The Far-Reaching Impact of Sustainable Finance
18 October 2021
The far-reaching impact of sustainable finance
Sustainability is on everyone’s mind these days. Consumers want to buy products that have been made through sustainable means. Governments have signed up to ambitious carbon reduction targets. Corporations are aiming to improve the environmental and social impact of their operations.
This development is now also visible in the investment community through the trend for sustainable finance, whereby banks and other financial institutions take into account the sustainability performance of a business when making investment decisions. The impact of taking such an approach has repercussions that extend far beyond the financial services and banking industry.
Sustainable finance is a smart investment approach
Sustainable finance means that investments in economic activities or projects are viewed through the lens of environmental, social, and governance (ESG) factors. Environmental factors related to the carbon footprint of a business, or its use of sustainable resources. Social factors include the treatment of workers or animal rights. Governance refers to how a business is managed as well as its relations with employees and compensation practices.
What is interesting is that investing in businesses with favourable ESG ratings has been found to have a positive correlation with financial results and returns. ESG-focused funds were long thought as performing more poorly than the broader market, but research shows that such funds have actually outperformed the S&P 500 in recent years.
There is also evidence that ESG-focused companies have a lower cost of capital, meaning it is easier for them to invest in the expansion of their business or to use these savings to boost their profit margins. Businesses therefore need to change their mindset and view sustainability as an opportunity rather than a cost.
ESG needs to be on everyone’s mind
You would be mistaken to think that sustainable finance only impacts companies that are actively pursuing a sustainable agenda (such as Patagonia or Beyond Meat) or businesses involved in potentially damaging activities such as oil companies or cigarette manufacturers.
ESG will come to impact virtually every company that relies on external financing – either through the stock market or as loans from financial institutions. This is because both market regulators and shareholders have taken a greater interest in this ESG and are requiring financial institutions to disclose more information on their sustainability performance.
For instance, the EU has recently announced its Sustainable Finance Strategy, which requires that financial institutions should fully account for their climate and environmental risks. In Hong Kong, the Securities and Futures Commission (SFC) has issued new guidelines on what factors need to be disclosed for an investment strategy to be classified as incorporating ESG factors. If financial institutions are to satisfy these demands, they will need to know more information about their clients and the companies they have invested in.
Companies that are ahead of the curve will be investing in ESG monitoring tools so that they are able to prove their sustainability credentials and potentially take advantage of better financing terms.