Climate change has become a crucial topic on the agenda for governments, investors, and corporates. This is because the costs of the steps which can be actioned now to mitigate the effects of climate change are far less than if nothing is done. So, what is sustainable finance?
Investors are no longer met with a choice between helping the planet and making a profit. Sustainable finance is helping businesses to do both, but it also focuses heavily on ethical business standards and inclusion.
So what is the impact on the way our pensions and savings are invested? The world of sustainable finance means investing your money in actions that will make the world a better place.
What is sustainable finance?
Put simply; sustainable finance is the process of taking environmental, social, and governance (ESG) principles into account when making investment decisions in the financial sector. This results in more long-term investments in sustainable economic projects and activities.
The environmental considerations could include climate change adaptation and mitigation in addition to broader goals like preserving biodiversity, adopting the circular economy, or fighting pollution. Social considerations under sustainable finance could include issues of inclusiveness, inequality, labour relations, investment in human communities, and also, human rights issues.
The governance considerations then focus on private and public institutions. In other words, employee relations, management structures, and executive remuneration. These all play essential roles in making sure the inclusion of environmental and social considerations is within the decision-making process.
EU policy understands sustainable finance as finance that aims to support economic growth. Not just that but finance which reduces pressures on the environment while also considering governance and social aspects. This type of finance also encapsulates transparency concerning risks related to ESG principles that could impact the financial system as a whole. In addition, the mitigation of these risks through appropriate governance of corporate and financial actors.
The importance of sustainable finance
Sustainable finance is so important because it will play a vital role in delivering on the policy objectives under the European Green Deal. In addition, the EU’s international commitments on sustainability and climate objectives. Sustainable finance does this by challenging private investment into the transition to a climate-resilient, climate-neutral, resource-efficient, and fair economy as a complement to public money. Essentially, sustainable finance will assist in making sure investments made support a resilient economy. The WWF sees finance as a critical lever to encourage sustainable outcomes.
They feel the private sector will play a vital role in redefining business as usual but also supporting the transition to restoring nature. The finance sector is in a positive position to incentivise this transition by only agreeing to invest in, lend to, and insure businesses that manage their nature impacts and risks. Nearly all the major companies across the globe have established sustainability and CSR departments.
In addition, they are issuing annual sustainability reports to share their impact. Most asset managers, particularly institutional investors, also claim to embed ESG into their investment strategy. The Global Sustainable Investment Alliance found that in 2020 more than $35.5 trillion was managed for responsible and sustainable investing worldwide.
Additionally, the UN Principles of Responsible Investment (UN PRI) has over 4,000 signatures managing $120 trillion in assets. Some of the signers include big investors like Calvert, BlackRock, CalPERS, and the Norwegian Government Pension Fund Global. This number has seen rapid growth over time. Policymakers are also working toward the SDGs, and to achieve them; we need trillions of dollars to finance various projects.
The money for these projects could come from sustainable finance. There are also other pressures which are driving sustainable finance. For example, events like international climate conferences as well as various campaigns. They are raising awareness of the need for sustainable finance among investors, corporations, and the public. Additionally, financing sustainable businesses has strong financial benefits as well as broader societal ones.
How does it contribute to sustainable business?
Previously investors had to choose between helping the planet or making money. With ESG investing and sustainable finance, the decision-making process has been altered. Therefore, more investors want to invest in businesses that will leave behind a better world while also enjoying greater returns.
The motivation for businesses to invest heavily to become more sustainable comes as consumers today care more for the environment. They want to support businesses that share their values. Consumers want to purchase products and services from businesses with a strategic purpose that means a lot to them. Ultimately, sustainable finance is a win-win scenario for investors, businesses, and customers.
Sustainable finance greatly contributes to sustainable business. This is because it refers to investing in a range of green and social initiatives. For example, placing more women on boards or investing in green energy solutions. In addition, because it is built on ESG principles, sustainable finance helps you ensure your business is contributing to sustainable development and a more vibrant society.
Besides the environmental and social benefits, there are many advantages for businesses that decide to invest in sustainable and social initiatives embedded in ESG principles. There is a mountain of evidence to show that sustainable businesses offer higher returns for investors.
One study facilitated by Fidelity measured the performance of a number of ESG investments globally between 1970 and 2014. They discovered half of the businesses outperformed the market. Businesses that are committed to sustainable finance are ultimately seen as more prosperous and attract businesses to invest in.
Overall, sustainable finance will enable businesses to provide more direct sustainable support for the planet and play a part in ensuring a more inclusive and functional society. It also allows for more opportunities for partnerships and increases customer loyalty through sharing values.
Examples
Corporations have an important role to play in relation to sustainable finance. They will be the primary channel of climate funds through CSR investments and initiatives in many business sectors. Below are some examples of sustainable finance that are relevant to businesses.
- Green bonds
Green bonds are essentially a type of investment that enables a business owner or entrepreneur to borrow funds from private investors. They basically use a bond secured against their home, and the investor can make between 1-5 percent on their investment.
This, of course, depends on the level of collateral, stability, and risk of the underlying assets. This type of sustainable finance is a fixed-income instrument that aims to support specific environmental or climate-related projects.
- Sustainable and Renewable Equity
This kind of sustainable finance involves setting up solar panels, and you can collect cash payments or tax credits in return for the power generated by them. The advantage here is that it is guaranteed and stable over a 20-year timeline. The finance you will receive will most likely go to the capital costs which are associated with installing the solar panels.
- Solar bonds
This form of sustainable finance cannot be purchased with cash. Rather, it must be bought with green energy credits. Business owners can receive between two and four percent on their investment. However, this does still depend on the company providing the bond and its history.
- Renewable energy credits
Renewable energy credits can be purchased as a direct investment in solar panel energy systems or to offset your business’ carbon impact by using forms of power generated elsewhere. They are not a source of capital but rather a means to reinforce the demand for sustainable investment. The credits help your business meet energy-saving targets and cut energy costs, too.
- Sustainability-linked loans
Another form of sustainable finance is sustainability-linked loans (SLLs). They present an alternative type of sustainable or green loan where the interest rate can be stepped down or up according to the borrower’s change in sustainability rating over the timeline of the loan.
- Sustainability-linked bonds
Sustainability-linked bonds are those where the proceeds from the issuance are not ring-fenced for sustainable or green purposes. In other words, they may be utilised for general corporate purposes or others. These bonds are linked to the performance of specific key performance indicators (KPIs) in achieving sustainability performance targets.
Summary
Once your business understands its ESG data, it will be a lot easier to pinpoint areas that need improvement. Then, you can implement goals to make those areas more efficient. This will make your business more attractive to investors. Once you have determined your best practices to improve your ESG rating, you can start to identify investors and research governmental funds.
Doing so will help you further improve your economic, social, and environmental impact. Sustainable finance has the potential to drive the world’s transition to net zero. Ecologically sound businesses are more likely to save costs by utilising fewer resources, winning contracts, retaining better staff, and avoiding losing money on carbon-intensive processes, according to McKinsey.
Reuters reported that sustainable finance bond issuance added up to $859 billion last year. This is the highest it has ever been and is only set to grow. All businesses should be looking at sustainable finance to see how they can incorporate it into their models to use their practice as a force for good.
When you are ready to delve into what is sustainability finance, consider taking the Diploma in Business Sustainability course to equip yourself with a comprehensive understanding of business sustainability best practices.
