Finance?

SF refers to the process of taking environmental, social and governance (ESG) criteria into consideration in investment decisions and practices. It involves channeling capital towards businesses and projects that have positive sustainability outcomes.

The core principle of SF is to link financial returns with positive impacts. It seeks to identify and manage material ESG risks and opportunities in order to enhance long-term investment returns and outcomes for both investors and society. Sustainable finance promotes transparency around ESG performance and impacts.

There are 575 investors controlling $54 trillion who are part of the Climate Action 100 project. The 167 corporations in these investors’ portfolios are responsible for 80 percent of industrial climate emissions worldwide.

Rationale for Sustainable Finance

The business case for sustainable finance is strengthened by several factors:

• Risk Management: ESG issues like climate change pose risks to operations, supply chains and markets that traditional approaches fail to capture. Sustainable finance helps identify and address these emerging risks to safeguard long-term returns.
• New Markets: The transition to renewable energy, green infrastructure, sustainable products and supply chain solutions is creating sizable new markets. Sustainable finance allows tapping the growth potential of these future-oriented sectors.
• Competitive Advantage: Adopting sustainable practices helps attract investment, talent and gain an edge over peers, especially as policy and stakeholder expectations evolve rapidly on ESG performance.
• Policy Support: With the EU, UK and others introducing regulations on ESG disclosures, taxonomy and green asset labeling, sustainable finance is gaining mainstream traction backed by policy tailwinds.
• Future Proofing: By focusing on long-term ESG factors rather than short-term gains, sustainable investments are better equipped to generate durable returns in a resource-constrained world facing climate change and social instability.

Mobilizing Capital at Scale

While public funds are limited, sustainable finance can mobilize the vast pools of private global capital towards financing sustainability. For example, the EU aims to mobilize €1 trillion in sustainable investments through its Sustainable Finance Action Plan using various policy tools:

• Taxonomy: The EU Sustainable Finance Taxonomy provides a classification system delineating environmentally sustainable economic activities. This provides clarity for investors regarding ‘green’ investments.
• Disclosures: The Sustainable Finance Disclosure Regulation (SFDR) mandates transparency around sustainability risks, impacts and products to empower investors with comparable ESG data.
• Benchmarks: The EU Climate Transition and EU Paris-aligned Benchmarks allow channeling investments towards climate-friendly solutions through standardized low-carbon indices.
• Green Bonds: With a dedicated Green Bond Standard, the EU is promoting the issuance of use-of-proceeds bonds for financing eligible green projects and assets.

These measures help overcome information gaps and mis-selling risks, directing capital at scale towards transition-enabling solutions like renewable energy and green infrastructure. Multilateral development banks are also increasingly prioritizing sustainable investments.

Why is Sustainable Finance Important?

There are several compelling reasons why the adoption of sustainable finance is gaining importance:

• Mitigating financial risks: ESG issues like climate change, resource depletion, and social inequities pose growing risks to businesses and investments. A sustainable finance approach helps identify and mitigate such risks, protecting long-term returns.
• Tapping new opportunities: The global shift towards a low-carbon, inclusive economy is creating new business opportunities in areas like renewable energy, green technology, and sustainable supply chains. Sustainable finance allows capturing these opportunities.
• Meeting stakeholder expectations: Investors, customers, and employees increasingly expect companies to address ESG issues and transparently report on sustainability performance. Adopting sustainable finance practices helps meet these rising stakeholder expectations.
• Future-proofing investments: Sustainable finance orientations investments towards long-term sustainability outcomes, ensuring their continued viability and returns in a resource-constrained world increasingly impacted by climate change and other environmental and social challenges.
• Regulatory tailwinds: With policymakers mainstreaming sustainability through regulations on ESG reporting, disclosures, and taxonomy, sustainable finance is gaining policy support worldwide. Early adopters gain competitive advantages.

Mainstreaming Sustainable Finance

Recognizing its importance, policymakers and regulators are taking steps to mainstream sustainable finance through new rules and guidelines:

• The European Union has introduced several regulations like the Sustainable Finance Disclosure Regulation (SFDR) and EU Taxonomy to reorient capital towards sustainable activities.
• Stock exchanges are launching ESG segments like Euronext’s segment for sustainable securities.
• The UK, Canada, Japan and other countries are also bringing in disclosure guidelines and sustainability-linked regulations.
• Multilateral development banks are increasingly prioritizing green and sustainable investments.
• Financial institutions are establishing dedicated sustainable banking windows and green investment funds.
• Stock exchanges like Euronext are launching dedicated sustainability segments to promote sustainable investments.
• Central banks are exploring ways to incorporate sustainability into monetary policy operations and financial stability mandates.