Sustainable finance series: Why does sustainable finance matter?

Mon 20 Mar 2023

The momentum towards a low-carbon economic system is only set to grow. Financial services firms are pivotal actors in the transition; consequently, increasing demands are being put on them to demonstrate their sustainable finance activities and credentials. This blog explains what sustainable finance is and why it matters to financial services firms.

What is Sustainable Finance?

The European Commission’s definition of sustainable finance is: “the process of taking environment, 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.”

Sustainable Finance has two practical aspects which can be summed up, as follows:

• Financing Green – mobilising financial capital to finance green/sustainable linked projects; and
• Greening Finance – encouraging support for the evolution of the financial system to a green/sustainable agenda through for example, policy making; and regulations.

In terms of ESG, we are perhaps more aware of the ‘E’ – climate and environmental issues – and how sustainable finance supports projects that mitigate climate change or policy-making that aims to build resilience to climate and biodiversity risks in the financial system. On the social ‘S’ side, examples would be employee engagement, diversity and inclusion, and access and affordability to financial services. The ‘G’, governance, considers an organisation’s ethical standards, board diversity and stakeholder engagement.

What does sustainable finance mean for your business?

We are seeing growing expectations on financial services firms to operate with sustainability ingrained in their business model. These expectations are coming from several directions:

Investors and beneficial owners – They want more information and disclosures on what firms are doing regarding ESG issues.

When it comes to customers, they are expecting products and services offered by firms to reflect their own growing sense for a more sustainable and fairer society.

Government policies and strategies – Governments are making national commitments around climate. To demonstrate clear action on those commitments governments are putting in place climate-related policies and regulations on companies and individuals.

Regulatory requirements – Regulatory bodies are responding to investor, consumer and government demands by introducing ESG regulatory standards including public disclosures at entity and product level. Of course, countries are at different stages in implementing ESG standards, but we can see that convergence is happening around the typical components in ESG standards [governance, risk management, stress testing, scenario analysis, metrics, disclosures, and transition plans].

Industry standards and practices – There are several voluntary industry-led frameworks and initiatives that provide practical guidance for firms. These can help firms to implement the regulations, pursue and evidence best practices, signal responsible business commitments and shape responsible finance change in your business.

Industry standards and initiatives can also pre-empt regulatory action. Financial institutions with a responsible and sustainable ethos recognise that industry standards, best practices and initiatives are the direction of travel if they want to identify, monitor, and manage their exposures to potential climate and biodiversity physical and transition risks.

Government policies, heightened regulatory scrutiny, industry standards promoting responsible business, and investor and consumer demand, mean that sustainable finance expectations are high. With the financial sector viewed as pivotal in the transition to a low-carbon economy, there is no reason to believe these expectations will subside. So, you need to understand how these market expectations impact your business and put the right processes and expertise in place to navigate a sustainable future.

Next steps for your business

Moving to a responsible business model requires a shift to a more holistic approach and demonstrate that yours is a responsible business supporting a more sustainable economy. This is an approach where ESG considerations and an ESG mindset are embedded throughout your business (in governance, strategic planning, risk management, investment and lending strategies and policies, to name a few). The extent of the changes is why it can appear daunting to work out where and how to start with Sustainable Finance.

In the next blog in the series, we explain how to get started on your ESG journey.