Sustainable finance has gained traction over the last decade in the financing community as discussions around sustainability and ESG became a core ask among shareholders and external stakeholders. According to google trends, ‘sustainable finance’ has seen a more than 11 fold surge in search volume over the past 10 years. This is just indicative of exponential growth witnessed in the Global ESG assets which are on track to exceed $53 trillion by 2025, representing more than a third of the $140.5 trillion in projected total assets under management. New issuance of sustainable linked bonds worldwide have already topped $575 billion so far this year, $100 billion more than all of 2020 and is set to hit $1 trillion for the first time ever. Even at today’s scale of both public and private investment in SDG-related sectors, developing countries face an average annual funding gap of $2.5 trillion for the goals to be realised by 2030.
What is sustainable finance?
Sustainable finance refers to any form of financial service integrating environmental, social and governance (ESG) criteria into the business or investment decisions for the lasting benefit of both clients and society at large. Sustainable finance therefore encourages companies to commit to climate and sustainability goals. Private and public investment is funnelled to invest into climate-neutral, climate-resilient and resource efficient projects while also promoting fair economy and sustainable growth. Responsible investments can take a targeted or untargeted approach with respect to their end use.
- Targeted Sustainable Finance: Capital is provided for the development and implementation of green technologies/ activities/ projects. The objective is to provide money where the proceeds will be used for projects contributing to ESG factors while reducing the stranded assets arising from changing policy and market demand.
- Untargeted Sustainable Finance: Capital is provided for companies that successfully manage ESG risks and are thus perceived as better adjusted to transition and physical risks than others. The proceeds here are available for general use by the company. The objective here is to help reduce ESG risks across the investors’ portfolio.
The development of innovative finance tools and instruments to address social and environmental problems is nothing new. Historically, such finance has focused on concessionary and micro-finance to support the “social economy”. Sustainable finance received its first recognition during the Earth Summit, 1992 in Rio De Janeiro. The financial sector was recognised as the key factor which could propel sustainable growth, which gave birth to the United Nations Environment Program Finance Initiative (UNEP FI). The UN Millennium Development Goals (MDGs) in 2000 raised awareness and provided a framework for the finance sector to understand its impact on sustainability. Countries had concerns about a growing rift between sustaining economic growth needed to generate employment and reduce poverty, while cutting down on GHG emissions. International cooperation on finance was identified as a tool to help manage such trade-offs, and create new incentives for sustainable development. It followed that finance for action on climate change became a central position in post-2015 development goals which helped set the stage for the SDGs set in 2015.
Types of instruments
Regular finance instruments, when coupled with a sustainability goal for its end use, gets termed as a sustainable finance instrument. The terms ‘green finance’, ‘sustainable finance’, ‘climate finance’ and ‘low carbon finance’ relate to an overlapping territory of issues. In times where each of them are becoming buzz words, it is important to understand the scope within which they function. This can be understood as follows:
(Source: UNEP Inquiry 2016)
Some of the prevalent instruments in the sustainable finance space are :
|Year of first issuance
|Green Bond Principles (GBP)
|Sustainability Bond Guidelines (SBG)
|Social Bond Principles (SBP)
|Green Loan Principles (GLP)
|Sustainability Linked Loan
|Sustainability Linked Loan Principles (SLLP)
|Sustainability Linked Bond
|Sustainability Linked Bond Principles (SLBP)
Frameworks and authorities
Setting up regulations for defining sustainability and its criterias in finance is still an evolving process. The financial authorities of many countries like Bangladesh, Brazil, UK, China, France have defined the scope within their landscape. There are wide gaps in terms of streamlining accountability for the use of proceeds and its reporting. The EU taxonomy framework is one example that has created a standard guideline to avoid greenwashing. The UNEP FI has helped setup the following frameworks for responsible finance to set the ball rolling:
- Principles for Responsible Investment (PRI), established in 2006
- Principles for Sustainable Insurance (PSI), established in 2012
- Principles for Responsible Banking (PRB), established in 2019
While sustainable finance grows exponentially it is important to shift financial flows from brown to green, not only grow the green niche. COVID-19 has in a way acted as a catalyst for financial and social opportunity such an instrument presents. With climate change on our doorsteps and the pandemic having created havoc over lives and businesses, repairing and rebuilding will require trillions of dollars while preparing for a more resilient financial future.