Finance impacts the natural environment both directly and indirectly. The environment also directly and indirectly impacts finance and the performance of investments. As global awareness of the impacts of climate change on all areas of business rises, so does investor concern about what actually counts as “green finance”. Green finance is one of a number of terms used to label activities related to the two-way interaction between the environment and finance and investment. Related terms include: responsible investment (RI), environmental, social and governance (ESG), sustainable finance and climate finance.
There’s growing concern amongst corporations and investors that wide definitions of sustainability aren’t meaningful, allowing some funds to sell themselves as green or ethical even though they may be doing very little to reduce their impact on the environment. And as shareholders become ever more aware of the potential impact of their investments, many people are now asking “how green is green”? There is also growing scepticism in some quarters that so-called ‘green washing’ of otherwise unsustainable businesses is beginning to undermine the integrity of those companies who are taking their environmental responsibilities seriously.
This makes the job of risk managers even harder, as they are being pressed to encourage investment in these types of asset classes, but at the same time companies are often left to make their own subjective judgements about the parameters of sustainability. Some asset managers want a very strict interpretation and will back only carbon pollution free energy. Others focus more on a range of policies and principles that relate to broader social issues, not just carbon reduction.
While there are many possible definitions of green finance, for the purposes of this article, green finance is defined as any financial initiative, process, product or service that is either designed to protect the natural environment or to manage how the environment impacts finance and investment. Given the growing importance of this financial sector, it is timely to explore the dimensions of green finance and compare and contrast it to other similar concepts such as sustainable finance and climate finance.
This is clearly a very significant part of the economy, and one which will continue to grow as concerns about environmental and social sustainability increase. At least $30.7 trillion of funds is held in sustainable or green investments, up 34% from 2016, according to a report by the Global Sustainable Investment Alliance, a group of organizations tracking those moves in five regions from the U.S. to Australia. Overall, these money flows account for one-third of the tracked assets under management, and in some places have reached more than half. Companies such as the oil major Royal Dutch Shell Plc, British Petroleum, or even the mining giant Glencore Plc are now setting environmental targets for the first time, bringing to boardrooms a new agenda demanding action to limits for greenhouse gases. And renewables developers are now offering major investors securities with steady yields. This has helped create a market for green bonds and loans that barely existed a few years ago, but which is set to grow exponentially. The value of green or ESG funds traded on exchanges hit a record $41.6 billion in 2018, according to data compiled by Bloomberg.
Some investment organisations are attempting to establish a new standard for green investments. For example, The GSIA has a very broad definition, counting any kind of fund that uses a strategy associated with sustainability. The GSIA also counts those that buy “best-in-class” assets on certain measures or that follow rules on environmental, social and governance, or ESG. Their definition also includes funds that engage corporate boards or that encourage shareholder action.
The International Capital Markets Association (ICMA) has also addressed this issue and established Green Bond Principles, which were updated in 2018. These are a set of voluntary process guidelines for issuing green bonds. Green Bonds are any type of bond instrument where the proceeds will be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible Green Projects.
As there is still no consensus on the parameters of sustainability as it relates to finance, companies are largely defining their own parameters for ESG, usually around one or more of the following elements:
- The environment: issues relating to the quality and functioning of the natural environment and natural systems including biodiversity loss; greenhouse gas emissions, renewable energy, energy efficiency, natural resource depletion or pollution; waste management; ozone depletion; changes in land use; ocean acidification and changes to the nitrogen and phosphorus cycles.
- Social impact: these issues can be very broadly defined and may relate to rights, well-being and interests of people and communities including human rights, labour standards, health and safety, relations with local communities, activities in conflict zones, health and access to medicine, consumer protection; and the use of controversial weapons
- Economic impact: which relates to the outcome of investment decisions on economic conditions at local, national, and global levels. Performance areas include direct financial performance and risk, and indirect impacts such as through employment, supply chains, and provision of infrastructure.
Examples of some of the initiatives being taken by both public and private organisations in response to these broad concerns about environmental sustainability include:
- to reduce its reliance on renewable and polluting plastic, the banking sector is considering the possibility of introducing biodegradable payment cards.
- In November 2017, the Spanish Government decided to transport to Spain an EU directive with which it tries to avoid financial exclusion, that is, that certain customer profiles remain outside the banking circuit simply because the entities do not find it interesting. Through a royal decree-law, banks will be required to provide all users with a checking account to deposit their money or make transfers, and have a card. And regardless of the profitability of that citizen.
- Basic payment account. The royal decree-law incorporates as a key tool the creation of a banking product – the basic payment account. This is the way the Spanish Government is aiming to ensure a universal right to financial inclusion, which is a concept that did not exist before now. That account must provide a number of essential services: direct debit, use of debit or prepaid cards, cash withdrawals or transfers.
- There are a number of wealth management businesses as well as much smaller start-up online investment platforms that now only invest in sustainable or ethical businesses. Many of these focus in particular on attracting investment from millennials, who want to be assured that their money is supporting the achievement of the UN’s SDGs.
- Many financial institutions and other traditional sectors of the economy, such as airlines or travel companies, give customers an option to support climate remediation initiatives or social programs in the course of their normal business. For example, passengers can now elect to offset the carbon pollution created by their flights, or they can choose to round up transaction costs to make a small donation to their favourite charity.
- Cryptocurrencies and crowd funding are being utilised in charities to enable supporters to fund a specific project, such as digging water wells in an African village.
These and other
examples show that the growth in green finance seems certain to continue as more
companies and governments worldwide are beginning to focus in earnest on how to
cut pollution and greenhouse gases and more regulators require companies to
disclose climate-related risks. This is sure to lead to more pressure to ensure
transparency of data about the actual impact of initiatives claiming to be
“green”. It will also give investors and consumers greater insights and more
power to influence business to reduce the impact on our planet and ensure that
our societies and our way of life are sustainable.
Victoria Hernandez is Board member (NED) at CaixaBank Payments, Business Angel and Head of the investment committee of Rising Tide Europe. Judge at the European Commission, in charge of evaluating EU proposals for the EIC Horizon2020 funding applications. Previously Victoria was Executive Chairman Orange Spain, Alliance’s Director BT Europe and SVP international Proximus. Computing Sciences Engineer at UPC, EMBA at INSEAD and a Master in Digital Marketing at Columbia Business School. Victoria lives in Paris.