Why all financial institutions must embrace sustainable finance?

Sustainable finance is now a critical focus for financial institutions globally, driven by the increasing recognition of the interconnectedness between economies, environments, and social netoworks. As climate change accelerates and social disparities widen, the finance sector is having to adapt its strategies to mitigate risks and seize any opportunities that emerge. This article explores the reasons behind the rise of sustainable finance, its significance for the sector, and the ever evolving landscape.

What Is Sustainable Finance?

Sustainable finance refers to financial decision-making that takes into account its environmental, social, and governance (ESG) impact. It is based on sustainable finance principles, which ensure that investments consider long-term environmental sustainability and social equity alongside profitability. But what does sustainable finance include?
The framework emerged due to the alarming effects of environmental and social issues on the economy. Sustainable decision-making underscores the need for a more strategic approach.

Financial sustainability began as a niche concept but has become increasingly relevant over time. Mainstream financial institutions now widely recognise how environmental degradation and ecosystem disruptions are impacting economies.

Some examples of negative consequences include climate change, low crop yields, flooding, marine life destruction, resource depletion, water shortages, and displaced communities. These pressing challenges highlight the necessity for proactive measures in financial decision-making. Sustainable finance therefore serves as another crucial tool to help address our most pressing problems, as these issues will persist without action.

The Value of Sustainable Finance

The escalating environmental crises underscore the value sustainable finance principles can play in mitigating financial and environmental risks while steering our economic future in a more sustainable direction.

The finance sector is a powerful force for encouraging sustainable awareness and action. Since funding is almost always necessary for managing environmental and social challenges, financial resources must be mobilized and deployed with sustainability goals in mind.

A recent report by the Global Sustainable Investment Alliance (GSIA) indicates that global sustainable investment reached $35.3 trillion in 2020, reflecting a 15% increase over the previous two years. This is a trend that haighlights the growing importance of sustainable finance in investment strategies.

What Is the Goal of Sustainable Finance?

The primary objective of sustainable finance is to promote environmental sustainability, social upliftment, and long-term profitability. By integrating ESG considerations into financial strategies, the finance sector can identify and manage the financial risks associated with unsustainable practices. These risks may manifest as regulatory penalties, reputational damage, and significant cleanup costs.

Sustainable finance aims to support sustainable activities, which brings several benefits, such as:

• Positive environmental effects
• Improved living and working conditions
• Long-term value creation for investors
• Increased adaptability and innovation

Therefore, sustainable finance presents a win-win approach that responds to planetary concerns and its people while also benefiting business and ultimately finance. 

How Sustainable Finance Can Deliver Impact

Acces to capital is a powerful resource that influences industries, including their impact on the environment and society. Sustainable finance can reinforce business activities that either harm or save the planet.

At our current rate of environmental degradation, sustainable finance is an obvious choice. Saving the planet serves businesses in various ways, making it a sound business decision even for non-environmentally conscious investors.

Business activities and projects that jeopardize sustainability do not just incur financial and reputational risks; they can also potentially harm the financial system and society. For instance, investing in nature-dependent industries like mining, forestry, and large-scale plantations can result in severe ecological damage and regulatory controls that impact investments. Additionally, any adverse impacts on communities and Indigenous groups can tarnish a company’s reputation.

Through sustainable finance, these risks are carefully considered. Banks and other financial investors are encouraged to allocate their capital toward projects and businesses that align with sustainable development. 

Sustainable Finance and ESG

Investing in businesses that adhere to ESG criteria can help to promote sustainable practices. However, effective implementation of these principles requires adequate funding. The financial sector can influence the transition toward sustainability by supporting businesses that practice ethical sourcing, transparency, and fair labor practices. It can also allocate capital toward sustainability-aligned industries like renewable energy.

Environmental

Financial institutions can significantly contribute to biodiversity conservation, renewable energy development, and sustainable agriculture through targeted investments. By providing loans or issuing green bonds, they can support projects that yield financial returns while delivering substantial environmental and social benefits.

Social

Sustainable investments help mitigate poverty, improve health and well-being, promote inclusion, and enhance quality of life. Creating a safe working environment can become a priority for companies and industries when investors make it a criterion for their financial decision making. Investing in companies that promote fair labor practices is not only humane but also harnesses the power of shared values. Businesses that uphold ethical operational practices are committed to serving the communities around them while attracting environmentally conscious customers and investors. This can open up new market opportunities and inspire other businesses to adopt the same best practices, creating a much-needed ripple effect that benefits everyone.

Governance

Sustainable finance also highlights the pressing need for nature-related financial disclosures. Businesses must be visible and accountable for nature-related risks and their dependencies on natural resources. Along with management ethics and compliance, sustainable finance encourages trustworthy and responsible leadership. Sound governance that identifies, manages, and addresses risks can help us transition to a more sustainable economy.Sustainable finance refers to financial decision-making that incorporates environmental, social, and governance (ESG) factors into investment strategies. The urgency for integrating these considerations stems from the recognition that traditional financial models often overlook the long-term risks of environmental degradation and social inequities. According to the United Nations Environment Programme (UNEP), “the financial sector plays a critical role in addressing global challenges such as climate change, biodiversity loss, and inequality” .

