SUSTAINABLE FINANCE
STEERING THE FLOW OF CAPITAL
Sourcing hard funds to achieve Sustainable Development Goals – Kiran Dhanapala
The forces of volatility, uncertainty, complexity and ambiguity (VUCA) will change the economy, types of investments that will thrive, and assessments of risks and returns. Therefore, steering capital towards a sustainable future is imperative.
Sustainable finance (SF) recognises various kinds of capital – natural, human, intellectual, social, manufactured and financial – and is often undervalued by the market. It directs financial capital through intermediaries including financial institutions (FIs) to where it’s needed to achieve the UN Sustainable Development Goals (SDGs) by 2030.
The current financial system and society don’t necessarily direct capital to sustainable financial activities as seen in the funding gap towards achieving the SDGs. This is due to existing barriers as well as market failures.
Growing SF requires addressing some free market failures with more consistent environmental, social and governance (ESG) information, including data on risks and returns, taking a longer-term and broader view of impact, pricing or valuation of usually unpriced externalities, reflecting ESG risk factors in the cost of capital, systems thinking to achieve scalable transition and so on.
There is rethinking on the relationship between growth, environmental sustainability and human wellbeing, and how it requires new economic frameworks and theories, as well as FI reforms.
SF integrates ESG factors into investment decision-making over the longer term to provide advantageous outcomes to society. Sub-categories of sustainable finance include climate and green finance, and its approaches encompass ESG integration, impact investing, shareholder action, microfinance, ESG ratings, triple bottom line and more.
Presently, global progress towards SDG achievement is weak with over 50 percent of targets not on track, only 15 percent on track and 30 percent stalled or reversed. This led to a 2023 call for a ‘Rescue Plan for People and the Planet.’
This stimulus proposes three action areas: a surge in finance for development, transformation of the business models of multilateral development banks and new debt initiatives.
The annual funding gap for the SDGs is estimated to be US$ 4.2 trillion. Given the flattening of public funding, rapid private capital deployment for SDG financing is needed.
Regulation is fundamental to promoting SF since tools, legal frameworks (including a review of fiduciary duty) and campaigns help re-steer capital. Increasing pressure on investors to promote sustainable finance through shareholder action and engagement also helps.
Individuals can influence the SF agenda through voting rights on shares owned by their pension, investments or savings funds.
The latest Global Sustainable Investment Review (GSIR) notes that 30.3 trillion dollars has been invested worldwide in sustainable investment assets. This increased by 20 percent in non-US markets since 2020 and denotes a maturing industry.
Common sustainable investment strategies are corporate engagement and stakeholder action, ESG integration and negative or exclusionary screening.
GSIR also saw several trends emerge.
Firstly, regulatory tightening and industry standards; secondly, greenwashing concerns that have led to ‘greenhushing,’ which poses challenges to comparability; and thirdly, a focus on stewardship and stakeholder engagement.
Further trends show that FIs are unhurried on climate action. Asian banks are slow on net zero commitments, and transitioning their lending and investment portfolios.
The UN Climate Change Conference of the Parties (COP28) didn’t set a specific timeline for a fossil fuel phase-out. Yet, growing pressure is expected on FIs to support transition finance. Republican states in the US are attacking ESG and could continue to do so in the run-up to the presidential election.
Meanwhile, the EU’s Corporate Sustainability Reporting Directive (CSRD), which became effective in January, requires company disclosure on a range of ESG impacts from a corporate risk perspective and also on people and the planet. Scope 3 emissions too are included. France has introduced hefty fines and the threat of jail time for CSRD noncompliance.
Green energy took a hit last year with share prices falling and increasing interest rates raising project costs. But with the levelling of interest rates, a recovery is expected.
The 2023 G20 Sustainable Finance Report prioritises three areas in its G20 Sustainable Roadmap – viz. mechanisms for mobilising timely and adequate resources for climate finance, enabling finance for the SDGs and capacity enhancement of the ecosystem for financing sustainable development.
In relation to SDGs, the two areas of social impact investment instruments, and improving nature-related data and reporting, have been highlighted. And capacity building includes overcoming data-related barriers to climate investments.
