The world of investing has experienced a handful of significant changes in recent years. Not only are there more opportunities than ever before, but this very same market has taken on a decidedly responsible and transparent flavour. Often referred to as sustainable finance strategies, these undertones clearly illustrate how times are indeed changing.
There are nonetheless several factors to highlight in order to fully appreciate the role that sustainability in finance currently plays. Therefore, let us examine the fundamental underlying principles before moving on to discuss the ways in which this sector is regulated by governing bodies.
The basis of sustainable approaches to finance
Many experts will argue that a forward-thinking and transparent mindset is one of the most important paradigm shifts that has been witnessed in decades. Sometimes referred to as eco-friendly finance, a sustainable approach involves several metrics, including:
- The ability to leverage long-term growth.
- An emphasis is placed upon ecologically sound investments.
- A greater sense of social and corporate governance (such as voluntary disclosure).
- Support for green initiatives.
- Focusing upon specific targets such as lowering the carbon footprint of an organisation.
These are some of the core components which serve to define a financially sustainable and responsible investment opportunity.
Sustainability in relation to ESG finance
It would be impossible to thoroughly discuss this topic without also highlighting ESG economics. ESG is an acronym for Environmental, Social and Governance. Here is a breakdown of how each element directly applies to sustainability from a broad perspective:
- Environmental: the impact of an organisation (such as the emission of greenhouse gases) upon the climate.
- Social: practices that impact society (such as values, mission statements and interaction with the public).
- Governance: variables such as corporate transparency, equal opportunity employment and bridging gender-related pay gaps.
It is therefore clear to see that many ESG financial products represent much more than opportunities to generate a source of capital alone. They are instead engineered to provide long-term solutions in regard to the problems that humanity as a whole is facing in recent times. This is also one of the primary reasons why ESG assets have become extremely attractive to more conscientious investors (such as millennials).
How are these products regulated?
As the reader may have already guessed, oversight is crucial in regard to sustainable investment opportunities. What types of organisations monitor these transactions, and how are they able to provide objective guidance? These questions are important to address in order to avoid less-than-transparent schemes such as greenwashing. There are actually several regulators to highlight before moving on.
The Loan Market Association
Otherwise referred to as the LMA, this governing body is associated with loans linked to sustainable ventures. It was originally created in 1996, and since this time, it has tackled a number of industry-wide issues relating to transparency, governance and finance sustainability in general.
The Sustainable Finance Disclosure Regulation
The SFDR is a European initiative intended to enhance levels of ESG transparency and to objectively evaluate claims made by green market participants. This organisation likewise addresses other issues such as bond standards, sustainable reporting techniques and ESG finance in general. At the time of writing, the SFDR supports over 400 European firms, and it is said that the aggregate assets of these companies exceed €20 trillion euros.
The International Capital Markets Association
The ICMA is primarily concerned with the issuance and transparency associated with green bonds. It regularly publishes a set of updated guidelines for both investors and firms alike. In terms of proactive ESG regulation, here are its core tenets:
- To determine how bond proceeds will be used.
- To define the environmentally sustainable goals of a venture.
- To clarify how profits are managed with in-house techniques.
- To ensure that transparent reporting methods are utilised at all times.
That said, there are several additional initiatives which are particularly relevant in relation to the European Economic Community. These will be discussed immediately below.
The Sustainable Finance Plan
One of the issues associated with ESG investing as a whole has always revolved around guaranteeing ample levels of transparency and oversight. As this article rightfully observes, the European Union is now taking additional steps to deliver on the goals stipulated within the larger ESG framework.
Dubbed the Sustainable Finance Plan, there are several ways in which sustainability will be addressed in the not-so-distant future. For example, this approach involves creating a taxonomy to clearly determine what represents a sustainable investment opportunity. This is also intended to highlight where these ventures can have the most beneficial impact.
A standardised system of “green labelling” will likewise illustrate which products and services are in accordance with ESG finance standards. Not only is this important for investors, but average consumers will also become better informed in relation to their spending habits.
Issues associated with governance are also addressed within this framework. Another role of the Sustainable Finance Plan involves clarifying the duties of industry professionals such as asset managers and institutional-level investors. The ultimate goal in this sense is to provide them with the knowledge required to identify prospective sustainable investment opportunities as well as to encourage the transparent disclosure of information.
Finally, this programme will require that major firms (such as investment and insurance conglomerates) inform their clients about their sustainable business practices. This also helps individuals (such as prospective shareholders) to better appreciate any risks that may be involved with a green finance company in regard to investment opportunities.
A more centralised form of governance
Currently, there is no single organisation or governing body which oversees all aspects of sustainable finance. However, some experts predict that this may change in the near future. The European Commission has already taken steps to guarantee that ESG investing is promoted to its fullest capacity.
For instance, banks may soon be required to report the number and types of sustainable holdings found within their balance sheets. Research is likewise being carried out in relation to how present investment methods may impact future climate-related scenarios. The European Banking Authority (EBA) is also carrying out fiscal stress tests as well as publishing environment finance guidelines in relation to how ESG risks are disclosed to stakeholders.
Sustainable finance and the future: a step in the right direction
In truth, sustainable approaches to finance can trace their roots as far back as the latter half of the 1970s. It is nonetheless a fact that looming environmental concerns have placed increased importance upon embracing the most appropriate practices. This is also why several regulatory changes should come to light in the near future. Not only can investors rest assured in the knowledge that they are making informed decisions, but the entire industry is set to benefit from such pronounced levels of transparency.