Sustainable Finance: Concept
Sustainable finance is financial investments aimed at economic activities that respect people and preserve the environment .
It is the union of two concepts: finance and sustainability.
It is a global trend that has gained more and more adhesion from market agents.
The reason is simple: if there is no balance in the use of natural resources and social development, the future of the planet will be seriously compromised.
The financial market always seeks to foresee the future. If someone makes an investment today, he does so with a view to results in the future.
From the clear notion that the resources offered by nature are finite, it is necessary to remodel consumption behavior.
Otherwise, there may be no future.
What Is Sustainability?
Sustainability in the socio-environmental context is an adaptation of economic systems and consumption behavior to the limits of the planet.
Sustaining means balancing , using resources in a rational and conscious way, without waste or exaggeration.
Sustainability is “to reconcile economic, social and environmental needs without compromising the future of any demands”.
What Are Finances?
The term finance refers to money management .
It is the field of knowledge that deals with the arrangements of financial resources (money or other instruments associated with it).
People, companies and governments deal daily with money, set goals and make plans.
Finance is divided into several categories , such as corporate finance, personal finance, public finance, behavioral finance, sustainable finance, among others.
An Overview Of Sustainable Finance
The topic of sustainable finance is not new in the financial market.
International institutions, experts and non-governmental organizations have been discussing the importance of the financial system for sustainability for decades.
In recent years, however, the subject has gained notoriety, especially with the evidence of ESG principles (we’ll talk more about them later in this article).
According to a study released by the Sustainable Finance Project (FiraS), the world needs US$ 6.3 trillion a year in infrastructure by 2030 to meet the UN’s SDGs (Sustainable Development Goals).
According to the OECD, the number should rise to US$ 6.9 trillion a year if the Paris Agreement is observed .
Of the total funding, 45% are for renewable energies .
Then comes land use, with 27%, mainly for activities related to paper and cellulose.
Data show that represents the largest green bond market among Latin American countries.
What Are The Principles Of Sustainable Finance?
Under the umbrella of sustainable finance, there are several other initiatives that aim to promote the sustainability tripod (economic, social and environmental).
In the financial aspect, the Principles for Sustainable Investment (PRI) launched by the UN in 2005, together with an international group of investors, stand out.
The six principles are:
- Incorporation of ESG topics into investment analysis and decision-making processes
- Incorporation of ESG topics into own policies and asset ownership practices
- Requirement for transparency and disclosure of actions related to ESG topics of investee entities
- Promotion, acceptance and implementation of the principles within the investment sector
- Union of forces for the expansion and effectiveness in the implementation of the Principles
- Dissemination of reports on activities and progress of implementation of the Principles.
In the internal sphere of companies, professors from Fundação Dom Cabral Michel Fleuriet and Rodrigo Zeidan also establish seven principles of sustainable finance.
In this article , the authors analyze how companies can promote the sustainability tripod to increase, at the same time, the wealth of their shareholders.
What Is The Purpose Of Sustainable Finance?
The objective of sustainable finance is to contribute to the transition from an economy driven by unsustainable consumerism to a conscious and low carbon economy .
And this is not a matter of corporate marketing .
The transition to an economic model that guarantees the future of the planet is a necessity.
In the Global Risks 2020 report , in English, the World Economic Forum lists the various risk factors that threaten global economies.
Among the main ones are the risks related to health and the environment due to extreme weather conditions or “failures to mitigate and adapt to change”.
The financial market has the capacity to allocate resources to initiatives that act on the front lines of this economic change.
The responsibility for the balance and maintenance of the future of the new generations belongs to everyone, not just the public power, which does not even have enough resources to fill all the gaps.
How Important Is Sustainable Finance?
Sustainable finance plays a key role in the emergence of new business models that respect people and the environment .
Banks, managers and investors in general are increasingly using social, sustainable and governance criteria when making investment decisions .
Considering only the market agents that have adhered to the UN Principles for Sustainable Investment (approximately 2,800 signatories ), the total assets under management reach US$ 90 trillion.
In addition to the traditional approach that takes into account risk-return analysis , investors also examine social and environmental impacts .
Imagine two companies that need capital to leverage their activities, one operates in an extractive sector, which pollutes the air, rivers and degrades the soil, while the other has a project that could revolutionize the production of clean energy .
Within the context of sustainable finance, the second company can count on special credit, tax incentives and more favorable payment conditions.
It can also attract the attention of investors interested in making contributions to the business in exchange for equity interest.
Why Has Sustainable Finance Been On The Rise In Recent Years?
Sustainable finance has gained prominence in recent years as a matter of necessity, but also of opportunity .
The need is linked to the realization that the planet’s resources are finite and that socioeconomic development needs to be less unequal.
In the short and medium term, climate change can, for example, compromise the profitability of an entire sector , such as agriculture, and result in losses for investors.
They can also harm health (damage to insurers) and result in pandemics, such as Covid-19 , affecting all markets.
