What is sustainable finance?

While traditional financial strategies focused almost exclusively on financial outcomes and wealth generation, sustainable finance includes environmental, social, and governance (ESG) objectives such as climate change and pollution reduction. The growth of sustainable finance has been reflected in public and policymaker attitudes around the world, and prompted financial institutions to introduce sustainable finance into their products and policies.

Given the rise of sustainable finance trends across the world, it is important that financial institutions and other services providers understand the new market landscape and how ESG concerns are reflected in their regulatory environment.

The evolution of sustainable finance

While sustainable finance emerged from a culture of socially-responsible investing by philanthropic trusts and religious groups in the 1960s, it did not gain traction in mainstream corporate contexts until the 21st century. The 2008 financial crisis reshaped the economic landscape and increased public awareness of the behaviour of financial institutions. As a result of that increased focus, policymakers began to push for sustainable financial programmes and initiatives, emphasising a need for financial institutions to tackle ESG challenges.

While its uptake has been gradual, major developments on the global sustainable finance landscape include:

• The Dow Jones Sustainability Index (199). Introduced in 1999, the DJSI lists the world’s highest performing sustainable finance organisations, ranked by economic, environmental, and social factors. The DJSI subsequently launched a family of indexes with the same sustainability tracking objectives including the Europe and Eurozone Index, and the Asia Pacific Index.
  
• United Nations Millennium Development Goals (2000). In the early years of the new millennium, the UN MDGs represented a framework for the global finance sector to consider sustainability and set out specific environmental and social goals.
  
• United Nations Principles for Responsible Investment (2006). The Principles of Responsible Investment were introduced to help investors meet and align their business goals with ESG goals. In 2018, PRI Assets (representing 1,961 signatories) had achieved substantial growth and amounted to around $81.7 billion.
  
• Green bonds. A financing tool for corporate entities, the first green bond was issued to the European Investment Bank in 2007. Since then green bonds have experienced global uptake: in 2018, $247 billion in sustainable financial instruments were issued.
  
• United Nations Sustainable Development Goals (2015). Building on the success of the MDGs, the SDGs expanded the UN’s approach to sustainable financing, with a focus on emerging and low income countries.
  
• European Commission Action Plan (2018). The EC Action Plan on Financing Sustainable Growth was introduced to help connect investors with the EU’s specific ESG-related economic goals through a series of legislative measures such as low carbon emission benchmarks.

Sustainable finance assets

Reflecting the growth of the ESG market, there are now a variety of sustainable finance assets and products on the market. Examples include:

• Sustainable food systems. Financial products and mechanisms that channel funding towards sustainable food-producing ecosystems.
• Green loans. Loans available to borrowers seeking to finance projects with environmentally friendly goals, including renewable energy, pollution reduction, green transport and construction, and sustainable water programmes.
• Sustainability-linked loans. Borrowers may take out structured loans that are linked to their ESG goals. The cost of financing the loans is contingent on the borrowers meeting specific performance targets.
• ESG bonds. Many financial firms offer ESG themed bonds, such as green bonds and social bonds, to customers that are seeking to pursue environmentally-conscious projects.
• Transition finance. Certain financial products are designed to help firms facilitate a transition away from using fossil fuels in order to meet their carbon emission goals.

The growth of sustainable finance

Once a niche investment concern, sustainable finance investment products have grown in value significantly in recent years, backed by support from the public and from policymakers. In 2019, over $20 billion was invested in sustainable funds in the US, almost four times the amount invested in 2018. Similarly, in Europe, the value of sustainable investment products is projected to rise to over €7.6tn by 2025, representing a share of around 57% of the fund sector.

Analysis suggests that larger investors are driving the growth in ESG-related products, with many fund managers repurposing existing funds or integrating environmental considerations into their strategies. Even the adverse economic effects of the Covid-19 pandemic have not derailed the sustainable finance growth trend: many investors and policymakers have used the crisis to emphasise the need for financial products that can meet unexpected environmental challenges such as climate change

Global regulations

Global regulatory standards relating to sustainable finance are inconsistent. In 2015, the Paris Climate Agreement (PCA) introduced a global commitment to reduce carbon emissions and address climate change, and was signed by 196 countries including major economies such as the US, the UK, France, Germany, Russia, China, and India. Under the Paris Climate Agreement, signatories haven taken a range of domestic ESG measures designed to help them reach their commitments, including record-keeping and reporting requirements. These include:

Europe

• Following the introduction of the PCA, the EU introduced its Sustainable Finance Action Plan in 2018 as a framework for future ESG regulation.
• The EU’s Green Deal was launched in 2020 and represents a range of regulatory reforms to help member state businesses take advantage of sustainable opportunities.
• The EU’s Sustainable Finance Disclosures Regulation and its Non-Financial Reporting Directive are important reporting regulations for financial sector organisations.

UK

• The UK’s Green Finance Strategy was introduced in 2019 as a way to match the EU’s Action Plan post-Brexit.

US

• The US’ Securities and Exchange Commission (SEC) has proposed requirements for firms to disclose ‘material’ ESG risks.
• In September 2020, the US Commodity Futures Trading Commission published recommendations for national regulators to manage climate risks.

Asia

• In Japan, firms have had environmental reporting requirements since the 1990s.
• In China, companies listed on the Shenzhen and Shanghai stock exchanges (and the Hong Kong stock exchange) must disclose details of their ESG practices.

Latin America

• Mexico’s national stock exchange has an advisory council dedicated to support green bonds and to prepare firms for better ESG disclosure requirements.
• Brazil’s Securities and Exchange Commission has launched a Finance Innovation Lab to promote sustainable financial practices and to propose ESG-related regulatory changes.