Today, sustainability and sustainable finance are buzzwords in every business sector. The Paris Agreement’s climate goals for 2021 have made every business, from consulting to retail, want to be more sustainable. Therefore, it is not surprising to see the financial sector exerting significant effort to adopt more sustainable practises, given that it is one of the largest and most illustrious industries in the world: Six of Forbes’ top 10 global companies are financial institutions. ESG-oriented investing and green finance are now mainstream practices in the financial services sector. They now have an impact on the entire industry’s direction. Simply put, this refers to investing money in projects that will improve the world. Before we move on, though, let’s talk about what sustainable finance is.
What is Sustainable Finance?
Sustainable finance refers to the process of incorporating environmental, social, and governance (ESG) factors into investment decisions in the financial sector, resulting in longer-term investments in economically sustainable activities and projects. Climate change mitigation and adaptation, as well as the environment as a whole, such as the preservation of biodiversity, preventing pollution, and the circular economy, could be part of environmental considerations. Social considerations include issues such as inequality, openness to all, labour relations, investment in human capital, communities, and human rights.
In terms of EU policy, sustainable finance is money that helps the economy grow while putting less pressure on the environment and taking into account social and governance issues. Additionally, sustainable finance involves transparency regarding ESG factors related to the financial system, as well as the need to reduce such risks through the right governance of financial and corporate actors.
Examples of Sustainable Finance
1. Green bonds
Green bonds are a type of debt instrument that can be used to get money for projects that are good for the environment. They can be given out by governments, companies, or other groups to pay for projects like clean transportation and water management that is good for the environment.
2. Sustainable investment funds
Sustainable investment funds are ways to invest that are meant to make money while also taking into account how the investments will affect the environment and society. These funds could be put into businesses or projects that focus on sustainability, like renewable energy or farming that doesn’t harm the environment.
These two examples demonstrate how this type of financing can provide funding for projects that have a positive effect on the planet and its inhabitants while also generating financial returns for investors.
Why is Sustainable Finance important?
Sustainability is becoming more important in finance because of the big environmental and social problems our world is facing right now. Climate change, running out of resources, and social inequality could all have big effects on the world economy and financial system. By prioritising sustainability, financial institutions can assist in addressing these issues and facilitating the transition to a more sustainable and equitable future. Investing in sustainable projects also pays off financially, especially since more and more consumers and investors are looking for greener, more socially responsible, and ethical ways to invest.
Principles of financial sustainability
1. Strategic and financial planning
Organisations must have clear and well-defined strategies in place, as well as effective financial planning and management systems, to achieve long-term financial stability.
2. Strong governance
Organisations need strong and effective governance systems to make sure they are well-run and in line with their strategic goals.
3. Diversified funding
Organisations need to have more than one way to get money so they don’t have to rely on just one source of money and can be more financially stable.
4. Risk management
Organisations need to have good risk management systems in place so that they can find and deal with possible financial risks.
Sustainable Finance provides better returns
- In addition to benefiting the environment and making society more equitable and inclusive, evidence is mounting that sustainable businesses provide higher returns to investors.
- In a study conducted by asset manager Fidelity, half of the ESG investments studied outperformed the market between 1970 and 2014. Only 11% demonstrated poor performance.
- The world’s largest asset management firm BlackRock reported that during the peak of the COVID-19 pandemic in 2020, more than eight out of ten sustainable investment funds outperformed their non-ESG counterparts.
- According to research by the financial website Morningstar, companies with high ESG ratings have also enjoyed stronger increases in their share price over the last five years, in addition to paying higher dividends to shareholders.
- This is significant because the majority of stock market investments are made by financial institutions such as pension funds. In the United States, organisations that manage other people’s money own 80% of listed equity in leading companies.
- Individuals may choose to earn a lower rate of return to save the environment, but institutional investors and pension fund trustees do not have that option. They must follow a fiduciary duty to act in the best financial interests of investors.
Despite this, the rise in returns on sustainable assets means that trustees no longer need to choose between profits and sustainability. The Transformational Investment report from the World Economic Forum uses New Zealand’s state pension fund as an example. The trustees of that fund said that climate change made it harder for them to pay pensions, so they switched to a sustainable finance strategy. Since its inception in 2003, the fund has outperformed comparable investments by 1.24% annually, a difference that now stands at $7.24 billion (NZD10.65 billion).
Conclusion
In conclusion, sustainable finance is an important approach that seeks to align financial practices with environmental, social, and governance (ESG) goals. It offers a pathway for investors to support environmentally and socially responsible projects while still achieving their financial objectives.
Sustainable finance has led to the creation of a variety of financial instruments, such as green bonds and sustainable mutual funds, which are gaining popularity among investors. However, there are still many challenges that need to be addressed, such as the lack of standardized ESG reporting and the issue of greenwashing.
Despite these challenges, the growth of sustainable finance is a positive development for both the financial industry and the planet. It provides an opportunity for investors to make a positive impact and help drive positive environmental and social outcomes. As more investors demand sustainability, companies are likely to respond with greater transparency and accountability, leading to a more sustainable future for all.
FAQs
1. What is Sustainable Finance?
Ans: Sustainable finance refers to the practice of aligning financial investments and activities with environmental, social, and governance (ESG) goals. It seeks to promote sustainable development by supporting projects that have positive social and environmental impacts.
2. Why is Sustainable Finance important?
Ans: Sustainable finance is important because it helps to ensure that financial investments and activities are not only profitable but also contribute to the well-being of society and the planet. It supports the transition to a more sustainable economy and helps to address pressing global challenges such as climate change, social inequality, and biodiversity loss.
3. What are the principles of Sustainable Finance?
Ans: The principles of sustainable finance are:
- Strategic and financial planning
- Strong governance
- Diversified funding
- Risk management
4. How to implement Sustainable Finance solutions?
Ans: There are several ways to implement sustainable finance, such as investing in sustainable mutual funds, exchange-traded funds (ETFs), or individual stocks of companies that prioritize ESG factors. You can also consider investing in green bonds or social impact bonds.
5. What is the difference between ESG investing and sustainable investing?
Ans: ESG investing refers to the integration of environmental, social, and governance factors into investment decisions. Sustainable investing goes a step further by focusing on investments that have a positive impact on society and the planet, rather than simply avoiding investments in companies with negative impacts.
