Sustainable Finance and Regenerative Finance: Same Same but Different

My two cents: If Sustainable Finance is done right, we won’t discuss it anymore since the whole financial system is sustainable from within. By then, we will only talk about finance. I started questioning my approach to Sustainable Finance when I came across Regenerative Finance. I thought it was just another term for Sustainable Finance.

This was six months ago. I dug deeper into the movement. I read blogs, listened to podcasts, and talked to people. By now, I know that I was utterly wrong and naive.

In this article, I will first explain why we need Sustainable Finance. I will break down and compare Sustainable Finance and Regenerative Finance, and finally, I will have an outlook.

Why shifting trillions is required

Climate finance aims to reduce and sink emissions and to make human and ecological systems less vulnerable and more resilient to climate change. It includes public and private capital.

In 2021/2022, climate finance reached an all-time high worldwide. Global climate finance approached USD 1.3 trillion — and nearly doubled compared to 2019/2020. This development is significant, but the current flows represent only 1% of the global GDP, which was USD 101 trillion in 2022.

Avoiding the worst impacts of climate change needs approximately USD 8.1 to 9 trillion annually until 2030 and more than USD 10 trillion annually from 2031 to 2050. Looking back, doubling climate finance is a ridiculous achievement since it must be five-fold annually.

Long story short: There is a massive gap in climate finance.

More importantly, climate finance is only one part of sustainable finance. As a result, the real gap — including social factors — is even bigger.

A brief look back: The well-known duty and years of stagnation

“Our Common Future” was the title of the final report submitted by the UN Commission on Environment and Development in 1987. As it brought sustainability to the attention of a global audience, the report represented a turning point for sustainable development. Until today, the term’s definition is derived from that report. Even then, the UN emphasized the financial sector’s role:

“Multilateral financial institutions have a crucial role to play. “

However, the report mainly refers to the World Bank and regional development banks — private sector financial institutions were not explicitly mentioned. This changed in 1991 with the formation of the United Nations Environment Programme Finance Initiative. This alliance marked the start of a global debate on sustainable finance. But the debate remained silent.

It took more than 20 years to address the financial market’s role vigorously. Two policy-driven actions happened with a huge impact.

The first one was in 2015. Again, the UN emphasized the financial market’s role in revealing the Paris Agreement. It states the needed action to align financial flows with a path towards low greenhouse gas emissions and climate-resilient development. Furthermore, it highlights the private sector’s duty to participate.

In 2019, the European Commission presented the European Green Deal. The European Union plans to combat climate change, advance sustainable development, and attain carbon neutrality by 2050. This was the second significant policy action, marking the final breakthrough for sustainable finance.

The EU describes the financial markets’ duty:

“The private sector will be key to financing the green transition. Long-term signals are needed to direct financial and capital flows to green investment and to avoid stranded assets.”

In other words, we need to close the climate finance gap — and we cannot steer enough capital without the financial market.

Considering the financial markets’ focus on return on investments, the incentives are given due to a vast transformation needed within the economy and society. Some call it the “200 trillion opportunity” until 2050. The EU states that EUR 180 billion in additional yearly funding will be needed until 2030 for the Green Deal. The transformation towards net zero is a business case.

Nevertheless, we failed to reach the USD 100 billion goal in climate finance until 2020.

Why shifting trillions is complex

Before looking at different concepts for shifting trillions, we need to assess the main functions of the shift of capital. I will focus on banks since they act as good examples of intermediaries between companies, individuals, and politics.

Banks are commonly known for their products, representing their main functions on the micro (individuals) and meso (organizations) levels in society.

Banks provide safe places to deposit money, provide loans, or facilitate payments. On a macro level, banks play a huge role in central banking functions (e.g., money supply), risk management (e.g., financial stability), and economic development.

According to Rosella Carè, banks have four main functions in their role as financial intermediaries:

1. to transform money by scale
2. to transform money by duration
3. to transform money by spatial location
4. to act as assessors of risk

These four main functions are quite rudimentary and, therefore, easy to apply. At least in theory.

