Three Challenges for Sustainable Finance in 2022

Krisztina Tora, Chief Market Development Officer, The Global Steering Group for Impact Investment, says the finance sector can act today while pushing for policy that will scale up impact investing.

In December the G7 Impact Taskforce, a group of leading voices and 100 organisations from the worlds of business, public policy, and the social sector, issued recommendations for increasing impact investment and ensuring that it reaches the people and places that need it most. To mobilise private capital for public good, the taskforce recommended mandatory impact accounting and the increased availability of impact investment vehicles.  

However, time is running out to narrow the gap between rhetoric and delivery and create a transition to a more equitable and sustainable future. For this ambition to become reality, we will have to think differently about current practices and focus on the markets and businesses that can make the biggest difference.   

Driving real impact not just avoiding risks 

Significant progress was made in 2021 to help investors and companies manage their sustainability impacts, notably the launch of the Impact Management Platform, which consolidates existing sustainability resources, looks to address gaps, and coordinates with policymakers and regulators. However, many hurdles still exist for such practices to become mainstream.  One of the immediate barriers is that most companies still report on ESG-related activities rather than outcomes achieved. For instance, having an equity and diversity policy doesn’t necessarily mean that an organisation has become more diverse or that it has improved its gender pay-gap. Investors have a significant role to play by becoming more strategic and accurate about their outcome intentions and expectations. To this end, some 150 organisations have signed up to the Impact Principles that set the bar for what investing for impact really means.   

While businesses and investors are embedding sustainability in their strategies and core business activities, there is still a gap between their pledges and reality. At an investor level, 90% of what is called “sustainable investing” is actually ESG risk management; only 10% intentionally targets the creation of positive outcomes. Similarly at a business level, there has been insufficient implementation of sustainability management tools and frameworks, and not enough investment into efforts that would lead to relevant sustainability outcomes.   

Set against this, successful cases of investors stewarding their investees towards faster progress on ESG topics are getting attention. Following deaths in Brazil as a result of the failure of dams owned by mining group Vale, the Church of England Pensions Board pushed for new safety measures – as well as audits and reporting – across the mining industry that encourage better standards and can save lives.   

Increasing focus on emerging markets 

Over 80% of global financial assets are held in OECD countries. In contrast, less than 4% of global wealth flows to lower- and upper middle-income countries (excluding China), yet these comprise 50% of the world’s countries and the majority of the global population. In order to achieve the UN Sustainable Development Goals (SDGs), we now need US$4.2 trillion annually to flow to businesses and projects that will deliver positive social and environmental impact, mainly in emerging markets.  

The G7 Impact Taskforce extensively analysed the barriers to investment in the SDGs and provided concrete and accessible solutions. We concluded that there is no need to reinvent the wheel. Rather, the key will be to scale up investment using existing instruments and tools, often combined through blended finance, mixed with guarantees and insurance products that have already proven effective in achieving expected levels of return. 

Supporting SMEs to transition will move the needle 

Many operators in private markets have been less than transparent on ESG performance. The venture capital industry, in particular, has been criticised by policymakers and commentators for not caring about sustainability and, in some cases, even turning a blind eye to unethical practices within the industry. Equally, private equity firms have had few incentives to take ESG seriously, besides increasing pressure from investors.   

However, private markets hold the key to the transition to sustainability, not least because the potential for transforming economies through change at small- and medium-sized enterprises (SMEs) is much greater than via public markets. SMEs represent over 90% of businesses globally, account for 60-70% of employees, and generate roughly half (or more) of GDP in any given country.   

Private investors also have the luxury of longer-term investment strategies, allowing them time to develop their own skills and capacity to improve sustainability impacts. It’s also easier to integrate ESG considerations into smaller businesses, especially at the start-up level, than to transform large and established listed multinationals. Finally, there’s now a wealth of literature demonstrating that ESG investing – both in general and via specific practices such as gender-lens investing – is simply more profitable.  

The race to the top 

Still, more needs to be done. Much depends on how fast investors, especially asset owners, intentionally begin engaging on ESG topics, and how quickly businesses invest in improving their sustainability impacts. In parallel, policymakers and regulators have an important role to play in creating the right incentives and regulations for shifts to happen at a fast enough pace. The good news is that we already have the necessary capital to meet our climate goals.  

However, it is only by mobilising both the private and public sectors at scale that it can be put towards the public good. Meaningful action can no longer be delayed. All stakeholders must urgently work together and take an ‘all hands on deck’ approach to overcome the inertia of our system and create a more sustainable future.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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