Sustainable Finance – The Why & The What (Part 2)

Accounting/Finance, Feature, Green

September 26, 2019, 6:47 am

by Jaison John, Partner, Avia Management

As mentioned in the earlier article, the 2 most common aspects of sustainable finance are that they have:

• a long-term view to create a lasting impact
• an interrelationship between environmental, social, and governance (ESG) issues and financial issues such as financing, lending, and investment decisions

A brief overview of the commonly used terms in sustainable finance.

1. Environmental Social Governance (ESG): ESG stands for Environmental (e.g. energy consumption, water usage), Social (e.g. talent attraction, supply chain management) and Governance (e.g. remuneration policies, board governance). Environmental factors include but are not limited to the environmental footprint of a company or country (e.g. energy consumption, water consumption), environmental governance (e.g. environmental management system based on ISO 14001) and environmental product stewardship (e.g. cars with low fuel consumption). Social factors in the context of investing include, but are not limited to, worker rights, safety, diversity, education, labor relations, supply chain standards, community relations, and human rights. Governance factors within ESG criteria refer to the system of policies and practices by which a company is directed and controlled. They include but are not limited to transparency on Board compensation, independence of Boards and shareholder rights.
2. Socially Responsible Investing (SRI): This is one of the approaches within Sustainable Finance that has gained the highest market traction. SRI involves integrating environmental, social and corporate governance (known as “ESG”) criteria, in an organized and traceable manner, into decisions on financial management and investment. It fashions a responsible economy by encouraging portfolio-management companies to consider extra-financial criteria when selecting asset values. The sector touched approximately 23 trillion dollars in 2016, up 25% from 2014.
3. Green Finance: Commonly seen as a subset of SRI, it combines all financial transactions that favor the energy transition and fight against climate change. Almost non-existent in the early 2010s, the market is expected to exceed a value of 100 billion dollars per year by 2020. One of its main tools is green bonds, issued with the aim of financing ecological initiatives. A complementary approach in green finance is the decarbonizing of investor portfolios, by financing companies that limit their environmental footprint.
4. Green Bonds: Green bonds are broadly defined as fixed-income securities that raise capital for a project with specific environmental benefits. Most green bonds issued to date have raised capital for renewable energy projects, energy efficiency measures, mass transit, and water technology. Most green bonds have been either plain vanilla treasury-style retail bonds (with a fixed rate of interest and redeemable in full on maturity), or asset-backed securities tied to specific green infrastructure projects.
5. Social Finance: This includes savings and assets invested in social finance products. Representing 10 billion euros in France in 2016, the sector offers to fund to projects that do not fit into classic financing circuits, such as businesses tied to employment (28% of capital), social and housing (31%), international solidarity (5%) and the environment (36%). In France, the specialized organization Finansol certifies certain social finance products (including SRI products) and monitors trends in social finance.
6. Social Business: This refers to businesses who aims are not just profitability, but primarily social in their core purpose. In addition, they also follow feasible and scalable economic models. Profits are reinvested to combat exclusion, protect the environment or promote development and solidarity. Social business comes in three main forms:

• Microfinance, a solution that facilitates access to credit for the most disadvantaged populations (132 million customers worldwide for a total balance of 102 billion dollars in 2016).
• Impact Investing, which refers to investing one’s savings in companies with a strong social or environmental impact.
• Social Impact Bonds (SIB), which are bonds repaid to investors upon maturation only if the project’s social objective is met.

Sustainable Finance then could be described as industry efforts to:

• improve the influence of finance towards sustainable and inclusive growth as well as the mitigation of climate change.
• and to fortify financial stability by combining environmental, social and governance (ESG) factors into investment decision-making.