Financial Services

What is sustainable finance and why is it important?

As the thrust on sustainable development gains momentum, the financial sector has emerged as the prime mover to drive sustainability. Sustainable finance is catching the interest of different stakeholders across the globe.

What is Sustainable Finance?

Sustainable Finance is investment planning that integrates environmental, social, and governance (ESG) factors.

Up until now, businesses were profit-driven and the focus of their attention was their shareholders. But now the priorities have changed. Factors such as environmental, social, and governance have become key components for planning capital allocation.

Environmental aspects of financial planning are the promotion of biodiversity and the conservation of nature. Some of the key elements include climate change, deforestation, air quality, waste management, and more.

The crux of social aspects is human relationships. They include components like customer satisfaction, human rights, employee engagement, fair trade practices, etc.

Governance factors determine the standards for running an organisation or an economy. Some examples of governance factors are board diversity, stakeholder accountability, measures against bribery and corruption, etc.

A financial investment decision that considers all the above factors fosters sustainable development which is the need of the hour. These decisions could include capital allocation for businesses that follow sustainable practices, R&D of renewable energy sources, and other such considerations. As the global concern for environmental issues takes center stage, sustainable finance will be a key driving force for decision-makers across sectors.

In recent years, asset owners, investors, clients, etc., have indicated a rising interest in financing a transition to a low-carbon economy that supports sustainable and inclusive growth. A recent report by PWC indicates that ESG assets are growing and are likely to constitute 21.5% of Global Assets under Management in less than 5 years.

Why is Sustainable Finance Important?

One of the driving forces for the growth of sustainable finance is the need to mitigate climate risk. Climate change is making its presence felt in different forms such as extreme weather conditions, water scarcity, melting icebergs, etc. It makes it imperative to develop a lower carbon economy. This requires investment in the installation of wind farms, solar parks, electric vehicle infrastructure, and more. This is where sustainable finance has an important role to play. 

Today most retail and corporate investors are looking to make a difference. They are looking for investment opportunities that include ESG factors. This has increased the pressure on businesses to meet sustainability objectives. Funding is required to support solutions that address environmental challenges. Therefore, governments and policymakers are keen to create a financial space that fosters sustainable growth.

The financial sector needs to develop a resilient framework that can respond to the vagaries of nature.

Trends in Sustainable Finance:

Net Zero:

More and more countries are setting mid-century zero emission goals. It is expected that this might stop investment in the fossil economy. Hence, capital will need to be channelised towards methods that support sustainability.

Impact Investing:

Impact investing plays a critical role in achieving environmental and social impacts while managing financial returns. The rising awareness of environmental sustainability has given an impetus to impact investing in recent years. According to Global Impact Investing Network, in 2022 impact investing surged past the $1 trillion threshold. This trend is expected to continue in 2023 and beyond.

Strategies to Impact Climate Change:

Businesses across the globe, especially those in developed economies like the US and Europe, are introducing new laws to incentivise decarbonisation efforts. This could lead to more companies deploying capital towards a carbon-neutralising economy.

Transparent Reporting:

The growth of sustainable finance requires the collaborative efforts of heads of state, policymakers, and financial leaders. Collaboration is effective when there is transparent reporting by various stakeholders involved in the process.

Boosting Sustainable Growth in Developing Nations

Most developed countries have state-funded programs and innovative strategies to support sustainable development. However, developing nations are finding it harder to adapt to the growing need for sustainable development. Therefore financial instruments like debt-for-climate, concessional loans, etc., have been introduced to give impetus to sustainable practices in those countries.

Electric Vehicles:

It is expected that the transportation sector may be completely decarbonised by 2040. Electric cars, trucks, trains, etc. will dominate the transportation industry in the next few years. Hence, governments will need to deploy capital to build the infrastructure that supports electric vehicles.

Final Takeaway

Today, there is an accelerated action to address the risks posed by climate change. There is more clarity among various stakeholders about integrating ESG factors into financial decision-making. The outcome is that most corporates have prioritised ESG initiatives to boost positive changes toward sustainable development. 

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