What in the World is Sustainable Finance?

In recent years governments have debated and established ambitious public policy initiatives such as the 2030 Agenda for Sustainable Development and its broad range of Sustainable Development Goals (“SDGs”) including reducing poverty worldwide and promoting sustainable economic growth, and the Paris climate agreement of 2015.? Funding these initiatives would require the deployment of massive amounts of external financing, much of which would need to come from governments in the form of “official development assistance”, which has been defined as government aid that promotes and specifically targets the economic development and welfare of developing countries.? Multilateral development banks (“MDBs”), which are created by governments including the World Bank and International Monetary Fund, would also need to play a significant role in stimulating and channeling aid into developed, low income and emerging companies, and other significant external financing assistance would be needed such as philanthropic assistance through foundations, international sovereign bond issuances across?various multilateral institutions including MDBs, development institutions and supranational organizations, and climate finance?through public-private partnerships. Capital for development projects would also need to be provided by financial institutions, insurance funds, pension funds and impact investors, and organizations active in the startup community are ramping up their support for sustainable entrepreneurship.[1]??

Sustainable finance has emerged in parallel to the policy initiatives mentioned above as it has become clear that they cannot be realistically undertaken and completed without innovative private sector financing models that allow a wide range of potential investors to participate in high growth, albeit risky and uncertain, opportunities.? Sustainable finance has been explained to be a long-term approach to finance and investing, emphasizing long-term thinking, decision-making and value creation, and has also been described as the interrelationships that exist between environmental, social and governance (“ESG”) issues on the one hand, and financing, lending and investment decisions, on the other, and long-term-oriented financial decision-making that integrates ESG considerations.[2]? According to the CFA Institute, examples of environmental issues include climate change and carbon emissions, air and water pollution, biodiversity, deforestation, energy efficiency, waste management and water scarcity; examples of social factors include customer satisfaction, data protection and privacy, gender and diversity, employee engagement, community relations, human rights and labor standards and examples of governance factors include board composition, audit committee structure, bribery and corruption, executive compensation, lobbying, political contributions and whistleblower schemes.[3]?

On its webpage describing “sustainable finance”, the European Commission (“EC”) explained that the term referred to the process of taking ESG considerations account when making investment decisions in the financial sector, leading to more long-term investments in sustainable economic activities and projects.[4]? Examples of environmental considerations offered by the EC?included climate change mitigation and adaptation, as well as the environment more broadly, for instance the preservation of biodiversity, pollution prevention and the circular economy[5], while social considerations included issues of inequality, inclusiveness, labor relations, investment in people and their skills and communities, as well as human rights issues.? The EC argued that the governance of public and private institutions (including management structures, employee relations and executive remuneration) was fundamental to ensuring the inclusion of social and environmental considerations in the investment decision-making process.[6]

The interest of the EC in sustainable finance has been driven by the European Green Deal, which is a growth strategy announced in December 2019 that seeks to make Europe the first climate neutral continent by 2050.[7]? The EC has acknowledged that the scale of the investments necessary to achieve the desired transition to a climate-neutral, green, competitive and inclusive economy is beyond the capacity of the public sector alone (e.g., in January 2020 the EC presented its European Green Deal Investment Plan that called for mobilization of at least €1?trillion of sustainable investments through the period ending in 2030), and that channeling private investment into the transition to a climate-neutral, climate-resilient, resource-efficient and fair economy, as a complement to public money, is essential for delivering the policy objectives under the European Green Deal and achieving the international commitments of the European Union (“EU”) on climate and sustainability objectives.

Capital for sustainable finance is available from investors who want to take part in financing enterprises involved in projects with high environmental or social value, including projects that will have an impact that the investors may experience directly; socially-responsible investment funds capitalized by institutional and private investors; pension funds and private banking and wealth management sources expected to grow significantly in the coming decades due to wealth transfers from Baby Boomers and Generation X to Millennials who surveys indicate have a strong commitment to incorporate social change into their investment decisions.[8]? Sustainable finance is just not about “doing good”, in fact consultants such as McKinsey have argued that companies with a robust ESG framework are more likely to add value as compared to companies that have not developed sustainable practices and that ESG creates value in several different ways including top line growth, cost reductions, reduced regulatory and legal interventions, employee productivity uplift and investment and asset optimization as key enablers in generating a long-term advantage.[9]? More and more companies are issuing financing instruments based on specific promises of use of the funds for environmental and/or social projects, and stock exchanges are facilitating these offerings by mandating more robust ESG disclosures.? The actions of all these actors are influenced by the priorities identified by non-profit think tanks, philanthropists, social change activists and enablers and civil society.[10]

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International and Regional Sustainable Finance Initiatives

The international policy context relating to the development of sustainable finance has been driven by the initiatives and actions of the following organizations:

OECD: In 2016, the OECD established a Centre on Green Finance and Investment to help catalyze and support the transition to a green, low-emissions and climate-resilient economy through the development of effective policies, institutions and instruments for green finance and investment.? OECD work on the environment helps countries design and implement policies to address environmental challenges and sustainably manage their natural resources. The OECD’s analysis covers a wide range of areas from climate change, water and biodiversity to chemical safety, resource efficiency and the circular economy, including keeping track of how countries are performing across a range of environmental indicators. The OECD works with governments at all levels, including in developing and emerging economies, with civil society, and the private sector to drive effective action to meet environmental goals, including through aligning and?scaling up finance and investment.

