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What is Sustainable Finance?

A new brand of finance, namely sustainable finance, is taking the world of banks and investment by storm. But what does that mean exactly?

Maja Jakobs
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Finance is fundamentally changing as money takes on a deeper meaning. The increasing awareness and understanding surrounding environmental, social and economic issues have begun to holistically expand discussions around what goal finance should serve.

At its core, sustainable finance is defined as the process of taking into account environmental, social, and governance (ESG) considerations when making any kind of investment decision.

Money is more than just wealth. Its influence extends further than the numbers on a balance sheet. From climate change mitigation and tackling issues of inequality, to promoting sustainable employee relations, the playground for ESG considerations is endless.

Although efforts are being made, a lack of financing is considered to be the biggest barrier in achieving the net zero goals set out by many countries. As a result, attention has increasingly been brought to the concept of sustainable finance and its underused potential to provide the funding required to shape a more sustainable future.

The ideals behind ESG finance follow financially sound logic, where doing the right thing meets doing the economical thing. Here’s why: according to a survey done by the World Economic Forum, economists agreed that the costs resulting from a lack of climate action could reach $1.7 trillion a year by 2050, even topping $30 trillion by 2075.

Yet, the sustainable finance market is already worth $30 trillion and is predicted to exponentially grow in the upcoming years, with some considering ESG assets to be ‘the growth opportunity of the century’.

Considering these numbers, there is no doubt that green finance is and needs to be the future.

Contextualizing sustainable finance

A battle is being waged in the boardroom. Cause for conflict: companies and their sustainability ambitions. Or lack thereof.

Small investment firm Engine No.1 became an overnight sensation as they led the charge against one of the world’s most infamous carbon emitters, Exxon Mobil. Their efforts, backed by the biggest players on Wall Street, such as Blackrock and Vanguard, installed three climate-conscious directors onto the Exxon board.

This was celebrated as a major win by climate activists. It’s a change precipitated not only by a new wave of activist investors but also benefits from support from the world’s biggest players in finance. And the change is visible.

As investors increasingly push for board-level change, sustainable finance is emerging as commonplace in the world of wealth and investment. “No issue ranks higher than climate change”, said Larry Fink, CEO of Blackrock in this annual letter to executives, widely considered as the pulse check of the global finance industry. In fact, he stated the next 1,000 “unicorns” will arise from the need to decarbonize our economy.

This high-scale transition has translated into demand on the retail side of finance and banking. Whether it be green/CO2 neutral bank accounts, climate credits cards with integrated green loyalty programs or integrated ESG investment platforms, 67% of consumers across all age groups demand engagement in sustainability from their bank (Eurogroup, 2021).

Similarly, approximately 70% of Gen-Zers and Millennials are interested in using a carbon footprint tracker if their bank provided one. Yet so far, the supply is still lacking.

Pressure from the top: regulation to promote sustainable finance

To meet the challenges that lie ahead, more and more central banks and governing bodies are regulating a field that has too long gone without standardization. In 2015, the Paris Agreement alongside the UN Sustainable Development Goals set out the roadmap to foster the collaboration between the private & the public sector to align financial flows with sustainability action.

Where has progress been made on climate-related financial disclosures?

Following that, in 2018, the European Commission released an action plan for sustainable growth as part of the overarching Green Deal framework. This deal is designed to kickstart the transition from the abstract concept of sustainable finance to concrete action.

The Sustainable Finance Action Plan (SFAP) has three key objectives:

  1. To reorient capital flows towards sustainable investment to achieve sustainable and inclusive growth;

  2. To manage financial risks stemming from climate change, environmental degradation, and social issues;

  3. To foster transparency and long-termism in financial and economic activity.

Additional measures to complement the SFAP included the implementation of the EU Taxonomy, a green classification system that defines which economic activities can be considered as ‘environmentally sustainable’ and the Sustainable Finance Disclosure Regulation (SFDR), setting out mandatory ESG disclosures to promote transparency amongst financial market participants.

Most recently, the U.S. Securities and Exchange Commission announced plans for new climate disclosure rules. The aim of this new regulation is to give transparency to investors about the climate-related risks of a company.

Many posit this development as a much-awaited shift in arguably the world’s most important financial market. Why? It gives new leverage to investors to hold companies accountable to net-zero claims and the ability to crackdown on greenwashing.

Navigating the pitfalls of ESG finance

As with many innovations, the world of sustainable finance and ESG investing is not without pitfalls. Although efforts are increasingly being made to provide a robust regulatory environment for sustainable finance, its concept and potential is yet to be fully understood nor realized.

Navigating the sometimes-wild west-esque world of ESG finance requires effective market standards on the definition and reporting of ESG ratings and clear action points to tackle potential issues, such as greenwashing or modern slavery, across difficult-to-track supply chains.

Nonetheless, these issues are not meant to deter from engaging with ESG. Instead, they serve as areas of improvement and a reminder that ESG is not a one-size-fits-all solution or a ‘quick fix’, but rather a comprehensive addition to promoting sustainability.

But what exactly do this all mean for banks? Well, overall, the supporting environment towards sustainable finance is strong and is rapidly growing. For example, Dutch banking powerhouse ING has recently announced it will no longer finance new oil or gas projects.

Finance is taking on a new form with each day. Looking at the sustainability potential, the market demand and the existing environment around sustainable finance, it becomes apparent that cutting-edge financial institutions not only have a once-in-a-generation opportunity to position themselves as market pioneers in the world of sustainable finance, but also have the opportunity to make profit while contributing to a better tomorrow.

Besides, sustainability is a great tool to create value for financial service providers. According to the Sustainable Development Commission (2017), companies who adopt an ESG-focused approach financially outperform companies who don’t. It’s a win-win-win situation!

Time is of the essence here. Find out more about the opportunities for your financial institution to integrate ESG practices into your business in our latest white paper.

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