2019 will be remembered as the year in which, among other things, the FridaysForFuture phenomenon spread across the globe. In the wake of a severely deteriorating ecological condition, the student-led climate change strikes rallied to spur the world’s global and economic elite into action. The message was clear - policymakers and decision-makers cannot afford to delay action any further and concrete steps should be taken towards mitigating -even reversing - the damage being inflicted upon our environment. Responding to the daunting challenge that is climate change can no longer be put on hold. Key to that is a fundamental shift towards an economy rooted in sustainability - no longer a nice-to-have, but a necessity.
Against this backdrop, our point of departure for pursuing such shift rests in establishing a guiding taxonomy to enable a common understanding between stakeholders to and devising a framework for shaping a sustainable economy. Such a framework ought to be premised on three founding pillars: a well-defined scope or end-objective; a combination of alternative methodologies through which such objective may be attained; and a model for measuring performance and ensuring accountability and transparency in all stages of the process.
When it comes to setting the end-objective, the term ‘sustainability’ suggests a preservation of affairs over a sustained period of time. Whilst preservation plays a central underlying theme in the concept of sustainability, it does not quite encapsulate all its facets. The true value of sustainability is succinctly captured by the United Nations Brundtland Commission when defining it as the ability to “meet the needs of the present without compromising the ability of future generations to meet their own needs”. At the very basic level, sustainability is thus concerned with balancing out the needs of today’s society against those of tomorrow’s - making strategic long-term choices when allocating scarce resources, be they natural, human, infrastructural, technological, or financial resources.
Homing in on the latter element, it is suggested that financial resources are finite and must necessarily be allocated in the most efficient and effective manner. But how?
Traditionally, the allocation of financial resources has been determined principally by reference to financial metrics such as the internal rate of return ratio, the return on investment ratio, or the pay-back period method, as well as other key financial metrics based upon an evaluation of historical and prospective financial information. In essence, these metrics adopt a narrow approach to financing, with very little regard to the wider socio-economic impact of such decisions.
This article is the first in a series of publications intent on challenging this traditional approach and illustrating the role of finance in shaping a sustainable economy. In this respect, this introductory piece establishes the parameters in which an array of means of sustainable finance with an eye to environmental or social principles, not just financial returns, will be explored and evaluated. Moreover, the series will seek to cut through the noise, to distinguish between what are oft-referred to as ‘green-washing’ practices or ‘green wrap-ups’, from those financial product and service offerings that are purposely designed to attain sustainability.
Sustainable finance is no longer a theoretical possibility, it is a flourishing reality. Interestingly, it is noteworthy that whilst ‘sustainable financing’ has its origins in ‘green financing’, the former has eclipsed the latter and has evolved in recent years to encompass a kaleidoscope of financing forms, from green financing to blue financing, and various shades in between. The adoption by the United Nations member states, in 2015, of the ‘Sustainable Development Goals’, marked a pivotal moment in this transformation, providing a shared blueprint for accelerating progress towards improving our quality of life and the world we live in. Similarly, this growth has been stimulated by a flurry of guiding principles issued by international bodies such as the International Capital Markets Association’s (ICMA) ‘Green Loan Principles’ (2014) and, more recently, the ‘Sustainability-Linked Loans Principles’ (2019), jointly issued by the Loan Market Association, the Asia Pacific Loan Market Association and the Loan Syndications and Trading Association, each sharing the common objective of supporting the issuance of sustainability-linked instruments. Closer to home, the European Commission’s ‘Action Plan on Sustainable Finance’ was formally launched in 2018 and sets out a comprehensive strategy with three broad aims: to re-orientate capital flows towards sustainable investment; to manage financial risks stemming from climate change, environmental degradation and social issues; and to foster transparency and ‘long-termism’ in financial and economic activity. Locally, having recognised the European Commission’s vision on the role of finance in sustainable development, the Malta Financial Services Authority has, on the 26 February, 2020, declared its commitment to making sustainable finance a key priority in its strategy.
Traceable to the World Bank’s first green bond issued back in 2008, the sustainable finance industry has undergone a gradual evolution, and whilst its end-objective remains the same, the variety of financial instruments, issuers and financiers, has grown exponentially. In addition, the market has matured, in the sense that market participants do not merely value the end-game, but also, and more importantly, value the process of getting there. Towards this end, the European Securities and Markets Authority (ESMA), the pan-EU securities markets regulator, has propelled a move away from sustainability on paper to sustainability in action, through its Strategy on Sustainable Finance published in 2020, placing sustainability at the core of its activities by embedding the central factors of ‘Environmental, Social and Governance’ (ESG) in its work, with Steven Maijoor (Chair of ESMA), highlighting “the measurement, verification and disclosure of ESG factors as the key pillars supporting the shift towards a more sustainable financial system”.
Sustainable finance is also seen as a critical incentivising mechanism to reward entrepreneurs for adopting sustainable practices and making sustainable investments. From the investors’ point of view, sustainability-linked instruments offer investors the opportunity to participate in the creation of a circular economy, by reaping their own investment benefits, whilst sowing benefits for the future economy.
Whilst the importance of developing a sustainable finance market that offers benefits not only to the long-term sustainability of the planet but also to all financial market participants concerned can be said to have been generally acknowledged among key stakeholders, a strategic mind-set change is yet to full unfold, and the political impetus necessary for this drive to reach its full potential could well do with more traction. In future instalments of this ‘Sustainable Finance’ series, we will explore key ways of developing a sustainable finance market.