How Does Sustainable Finance Work?

·5 min read
Pair of hands holding Earth
Pair of hands holding Earth

Sustainable finance is a movement of investors, companies and financial institutions as well as advisors who consider more than just the bottom line. Pursuing sustainable finance means taking environmental, social and governance (ESG) factors into consideration. It’s common to discuss sustainable finance in terms of investing, but it also applies to general financial planning as well. Here’s what you need to know about this movement. A financial advisor can provide practical insights into how to make sustainable finance a priority for your investment decision making.

What It Is, Why It Matters

Sustainable finance, also known as “green finance,” entails concern for climate change mitigation, environmental impacts, culturally appropriate operations and social inclusivity when considering the overall impact of investments and related financial initiatives.

Participants in this movement want to avoid decisions that could back income inequality, habitate destruction and pollution – among other concerns – and instead back ventures that advance equality and a healthy environment. Each category of ESG breaks down into a different cause that a sustainable finance investor may want to support, including biodiversity, renewable energy, human rights, labor relations, corporate transparency and shareholder rights.

Sustainable finance matters to the planet. In August 2021 the U.N.’s Intergovernmental Panel on Climate Change issued a warning about climate change, saying human activities “unequivocally” cause climate change.

According to a report by the Nature Conservancy, $598 billion to $824 billion must be spent annually to backpedal the biodiversity crisis by 2030. While this seems like a lot, the Nature Conservancy claims this is possible by changing current spending flows through sustainable finance.

Who Provides Sustainable Finance?

Businesswoman presenting a sustainable project proposal
Businesswoman presenting a sustainable project proposal

One key strategy on the investing side of sustainable finance is “impact investing.” It includes investments made with the intent to create measurable, positive impacts without losing out on returns. For example, investors who put their money into renewable energy companies positively impact the environment and can still boost the bottom line.

Investors can find opportunities for impact investing across almost any type of security, from stocks and bonds to ETFs and private equity. More and more companies and nonprofits are picking up corporate social responsibility (CSR) practices. One example is Craft3, a nonprofit that provides financing for those who can’t access traditional sources of money. In particular, the entity targets those who want to improve social or environmental standards – like a home’s energy efficiency.

A number of corporations, banks, climate funds, national governments, stock exchanges and central banks are offering sustainable finance opportunities. For example, in February 2021 investment bank Goldman Sachs issued its first “sustainability bond.” That’s a sector that’s projected to surpass $650 billion in 2021, fueled largely by demand among investors for climate-friendly investments. According to Moody’s, sustainable bonds are estimated to account for 8% to 10% of total bond issuance in 2021.

The World Economic Forum’s Davos Manifesto 2020 challenges companies and financial institutions to promote sustainable finance. “A company is more than an economic unit generating wealth,” the WEF manifesto says. “It fulfills human and societal aspirations as part of the broader social system. Performance must be measured not only on the return to shareholders, but also on how it achieves its environmental, social and good governance objectives.”

Measuring the Impact of Sustainable Finance

There are a number of options when it comes to assessing whether an investment or financing venture qualifies as legitimately sustainable. For example, companies and investors can use a framework called total societal impact (TSI) to check both shareholder returns and the resulting impact on society and the planet. TSI allows groups to evaluate the relationship between ESG factors and their financial success.

According to Boston Consulting Group, ESG metrics are “statistically significant” in the prediction of valuation multiples in a group of analyzed industries. On top of that, investors rewarded high performers in ESG factors – more than median performers.

Similarly, the Sustainability Accounting Standards Board aims to provide “comparable, consistent, and reliable data on financially material sustainability factors” for specific industries. Such data includes empirical metrics useful to investors, advisors and financial institutions.

The Takeaway

"There is no Planet B" sign
"There is no Planet B" sign

Many experienced individuals are familiar with what it means to be a financially responsible investor. They have to learn the terminology, keep up with changes and allocate their assets according to their risk. That protects the individual. On the other hand, sustainable finance encourages investors to take on a greater sense of responsibility: for their society and environment. They aim to invest based on ethics without losing out on returns.

Tips for Investing

  • Getting into investing isn’t easy. Investing beginners have a whole new language to learn and options to navigate. Even though it’s sometimes overwhelming, you don’t have to do it alone. A financial advisor can help you learn the ropes to help you make financial decisions. SmartAsset offers a matching tool to find a local advisor for you. Simply answer a few questions and in no time you’ll have up to three financial professionals in your area ready to help. If you’re ready, get started now.

  • More and more investors want to take the world into consideration when they make financial decisions. However, it’s also important to protect your own interests. Maintaining a diverse portfolio is one of the best ways to protect yourself and your investments. Allocating money into various stocks, bonds and other assets can stop you from losing everything. If one investment goes south, the success of the rest will keep you safe. If you want to find the right balance, consider speaking to a financial advisor or checking out an asset allocation calculator.

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