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What is Sustainable Finance?

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Over the last 30 years, government organizations have come to recognize that the key to a more sustainable future lies in transforming the world of private finance. Since then, several sustainable finance models have been introduced, aiming to make environmental and social impact part of the corporate decision-making process.

But what exactly is sustainable finance, and how is it affecting change? Keep reading to find out.

What does sustainable finance mean?

The European Commission defines sustainable finance as “the process of taking environmental, 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.”

Such environmental considerations may include climate change mitigation, the protection of endangered species, the preservation of biodiversity, and reducing pollution.

Social considerations might refer to a drive towards equality, inclusiveness, and equity. This can be done, in part, through an investment in human capital, creating a safer work environment, and standing up for human and civil rights.

On the other hand, governance is more about a business’s management structure and how much these environmental and social issues factor into the decision-making process.

Sustainable finance models

There are several different, overlapping models of sustainable finance your business could follow.

Socially responsible investing (SRI)

SRI is the most commonly implemented approach to sustainable finance. It involves the systematic incorporation of ESG considerations within an organization’s financial management/investment decision-making process. Under the SRI method, portfolio management companies are also encouraged to consider these criteria when choosing asset values.

Green finance

Green finance is an offshoot of socially responsible investing. It refers to the prioritization of environmental concerns, e.g., the energy transition and restoring ecosystems. Since 2007, green bonds have allowed investors to finance ecological incentives aimed at tackling problems like this. Equally, investors can engage in green finance by putting money into companies committed to cutting down their ecological footprint and going carbon-neutral.

Social finance

This is similar in approach to green finance, but the focus is on investing in social rather than environmental change. In 2016, 10 billion euros were spent on social finance in France alone. This money funded projects that did not fit into traditional financing models, including social and housing initiatives.

Social business

The social business model of sustainable finance applies to businesses that turn a good profit in the social sector. These companies reinvest their profits into projects aimed at combating exclusion, protecting the environment, and contributing to development.

Social business can be broken down into three main subcategories:

  • Microfinance – gives disadvantaged populations access to financial credit.
  • Impact Investing – when you invest your savings in companies with a strong and transparent commitment to tackling social and environmental issues.
  • Social Impact Bonds (SIB) – bonds are repaid to investors when they mature if the project’s objective is met.

But generally speaking, sustainable finance can be seen to have three main, interlinked components, which all come together to aid the transition to a low-carbon, sustainable economy. These are:

1. Reporting

Collect and disclose relevant data on how ESGs can affect an organization’s long-term profitability. This might include looking into carbon emissions, waste storage, labor conditions, etc.

2. Analysis

As more and more companies start sharing this kind of information, it will become more commonplace for investors and firms to consider this information when making financial decisions.

3. Action

Over time, the allocation of funds will change. Investors will prioritize opportunities that demonstrate sustainable growth, and in turn, companies will put more money into projects dedicated to mitigating social and environmental risks.

Why is sustainable finance important?

Sustainable finance is going to be crucial to meeting the goals set out in the European Green Deal (2019), which include:

  • No net emissions of greenhouse gases by 2050
  • Economic growth decoupled from resource use
  • No person and no place left behind

This is because the finance sector is uniquely placed to offer incentives to organizations that operate using greener and more equal business practices. For example, if private investors and funds only lent money to companies who were clear and transparent about their commitment to environmental and social causes, many more businesses would collect and share their data, as above, leading to the long-term growth of the sustainable market.

Who invests in sustainable finance?

Capital from a wide range of sources can be invested in sustainable finance schemes. Funds for these projects come from individual investors, investment and pensions funds, and companies of all shapes and sizes. Let’s take a look at their interest in sustainable finance in a little bit more detail below.

  • Investors – those who want to finance organizations seeking funding for socially- or environmentally-charged projects. Private investors may look for projects which are directly connected to a cause they care about.
  • Investment funds – SRIs are a great asset to their portfolios. For example, in 2016, the 122 SRI conviction funds listed by Novethic showed a 20% growth in total investment.
  • Pension funds – are starting to come around to the idea of sustainable finance models. Pension funds from countries all around the world, including the US and Japan, have started to include ESGs in their capital management strategies.
  • Private banking and wealth management – the transference of wealth to the millennial generation means the demand for green financial solutions will only go up. EY reports that 17% of Millennials prefer to invest in companies prioritizing ESGs, vs. 9% of Boomers and Gen X.

Interested in a career in banking or finance?

At EU Business School, we offer a range of undergraduate and postgraduate degree programs aimed at preparing students for a career in international banking and the finance sector. 

For more information, please take a look at the course overviews on our website and sign up for one of our Open Days, which are taking place throughout October & November.

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