The other explanation lies in opportunities: the financial market is always looking ahead, looking for assets that offer the best risk-adjusted return .
By allocating resources to companies that develop new business models in sectors such as clean energy, organic products and sanitation, sustainable finance seeks opportunities for future gains.
What Is The Relationship Between Sustainable Finance And ESG Investments?
This theme emphasizes the environmental aspects of sustainability, but the concept is broader than that.
In this context, they have a close relationship with ESG, three small letters that have frequently appeared in economics and business headlines.
ESG is the acronym for Environmental, Social and Governance .
Therefore, it covers the three aspects of the sustainability tripod.
The demand for the adoption of ESG practices within sustainable finance began in the stock market, through shareholder activism.
Companies that degrade the environment , do not value the local community or neglect their stakeholders are not seen with good eyes by the market.
On the other hand, shareholders began to prefer organizations committed to the environment, with impact social projects , in addition to factors related to governance .
ESG principles have also reached fixed income , mainly with the issuance of so-called green bonds.
This sieve of sustainable finance, led by investment funds and financial institutions, promotes a redirection of the flow of capital.
This change of direction, in turn, influences the attitude of “traditional” companies, while encouraging the emergence of new businesses .
According to information from PwC, released by Great Place to Work , the volume of sustainable finance destined for ESG businesses is expected to be $4.3 trillion by 2030.
Why Work With Sustainable Finance?
Depends on which side you’re on.
If you are an investor or asset manager , you may decide to adopt ESG principles as your investment criteria.
If you are an entrepreneur, you need to understand that sustainable finance can irrigate your business, depending on your company’s initiatives.
Examples Of Sustainable Finance
Good examples of sustainable finance come from the startup ecosystem , innovative companies that seek to transform the way business is done.
Innovative Solutions
Among the companies surveyed, the majority (52.4%) work in the management of clean energy and electric mobility.
One of the startups mapped by the research is Biomethane Energia, a startup that works in biodigester projects and transforms waste into energy.
Differentiated Credit
On the financial institutions side, an example of sustainable finance comes from the National Bank for Economic and Social Development, which launched BNDES Crédito ASG .
The program has R$ 1 billion available to finance companies that undertake environmental, social and governance advancement goals .
Each company or economic group can claim up to R$150 million directly with BNDES until December 31, 2023.
The cost of financing is lower considering other lines of credit and can still be reduced if the agreed targets are met.
In Practice, How To Apply The Concept Of Sustainable Finance?
The concept of sustainable finance can be applied in different ways.
Let’s consider two hypothetical examples: shareholders of a large company that produces packaging begin to demand the improvement of the production process and the gradual replacement of plastic by material that is less harmful to the environment.
Does it mean that shareholders are activists? Not necessarily.
They may be keeping an eye on consumer behavior trends , which are demanding a change in attitude from organizations.
As the shareholders own the company’s capital stock, management needs to move to adapt to the requirements that, in this case, are not regulatory.
Another hypothesis for the application of sustainable finance in practice: an entrepreneur , aware of the size of the capital destined for sustainable finance, perceives a market niche that can be a profitable business and, at the same time, of social impact.
Decides to build and renovate homes for low-income families through partnerships with large corporations or low-cost financing lines.
As it is a socially sustainable initiative, the business can attract the attention of important market players, such as investment funds and development banks.
Green Bonds Vs Conventional Bonds
The difference between green bonds and conventional debt bonds is in the application of resources .
Green bonds are specific to financing projects that benefit the environment, such as recycling, sustainable agriculture and bioenergy.
Conventional bonds are instruments that companies from different sectors and segments use to finance their activities.
There are also public bonds , such as the Treasury Direct bonds , used by the government to finance the federal administrative machinery.
Sustainable Finance And Financial Stability
Sustainable finance plays an important role in financial stability by contributing to the balance of the real economy .
By channeling resources to social, environmental and governance development projects, they also mitigate the risks of economic disruptions.
Environmental catastrophes, for example, result in huge losses for insurers and health plan administrators.
Inefficient governance of financial institutions can result in bubbles, unrestrained credit and global financial crises.
Extreme weather changes can affect field production and result in losses for the agricultural sector.
These are risk factors for the economy that can be mitigated or avoided through investments channeled through sustainable finance.
Sustainable Finance: The Main Trends For The Coming Years
The sustainable finance market is expected to continue to grow , both in volume and asset diversification in the coming years.
Some points to note are:
- Increase in the issuance of bonds and sustainable bank loans : the expectation is that the funds will also reach small and medium-sized companies in a significant way
- Growth of sustainable investment funds : the fund shelf should diversify (equity funds, structured credit, among others) focused on impact assets, both social, environmental and governance
- ESG principles increasingly used as investment criteria : investment screening should become more frequent, including among traditional managers
- ESG topics incorporated into the day-to-day of companies : executive compensation aligned with sustainable goals and ESG as part of corporate boards.
