Sustainable finance: an overview

What is sustainable finance?

Definition

The European Commission defines sustainable finance as the process of taking environmental, social and governance (ESG) considerations into account when making investment decisions in the financial sector, leading to more long-term investments in sustainable economic activities and projects. 

Environmental considerations might include climate change mitigation and adaptation, as well as the environment more broadly, for instance the preservation of biodiversity, pollution prevention, and the circular economy. Social considerations could refer to issues of inequality, inclusiveness, labour relations, investment in human capital and communities, as well as human rights issues. The governance of public and private institutions – including management structures, employee relations, and executive remuneration – plays a fundamental role in ensuring the inclusion of social and environmental considerations in the decision-making process.

EU policy seeks to align financial investment with a pathway towards a more climate-resilient economy across the bloc while also developing social and governance considerations. Under the new round of policies financial and corporate actors will have far more accountability relating to the ESG performance across all 3 pillars of sustainability as more stringent disclosure and reporting requirements are introduced. 

Examples of sustainable finance

Sustainable finance encompasses a wide range of investment tools, initiatives and products as well as transparency when it comes to ESG-related risk factors in financial decisions. Below are a few examples of sustainable finance in the current market: 

Investment in financial instruments that support sustainable development and practices is rapidly growing across all facets of the financial markets. Somewhat unsurprisingly, debt markets are leading the charge with versatile Sustainability-Linked Loans (SLLs) and Bonds (SLBs). Global issuance of SLLs rose 300% between 2020 and 2021 to over $700 billion which is in part due to their flexibility for borrowers as they are only tied to overall company KPIs and not the performance of a specific asset or project. Conversely, Green Bonds, Blue Bonds and Social Bonds are linked to the predetermined KPIs for the asset or project in question. For both groups of products not fulfilling the KPIs will add a premium on top of the repayment or coupon rates to incentivise borrowers to attain their ESG goals.  

ESG or Sustainable ETFs (passive funds that track the performance of companies with specific ESG commitments) are rapidly becoming a popular choice for conscious investors, particularly for European assets as the EU is at the forefront of ESG regulation. This trend towards ESG investment is known as Socially Responsible Investing (SRI). The SEC in the USA has recently proposed a new ESG taxonomy for US markets to impose mandatory non-financial disclosures on listed ETFs which reflects the current European regulations. Under the proposed new system, funds will be divided into 3 different categories depending on the level of their ESG commitments. 

Within the financial services industry, there are now a growing number of companies or teams within companies who are specifically mandated on ESG focussed projects. For example, each of the Big Four Accounting firms now have ESG Audit, and to some extent, ESG Consulting services as well as partnerships with smaller ESG focussed companies. 

Why is sustainable finance important?

Sustainable finance represents an efficient means of channelling resources from private investment towards sustainable practices which either promote the transition to a more climate-resilient, resource-efficient and fair economy to complement investment of public money. This will be vitally important to deliver on key international agreements such as the UN Sustainable Development Goals and the 2015 Paris climate agreement. 

As investors and consumers become more socially and environmentally conscious, companies will need to react accordingly. Divestment from fossil fuels and other ecologically or socially irresponsible practices will be essential for securing long term sustainable and low risk investment. Businesses that integrate ESG considerations into their decision-making experience improved financial performance and better shareholder returns.

For companies, the increasing pressure on regulators for requirements on transparency with non-financial information will likely make ESG credentials a crucial factor in investment decisions, in particular with respect to understanding any future risks. This will be felt acutely by consumer-facing sectors and companies. According to a recent consumer report published by the Bank of the West, four out of five Americans buy goods and services that support the environmental and/or societal issues they are passionate about and that the sales of products marked as sustainable grew 5.6 times faster than conventional products despite representing only 16.6% of the market. This shows a growing awareness and the importance of sustainability in the minds of consumers, and that it will be vital for corporations to meet these challenges head on to maintain healthy growth and profitability in the medium to long term.

How can APlanet help?

APlanet takes a holistic approach to ESG data collection, management and analysis meaning that we consider all 3 pillars of ESG equally. Our audit-ready platform allows users to input relevant datasets, review using interactive dashboards and produce clear and concise reports at the click of a button. This technology will help users to keep on top of their ESG data and easily track or disclose KPIs for auditing or reporting purposes. 

If this interests you please contact us or book your free demo on our website!

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