Sustainable Finance

Updated on January 5, 2024
Article byAswathi Jayachandran
Edited byShreeya Jain
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Sustainable Finance?

Sustainable finance refers to investment choices considering the ESG (environmental, social, and governance) aspects of the projects or activities undertaken. It aims to align financial decision-making with the broader goals of sustainable development, such as reducing greenhouse gas emissions, promoting social equality, and conserving natural resources.

Sustainable Finance

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This financial approach considers the long-term impact of investment decisions on financial returns and the broader impact on society and the environment. It enables corporations to invest in initiatives that improve standard of living, protect ecosystems, and safeguard natural resources for future generations. Positive environmental impact leads to improved individual health and increased human capital investment.

Key Takeaways

  • Sustainable finance is the financial rules, guidelines, benchmarks, and products that work toward protecting the environment. It enables the financial system to interact with the economy and people by supporting its agents while pursuing a growth objective.
  • The development of the financial system in a sustainable manner involves various activities. Examples include active ownership, credit for sustainable projects, green bonds, impact investing, microfinance, and sustainable funds. 
  • It promotes and enhances economic competitiveness, efficiency, and prosperity now and in the future. It also helps preserve and restore ecological systems, promotes cultural diversity, and increases social well-being.

Sustainable Finance Explained

Sustainable finance is the financial rules, guidelines, benchmarks, and products that work toward protecting the environment. It enables the financial system to interact with the economy and people by supporting its agents while pursuing a growth objective. Besides, sustainable finance frameworks provide a structured approach to these financial activities, ensuring that investment and financing activities align with sustainable development objectives.

Environmental, social, and corporate governance are components of sustainable finance (ESG). Environmental considerations typically include climate change adaptation, mitigation, and environmental concerns. The term “social considerations” can describe issues with human rights, human capital investment, labor relations, inequality, and inclusivity. Governance is concerned with the regulation of public and private institutions. Therefore, this plays a vital role in ensuring social and environmental considerations are included while making decisions.

Hence, sustainable finance disclosure regulation is becoming increasingly important as investors and stakeholders demand greater transparency and accountability from companies and financial institutions. These regulations help investors make informed investment decisions about the sustainability of their investments.

Therefore, these business decisions benefit both clients and consumers. The development of the financial system in a sustainable manner involves various activities. Examples of such activities include active ownership, credits for sustainable projects, green bonds, impact investing, microfinance, and sustainable funds. Moreover, this approach promotes and enhances economic competitiveness, efficiency, and prosperity both now and in the future. It also helps preserve and restore ecological systems, promotes cultural diversity, and increases social well-being. Furthermore, sustainable finance principles promote responsible financial practices and mitigate adverse environmental and societal impacts. The principles of this investment include:

  • Positive contribution to sustainable development
  • Transparency and disclosure
  • Stakeholders engagement
  • Responsible investment and lending
  • Corporate responsibility

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Examples

Let us understand the concept better with the help of examples.

Example #1 

Let us assume a renewable energy company looking to finance the construction of a new wind farm. Therefore, the company issues green bonds instead of seeking traditional financing to fund the project. The green bonds are structured to ensure the funds raised are used solely for the development, construction, and operation of the wind farm. Thus, the company must regularly report on the project’s environmental impact and energy production.

Hence, investors investing in green bonds would be aware their investment is contributing to a sustainable project that reduces carbon emissions and promotes the transition to a low-carbon economy. Therefore, the company would benefit from lower financing costs due to issuing green bonds, as there is growing demand for sustainable investment opportunities.

Overall, this example of sustainable finance illustrates how companies can use innovative financing methods to support environment-friendly projects and promote sustainability while achieving their financial goals.

Example #2

According to recent studies, regulators are shifting their focus to sustainable finance while incorporating new reports and regulations that promote more acceptable and transparent reporting for businesses and investors. In addition, climate change and its environmental impact have a more significant impact on financial markets and investor portfolios. As a result, policymakers want firms to be more accountable for ESG.

As a result, companies, investors, and regulators will need to work together to develop more sustainable finance standards in their respective jurisdictions, according to Nishant Tiwary, a climate change and energy transition expert. And at Stanford, Jack Mcdonald works in investments and the Finance Fund. According to PwC reports, researchers estimate that at the current growth rate, ESG assets will contribute 21.5%  of total global assets under management in less than five years.

Therefore, researchers believe that companies with ESG-focused policies will benefit more from institutional investors willing to close the gap and take a chance on a constantly growing sector in the sustainable future.

Example #3

Large businesses invest in sustainable finance projects not only for the environment’s sake but also for profitsGoldman Sachs announced plans to invest $750 billion (2019) in climate transition activities over the next decade. Therefore, this includes sustainable transport, affordable education that is also accessible, and food production. In addition, they opted for environmentally friendly methods to address climate issues, promote inclusive growth, sustain those returns, and invest in evolving trends.

Importance

Earlier, stakeholders could either enjoy the returns or help the environment. But, in today’s world of ESG investing, the decision-making process has changed. Many investors aim to invest in companies that will improve the world while enjoying competitive returns. Let us look at the importance of this approach.

  • Addressing climate change: This approach can help address climate change by directing capital towards low-carbon investments and supporting the transition to a more acceptable economy.
  • Mitigating environmental risks: They can also help identify and reduce environmental risks associated with investments. By disclosing the environmental impact of investments, companies can make better decisions, and investors can make informed choices.
  • Enhancing corporate responsibility: This financial activity encourages companies to adopt environmentally and socially responsible practices, improving their reputation and enhancing their long–term sustainability.
  • Meeting investor demands: There is a growing demand among investors for sustainable investment opportunities. Therefore, by providing balanced investment products, financial institutions can attract a broader category of investors and tap into new sources of capital.
  • Improving transparency and accountability: This approach can enhance transparency and accountability by requiring companies to disclose ESG-related information and metrics, allowing investors to make more informed decisions about the sustainability of their investments.

Frequently Asked Questions (FAQs)

What is the difference between green finance and sustainable finance?

Though green finance and sustainable finance are related concepts, they are different.
Green finance vs sustainable finance

What is sustainable finance disclosure regulation?

A European regulation called the Sustainable Finance Disclosure Regulation (SFDR) was created to provide transparency for sustainable investment products in the market. It was initiated to stop “greenwashing” and to boost clarity surrounding sustainability claims made by financial market participants.

How does fintech promote sustainable finance?

Fintech companies can promote this approach in several ways, including:
– Increasing accessibility
– Improving efficiency
– Enhancing data analytics
– Encouraging innovation
– Engaging and educating investors

This article has been a guide to What is Sustainable Finance. Here, we explain the topic in detail with its examples, importance, and principles. You can learn more about from the following articles –

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