G20: In 2021, the G20 Finance Ministers and Central Bank Governors endorsed the establishment of the G20 Sustainable Finance Working Group. The Group aims to mobilize sustainable finance as a way of ensuring global growth and stability and promoting the transitions towards greener, more resilient and inclusive societies and economies. The Group is tasked to identify institutional and market barriers to sustainable finance and to develop options to overcome such barriers and contribute to a better alignment of the international financial system to the objectives of the 2030 Agenda and the Paris Agreement.

Financial Stability Board: In 2015, the Financial Stability Board (“FSB”) established the Task Force on Climate-related Financial Disclosures (“TCFD”) to develop recommendations, which were eventually published in 2017, for more effective climate-related disclosures.? In 2021, the TCFD published guidance on climate-related financial disclosures including metrics, targets and transition plans.[11]? In June 2023, the IFRS S1 and IFRS S2 standards were issued by the International Sustainability Standards Board, and both fully incorporated the recommendations of the TCFD, which was disbanded in October 2023.

International Monetary Fund: Since 2019, the International Monetary Fund (“IMF”) has focused on the link between sustainable finance and financial stability, acknowledging that ESG issues can have a material impact on firms’ performance and on the stability of the financial system more broadly.? Analytical work of the IMF relating to climate change has examined policy issues such as an international carbon price floor, the transition to a green economy, border carbon adjustments, scaling up private climate finance in emerging market and developing economies, strengthening climate information architecture, fiscal policies to support adaptation, and green public investment and public financial management.

The World Bank: The World Bank Group (“WBG”) long-term finance unit has been active in promoting Sustainable Finance globally though data provision, analytical work, instrument design and technical assistance to support regulators and investors to “green” their financial systems. The WBG issued the world’s first green bond in 2008, creating a blueprint for sustainability across markets, and it is the biggest multilateral funder of climate investments in developing countries. The World Bank Climate Change Action Plan 2021-25 aims to increase climate finance to reduce emissions, strengthen climate change adaptation and align financial flows with the goals of the Paris Agreement.

Central Banks and Supervisors Network for Greening the Financial System: The Central Banks and Supervisors Network for Greening the Financial System (“NGFS”), established in December 2017, is a group of over 114 Central Banks and Supervisors exchanging experiences, sharing best practices, contributing to the development of environment and climate risk management in the financial sector, and mobilizing mainstream finance to support the transition towards a sustainable economy. The NGFS has been actively publishing various reports and guides on integrating climate-related and environmental risks into supervision, climate scenarios and climate scenarios analysis for central banks and supervisors, implications of climate change on monetary policy, climate-related disclosure for central banks and other relevant topics.

International Organization of Securities Commissions: In 2018, the International Organization of Securities Commissions (“IOSCO”) established its Sustainable Finance Network (SFN) to allow members to exchange experiences and gain a better understanding of sustainability issues, including the details of issuer disclosures, their relevance to investor decision-making and the level of uptake and the implementation of industry-led initiatives, and to have structured discussions around these issues. In February 2020, the SFN was replaced by the Sustainability Task Force, which has focused on improving sustainability–related disclosures made by issuers and asset managers; collaborating with other international organizations and regulators to avoid duplicative efforts and to enhance coordination of relevant regulatory and supervisory approaches; and preparation of?case studies and analyses of transparency, investor protection and other relevant issues within sustainable finance to illustrate the practical implications of its work.

International Association of Insurance Supervisors: In 2017, the International Association of Insurance Supervisors (“IAIS”) identified climate risk and sustainability as a strategic focus.? The IAIS’ work on climate change spans across many activities such as financial stability risk assessment, development of supervisory and supporting material and capacity building.? The IAIS has focused on promoting a globally consistent supervisory response to climate change and providing supervisors with the necessary tools to monitor, assess and address climate-related risks to the insurance sector.??

Sources: Annex A (“Summary of international policy context relating to sustainable finance developments”) in Financial Consumers and Sustainable Finance: Policy Implications and Approaches (OECD, 2023).? Reference should also be made to the compendium of international and regional initiatives to further green and sustainable finance compiled by the International Capital Market Association and the list of sustainable finance organizations maintained by Swiss Sustainable Finance.

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To learn more, read my recently updated chapter on Sustainable Finance and my new book Sustainable Finance and Impact Investment: A Guide for Sustainable Entrepreneurs.

Notes

[1] The discussion in this paragraph is adapted from Sustainable Finance (The middle Road).

[2] A. Krauss et al., Sustainable Finance in Switzerland: Where Do We Stand? (Zurich: Sustainable Finance Institute, September 2016), 13 and 15.

[3] Id. at 16.

[4] Overview of sustainable finance (European Commission).

[5] The EC noted that sustainable finance is about financing both what is already environment-friendly today (“green finance”) and what is transitioning to environment-friendly performance levels over time (“transition finance”) and explained that transition finance is about financing private investments to reduce today’s high greenhouse gas emissions or other environmental impacts and transition to a climate neutral and sustainable economy.? The distinction is important and has been acknowledged by the emergence of a separate, but related, field of transition financing focusing on supporting companies that want to become sustainable but need to do so in steps over time (i.e., companies with different starting points that want to finance their journey towards a sustainable future.? Id.

[6] Id.

[7] See The European Green Deal (European Commission).

[8] Sustainable finance: what’s it all about? (BNP Paribas).

[9] Sustainable Finance (The middle Road) (citing Five Ways that ESG Creates Value, McKinsey Quarterly (November 14, 2019)).

[10] The discussion in this paragraph is adapted from Sustainable Finance (The middle Road).

[11] FSB Roadmap for Addressing Climate-related Financial Risks (Financial Stability Board).