The repercussions of neglecting sustainability and ESG are profound. Financial institutions face increasing regulatory pressures, reputational risks, and potential financial losses associated with unsustainable practices. A report by the World Economic Forum highlighted how “over 50% of global GDP is moderately or highly dependent on nature” , underscoring the economic risks tied to environmental degradation.

Understanding the Value of Sustainable Finance

The growing concern around sustainable finance is not merely a response to external pressures; it also represents a significant opportunity for financial institutions. Sustainable finance can enhance risk management, drive innovation, and create long-term value for investors.

Risk Mitigation

Financial institutions that adopt sustainable practices are better positioned to identify and manage the risks associated with climate change and social instability. MSCI has highlighted that companies with strong ESG performance tend to exhibit lower volatility and better financial performance over time . As such, integrating sustainability into investment strategies can lead to more resilient portfolios.

Investment Opportunities

The demand for sustainable investment products is on the rise. According to the Global Sustainable Investment Alliance (GSIA), global sustainable investment reached $35.3 trillion in 2020, reflecting a 15% increase over the previous two years. This trend indicates a growing appetite among investors for products that align with their values, prompting financial institutions to develop innovative solutions that cater to this demand.

Regulatory and Market Pressures

Regulatory frameworks are evolving to support sustainable finance initiatives. Governments and regulatory bodies globally are implementing policies that require financial institutions to disclose their ESG risks and impacts. The European Union’s Sustainable Finance Disclosure Regulation (SFDR) is a prime example, mandating that financial market participants provide transparency regarding sustainability risks in their investment decisions (known as ‘greenwashing’)

Moreover, market pressures from stakeholders — including investors, customers, and employees — continue to put pressure on financial institutions to adopt more sustainable practices. “Investors are increasingly demanding that companies disclose their climate-related risks and align their business models with a net-zero future,” highlghted Mark Carney, former Governor of the Bank of England. This shift in expectations is compelling financial institutions to prioritize sustainability in their operations and investment strategies.

Sustainable Finance Products and Services

Financial institutions are increasingly innovating new sustainable finance products and services designed to support environmentally and socially responsible initiatives. These include:

• Green Bonds: Debt instruments that raise capital for projects with positive environmental impacts, such as renewable energy and energy efficiency initiatives. The International Capital Market Association (ICMA) emphasizes the importance of transparency and accountability in the use of proceeds from green bonds .
• Social Bonds: Issued to fund projects addressing social issues, such as affordable housing, healthcare, and education, social bonds aim to improve the quality of life for marginalized communities while providing returns to investors.
• Sustainability Bonds: These bonds finance projects that offer both environmental and social benefits, supporting initiatives that contribute to sustainable development while generating financial returns.
• Impact Investing: This approach involves investing in companies, organizations, or funds with the intention of generating measurable social and environmental impact alongside financial returns.
• ESG Funds: Investment funds that specifically target companies with strong ESG performance, allowing investors to align their portfolios with their values while pursuing competitive returns.

Conclusion: A Strategic Necessity

Sustainable finance should be a strategic priority for all financial institutions. By integrating sustainability and ESG considerations into their operations and investment strategies, financial institutions can effectively mitigate risks, capitalize on new opportunities, and meet evolving regulatory and market expectations.

As the world grapples with pressing environmental and social challenges, the finance sector must play a pivotal role in driving positive change. Sustainable finance is not just a trend; it is a fundamental shift in how financial institutions operate and make decisions. By prioritizing sustainability, financial institutions can future-proof their businesses and contribute to a more equitable and sustainable future for all.

—

For further insights into how WeESG can upskill your workforce with the sustainable finance skills and knowledge needed, explore our training and capacity-building pages .

References

1. United Nations Environment Programme (UNEP). (2021). Financing the Sustainable Development Goals. Retrieved from UNEP
2. World Economic Forum. (2020). Nature Risk Rising: Why Financial Institutions Need to Act. Retrieved from WEF
3. MSCI. (2021). 2021 ESG Trends to Watch. Retrieved from MSCI
4. Global Sustainable Investment Alliance (GSIA). (2020). 2020 Global Sustainable Investment Review. Retrieved from GSIA
5. European Commission. (2021). Sustainable Finance Disclosure Regulation. Retrieved from European Commission
6. Carney, M. (2020). The Future of Finance: The Role of the Financial Sector in Achieving a Net Zero Economy. Retrieved from Bank of England
7. International Capital Market Association (ICMA). (n.d.). Green Bond Principles. Retrieved from ICMA