Sustainability was once far from the top of the agenda for many in the finance world – but today everything has changed. The awareness of – and attitudes towards – the world’s environmental, social and governance (ESG) challenges has been transformed.
To take one recent example, the public in many countries has called for action on plastic pollution in our oceans; governments around the world have responded by banning or taxing single-use plastics.
As attitudes among the public and policymakers have shifted, the finance sector has responded, with sustainable finance now a hot topic for investors, banks and corporates around the world. It is becoming increasingly sophisticated, with new frameworks, initiatives and financial products emerging, and a growing distinction between the use of risk filters (to do no harm) and impact financing or investing (to actively do good).
"Financial institutions have an important role to play in using their capabilities to promote economic and social development in a sustainable way"
This change is critical to the future of our planet, as developments at a governmental and industry level are critical in helping sustainability gain traction. But individual financial institutions also have an important role to play in using their capabilities to promote economic and social development in a sustainable way; they can both further the development of sustainable finance and sustainability more generally.
By committing to deliver long-term value for their shareholders, society and the environment, banks can make a real difference while benefiting from an enormous opportunity: the International Finance Corporation (IFC) estimates there are USD23 trillion of climate-related sustainable finance opportunities in emerging markets alone in the years to 2030.
Why sustainable finance is gaining ground
Both investment managers and corporates increasingly accept that consideration of ESG factors does not hamper investment returns. In fact, it can deliver risk and performance benefits. A report by Boston Consulting Group shows that non-financial performance (captured by ESG metrics) is statistically significant in predicting the valuation multiples of companies in a variety of industries.
Other evidence confirms the significant financial benefits of ESG factors. The IFC analysis of 656 companies in its portfolio found that those with a good environmental and social performance outperformed others by 2.1 per cent in terms of return on equity.
Companies that focus on ESG issues are more highly valued and can perform better because they have a lower cost of capital due to their superior risk profile (they are more profitable and will outperform should unexpected events occur), according to an MSCI report. In short, even if one were to ignore any ethical imperatives for companies to commit to ESG and investors to consider ESG factors, there appear to be clear financial rewards from adopting ESG as best practice.
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The role of banks
Public opinion will continue to drive the growth of sustainable finance and sustainability. New regulations will also entrench sustainability for business and finance. The European Union plans to develop a climate mitigation classification system, a green bond standard, benchmarks for low-carbon investment, and guidance on corporate disclosure of climate-related information. And in China, all listed companies and bond issuers in China will have to disclose ESG risks by 2020.
Banks have a powerful tool – financing – to promote change. They can blacklist industries that contribute to climate change such as coal-fired power, agro-industries involved in deforestation, or sectors where there are human rights violations, for example. And they can support microfinance, renewable power, blended finance (which uses development finance to leverage private sector funds) and other sustainable financing that promotes sustainability.
To help solve world’s environmental and social challenges, I firmly believe that sustainability should be at the forefront of finance.
A version of this article first appeared in The Asset magazine. Click here to read the full piece.