What Is Sustainable Finance and Why Is It Important?

We all understand that we need to do more to protect the environment and it is clear that we can’t rely upon politicians to do it for us.

History has shown that society makes the most advances when business takes the lead and with this in mind, the development of environmental, social, and governance (ESG) is a development that promises to make a major change in the way that companies interact with their environment.

So what is sustainable finance and how do businesses need to change to take advantage of the new ways of working?

In this post, we’re looking at what sustainable finance is and why it is becoming important.

Sustainable finance is all about using the power your investment funds give to choose only companies that adhere to the highest environmental, social, and governance standards possible.

In some cases, this may be through a formally constituted fund, such as a green energy investment fund. Sometimes it may apply to only financing companies who use a fair trade business model. And sometimes it may be a less formal general approach to making sure that the companies you look to support act in the best interests of the community that they are a part of.

There are three strands to sustainable finance;

Environmental

The environmental aspect of the ESG principles looks at the way that the company interacts with its environment. Among other things it assesses the way the business uses energy and the waste it produces, the conservation of natural resources, the way it treats animals and deforestation.

Social

The social element of ESG examines the way that a business treats people both inside and outside the organisation.

It will look at the company’s record on diversity and inclusion, data hygiene and security, its record on human rights the way it interacts with stakeholders and the contribution it (and its staff) makes to society.

Governance

When we come to governance, the ESG standards are really looking at the way the company is run and how it seeks to influence and affect decision-makers.

It looks at shareholders’ rights, transparency, the board of directors and its makeup (including diversity), executive compensation, anti-bribery practices, political contributions and lobbying and venture partner compensation.

The first (and most obvious) reason that sustainable finance is important is that we should all be doing our individual bits to make the world a better place.

Sure this means making sure that we are good custodians of the natural world, but it also means more than that.

It means treating our fellow citizens with respect, paying our taxes, and contributing positively to the wider society.

So from a moral standpoint, sustainable finance principles should underpin our thinking on a daily basis.

But there is a more hard-headed approach that makes total business sense.

The sustainable finance sector is growing at a remarkable rate with private investors, banks, and all the way through to institutional investment funds all looking at ways to promote an ESG compliant agenda.

For any business looking to raise capital in the future, cutting itself off from a sizeable chunk of capital is a bad move.

It is also distinctly likely that in response to tighter COP26 commitments, governments may shortly introduce greater reporting requirements. This could result in non-compliant businesses taking severe reputational hits, both with funders and with their customer base.

If nothing else, we expect that investors will want to see their target companies show that they have, as a very minimum, assessed the environmental risks and put in plans to mitigate their effects.

This has knock-on effects for finance leaders. As Kevin Hagen, Vice President of Environment, Social, & Governance (ESG) Strategy at Iron Mountain says “accounting functions need to add skills for gathering, managing, analyzing, and reporting a whole new genre of business metrics, such as greenhouse gas emissions, gender pay gap results, and ethics and anti-corruption indicators.”

For many executives, ESG finance is a new and uncharted land.

But to a large extent, sustainable finance has been going under the radar for quite some time and has now reached the point where there are more sources of funding than ever for compliant enterprises. These include;

• Official bodies –for example, the UNFCCC, the UNEP, the OECD, and the G20. 
• Governments – this can include finance earmarked for climate change initiatives, Money often exists at national, regional, local and municipal government levels.
• Development Finance Institutions – this includes Development Banks and sources such as JICA, KfW (Germany), and the UK Development Fund (UK).
• Green Investment Banks – In the last few years, the market has seen a rapid increase in Green Banks and as the name suggests, these are banks with a specific focus on providing capital for projects focusing on climate change mitigation 
• Domestic capital markets – including institutional investors who support projects in the same country.
• Corporations – corporations such as Venture Capital and Private Equity firms are increasingly looking for ‘climate-friendly’ investments, often driven by consumer and shareholder demand for improved CSR.
• Aid agencies – like the WWF. these groups can play a key role in helping finance projects which are highly important but which are otherwise unfinanceable and usually look for projects that specifically deliver on their area of interest.
• Community-focused approaches – online ‘crowdfunding’ and fundraising platforms have made it easier to mobile the public to provide capital for the development of specific ideas and technologies. 
• Foundations – Large foundations have an important role to play in funding the ESG initiatives that commercial funding sources are unwilling to support.

The first thing to consider here is how ESG manages to reduce the risk profile of any potential investment.

Companies with superb sustainable practices are much less likely to suffer reputational damage due to poor ESG compliance and are more likely to understand fully the environment in which they exist.

Good environmental awareness also reduces the risk of high costs of remediation works when damage occurs, reducing any unseen contingent liabilities.

It is also true to say that when investment funds are available only for green and ethical investments, sustainable strategies allow the company to access these, providing a ‘seat at the table’ so to speak.

The governance and transparency aspect is also a key driver of sustainable finance interest. Companies that fully embrace the ESG principles are much more likely to provide clear and unambiguous reports which will include a full CSR audit of the company’s activities.

Whilst the aims and ambitions of sustainable finance are laudable, nobody is suggesting that a company can adopt all of the principles in one go.

Instead, businesses need to develop a transitional model, which shows the move towards fully sustainable operations over a period of time.

This move needs to be cultural because it will only be truly attractive to ESG investors if the principles are adopted from top to bottom.

The good news is that there are funds available for companies that want to start out on the transitional journey with platforms such as the OECD centre for green finance signposting opportunities to attract grant and low-cost loan funding.

We’d argue that the starting point for any company wanting to adopt a sustainable business model is to fully identify all the benefits that will accrue from the move.

Only when you see how ESG operations can provide real and lasting benefits can you then sell the project to executives, customers, shareholders, and employees alike.

We aren’t suggesting that the move is easy, but with a robust plan and true leadership, any business can accrue significant benefits and attract sustainable finance.