Unlocking the potential of financial markets, especially the private sector, is recognized as key to enabling a clime-neutral economy. But are there any differences between sustainable finance and other concepts such as green finance, impact investing, responsible finance, etc.? Read on to get a brief account of the promises of this huge deal in equipping countries in their transition to environmentally and socially sustainable economies.
Today, you can hear many terms starting with ‘green’ and ‘sustainable’. One of these very important concepts is sustainable finance. By European Commission (EC) definition, sustainable finance is 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 ‘ingredients’ of sustainability could be climate change adaptation and mitigation, biodiversity conservation, and pollution prevention among others, while social considerations include inequality, working conditions along with human rights. Governance, on the other hand, is crucial in integrating the former two aspects into public or private institutions’ decision-making processes and it encompasses management structure, compensation policies, and employee-employer relationships within companies. This definition is very broad, indeed, and it begs the understanding of several other concepts.
If you think of financing or investment as a spectrum, one extreme of it is traditional investment seeking only financial returns and, therefore, considering only the financial health of investees. At the other end of the investment, activities stand philanthropy which is an investment totally devoid of financial gains and wholly voluntarily dedicated to contributing to some thematic areas such as climate adaptation and access to education. Between these two extremes lie several concepts as outlined below.
Green financing aims at boosting the level of financial flows from the public, private and not-for-profit sectors to fund the achievement of sustainable development targets. A key part of green financing activities is to take up investment in a way that brings both a reasonable rate of return and some environmental or social benefits for society overall. This is done through better managing environmental and social risks, as well as channeling funds into sustainable development priorities of recipient countries.
What is different about impact investing is its intentionality with regard to achieved impacts. In this kind of investment, the role of specific impact indicators, processes, and procedures to manage risks and impacts and impact evaluations are crucial in order to live up to the name ‘impact investing’.
There can be two levels of impact when investing in a financial institution: first, at the higher level of improving the capacity of the investee for achieving its environmentally and socially impactful objectives, and second, at the local level of achieving an ultimate impact. The ultimate impact can be an actual improvement in the quality of life of people or a restored forest area and reversed species loss.
When it comes to responsible investment, the definition provided by the institution that coined the term – Principles of Responsible Investment (PRI) – goes “a strategy and practice to incorporate environmental, social and governance factors in investment decisions and active ownership.” The first component – ESG incorporation – can be realized by explicitly and consistently considering ESG concerns in the analysis of existing investments, better managing ESG risks, and improving monetary returns. In terms of potential investments, this amounts to screening the investments based on exclusion lists, i.e. not financing particularly potentially harmful sectors and activities, and intentionally searching for investments that combine attractive returns with a purposeful contribution to one or more of the sustainability themes, i.e. impact investing.
Active ownership, on the other hand, can mean investors being responsible by encouraging their existing investee companies to develop and improve their capacity to handle environmental and social risks. Such capacity may include having environmental and social management systems (ESMS) or disclosing ESG risks and impacts publicly or to shareholders.
What Sustainable Finance Promises
As it is obvious, all these terms fit under sustainable finance and they can be understood as specific instruments or strategies to contribute to sustainability actions while also making money. Sustainable finance unleashes much-needed finances for achieving development goals through international development cooperation. It was estimated by the United Nations (UN) that the financing gap to achieve Sustainable Development Goals (SDGs) in poor countries until 2030 is 2.5-3 trillion dollars per year. It is also estimated that gross world product and global gross private-sector financial assets stand at 80 trillion and 200 trillion dollars, respectively. What it means is that needed finances are available but not channeled to where they are needed.
Sustainable finance promises exactly this. Although it also brings with it a wave of ‘greenwashing’ activities, we all know that every coin has two sides. Financial market players and regulators will have to deal with the risks of huge amounts of sustainable financial flows if the people and planet are to be protected through these flows.
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