Financial Insights

Sustainable Finance

What is Sustainable Finance:

Sustainable finance is the process of considering the environmental and social considerations when making investment decisions, which lead to increased investment in longer-term and sustainable activities. It is a form of financial service integrating environmental, social and governance (ESG) criteria into business or investment decisions for lasting benefits to clients and society at large.

Environmental considerations refer to climate change mitigation and the environment more broadly and related risks such as natural disasters. Social considerations include issues of diversity, inclusiveness, labour relations, investment in human capital and communities.

A sustainable financial centre refers to a financial marketplace that contributes to sustainable development and value creation in economic, environmental and social terms. It ensures and improves efficiency, prosperity, and competitiveness today and in the long-term, while contributing to protect and restore ecological systems, and enhance cultural diversity and social well-being.

Activities that fall under the heading of sustainable finance include sustainable funds, green bonds, impact investing, microfinance, active ownership, credits for sustainable projects and development of the financial system in a more sustainable way.

Governance including management structures, employee relations and executive remuneration, also play a key role in ensuring inclusion of social and environmental considerations in the decision-making process.

All three components – environmental, social and governance (ESG) – are integral parts of sustainable economic development and finance.

Standards:

Currently, a number of standards exist to aid investors in evaluating and differentiating between financial products described as sustainable. These include:

Eurosif Transparency Code which focuses on retail Socially Responsible Investment (SRI) funds distributed publicly in Europe that cover a range of asset classes. It increases accountability to consumers and creates more clarity for asset managers, researchers and stakeholders. The code indicates that asset managers should be open, honest and provide accurate and timely disclosure of information for stakeholders and retail investors to understand policies and practices of SRI funds.

Febelfin Quality Standard and Label is a quality standard for sustainable financial products where all distributors and managers of socially responsible or sustainable financial products can apply for the label.

FNG-Label for Sustainable Mutual Funds ensures that exclusion criteria of nuclear power and armaments are applied and the 4 areas of the UN Global Compact i.e. human rights, labour, environment and anti-corruption, are taken into consideration. The FNG quality standard requires transparency and process criteria to be met.

FNG Sustainability Profiles and Transparency Matrix are guidance tools to help investors in selecting sustainable mutual funds. Both tools help investors and financial advisors get an overview of sustainability strategies used and provides key fund data.

Luxflag ESG label is an independent and international non-profit association created in Luxembourg that aims to promote raising capital for the Responsible Investment sector through awarding a recognizable label to eligible investment vehicles that reassures investors of the applicant investment in the Responsible Investment sector. The agency offers 5 different labels – Microfinance, Environment, ESG, Climate Finance and Green Bond.

Nordic Swan Ecolabel for Investment Funds is the ecolabel of the Nordic countries which also has investment funds criteria.

Novethic SRI & Green Fund Labels ensures that SRI funds are transparent and instructive for investors. It certifies that funds are environmentally beneficial and ‘green’ objectives are clearly explained.

Trends:

In 2019, investors globally continue to be concerned about climate change risks and the transition to a low-carbon economy. As awareness of climate risk has grown, so too has the sustainable finance market. The growth in the green finance market for issuers has been especially strong since the introduction of green bonds which focuses on performance of assets with positive environmental impact and economic value. Since 2007, when the first green bond was issued by the European Investment Bank and the World Bank, the market has grown to more than $160 billion in issuances in 2018.

With green bonds picking up pace, both government and businesses are starting to explore opportunities, and diversify their bond portfolios, incorporating social and sustainability factors. With this backdrop, we look a three sustainable finance trends that we think will shape the market in the near future:

  • Sustainability Bonds – investors are increasingly using the UN Sustainable Development Goals (SDGs) as a benchmark for impact and are creating demand for sustainability bonds such as assets with a positive social impact.
  • Business model transition – where investors are looking for companies to demonstrate their sustainability commitments and how such bonds contribute to their transition strategy.
  • Taxonomies – the EC’s efforts to create and regulate a green finance taxonomy will help to create clarity on what is considered green or sustainable. This can help to simplify transaction costs to enter the mark.

A number of other solutions are being offered including transition bonds, social bonds, climate bonds, ESG rating license, green or sustainability-linked loans

Financial institutions are increasingly seeing the benefits of aligning their strategy with the sustainable economy, seeking new financing opportunities, engaging clients to develop new products, and developing new policies and metrics to understand the implications of sustainability.

Sustainable funds which invest based on environmental, social or governance themes, drew $20.6 billion in new money in 2019 which is almost four times the amount in 2018. While mutual funds and ETFs with a focus on sustainability raked in $20.6 billion of total new assets in 2019. There are a few reasons for the trend, including lower costs, more availability and increased investor interest. 

Sustainable finance is increasingly proving it can not only offer valuable portfolio diversification opportunities but also generate good returns and address risks posed by issues such as climate change.

Private Equity Outlook 2020

Private equity firms continued to make deals and raise more capital in 2019. Increasing returns during ongoing fiscal and geopolitical uncertainty has pushed PE firms to focus on value and digitalisation.

Fundraising in 2019 totalled £720 billion in private capital with £290 billion explicitly raised by buyout asset class. With large funds, sizeable sovereign wealth and pension funds distributing large chunks of capital, the disparity between significant players and the rest of the field has continued to grow, urging firms to start creating differentiated go-to-market strategies.

In future, large funds will need more diversification, across activities and also across markets and asset classes. Small firms should focus more on high growth niche areas.

In 2020, firms have accumulated almost £1.2 trillion in unspent capital, more than 3 times the amount of last year’s private equity deals. As competition over a limited number of quality assets remains strong, careful consideration is crucial when thinking about how to use these funds efficiently.

As the PE industry represents less than 5% of total global assets under management worldwide, it leaves room for the industry to grow. According to Bain & Co, there are reasonable grounds for PE firms to invest in the technology sector e.g. enterprise software and services where there is strong revenue growth and solid fundamentals, due to the transition of many cloud and mobile technology companies to mature stages.

Investors are also shifting focus to smaller, more innovative start-up fintech companies that combine payments with other business services e.g. merchant services, buyer services, networks. Due diligence is also a key area particularly identifying disruptive patterns in an industry and understanding their impact on investments. This can be done by evaluating competitors, start-ups and patterns in spending.

Firms should embrace their role as holistic value creators and industry supporters by considering the impact of decisions on Economic, Social and Governmental practices (ESG) to enhance social and business value of firms. Managers need to focus on including ESG metrics into investment methodologies and demonstrating the financial value from this approach.

Business leaders should identify digital innovations such as business intelligence, big data analytics, machine learning and business process automation to help companies evolve and gain required skills for better performance and competitiveness.

Ref: Global Private Equity Report 2020, Bain & Company