In reality, we must consider market dynamics, a lack of standardization, data quality and availability, regulations, risk and return considerations, exiting portfolios (e.g., ongoing contracts, divestments), educational and cultural factors, and incentive structures.

In my eyes, the most crucial factor is the widespread short-term thinking among investors — or, as Mark Carney, former governor of the Bank of England, calls it — the tragedy of the horizon.

How can we shift trillions?

As we have seen so far, shifting capital is urgently needed. Two approaches can fulfill the financial sector’s duty: Sustainable Finance (SuFi) and Regenerative Finance (ReFi). Let’s have a look at these concepts.

Defintion:

Sustainable Finance (SuFi) can be defined as financing to support sectors or activities that contribute to achieving or improving at least one of the relevant sustainability dimensions. When making investment decisions, it is about considering environmental, social, and governance (ESG) issues.

Regenerative Finance (ReFi) is a principle that aims to create a financial system with environmental and social impact through decentralized technology. ReFi focuses on outcomes beyond financial gain. It creates value for the planet and people. ReFi is a long-term approach that restores natural resources and promotes sustainable ecosystems.

As we can see, SuFi and ReFi both consider ESG criteria in their investment decisions. However, the main difference is that SuFi does not seek to redefine finance. Instead, it focuses on recognizing finance’s role in supporting sustainability. Meanwhile, ReFi is a paradigm shift in our approach to finance.

ReFi and SuFi are based on different economic models. SuFi is intended to be implemented in the traditional economy, whereas ReFi seeks to establish a regenerative economy. Sustainability means to preserve the current status quo without compromising the ability of future generations to meet their own needs. A regenerative economy encourages the restoration and regeneration of natural resources and social systems.

Political:

Politically, SuFi is evolving at a tremendous pace and is shaped by regulators and multi-stakeholder initiatives worldwide.

The EU is a frontrunner and took numerous measures within the last few years: Action Plan: Financing Sustainable Growth, EU-Taxonomy, Sustainable Finance Disclosure Regulation, Corporate Sustainability Reporting Directive, Progress Report on Greenwashing… Dealing with the development and essential actors is an article itself. Here, you can get a good overview.

Regarding ReFi, one certain regulation will change the ReFi (european) ecosystem massively: The European Commission introduced in 2020 a proposal for a regulation on Markets in Crypto-Assets (MiCA) as part of its digital finance strategy. On 29 June 2023, the Regulation entered into force. The MiCAR will apply from 30 December 2024 (with exceptions).

It has four objectives:

1. Ensuring legal certainty for crypto-assets in scope
2. Supporting innovation and fair competition
3. Protecting consumers, investors, and market integrity
4. Ensuring financial stability with the inclusion of safeguards

Click here for a worldwide overview of crypto-regulation.

It becomes clear that politically, SuFi is developing rapidly due to bottom-down decisions and actions. This leads currently to a zone of transition for the financial market. ReFi, on the other hand, is quite a new concept, mainly driven by a bottom-up approach thanks to the ReFi community.

Clearly, there needs to be more political awareness of ReFi. But it might profit from the current SuFi regulation, and hopefully a solid ground for ReFi is laid.

Technological:

For a successful implementation of SuFi, data is key. Currently, there is a massive lack of ESG-Data. Besides that, SuFi can be seen as an add-on to current technology based on Web 2.0; “to implement” is an adequate verb.

This is a big difference to ReFi. ReFi is completely based on Web 3.0 technology, mainly blockchains. Therefore, it is decentralized, based on open-source software, trustless (no third party needed), and permissionless. It interconnects with Decentralized Finance, an alternative financial system that aims to democratize goods and services. Drastically speaking, “to substitute” might be an adequate verb.

While SuFi deals with a need for digitization, ReFi is based on future-proof technology. But Web 3.0 is still a world under construction. Before it can be scaled up to gain mainstream adoption, several issues need to be fixed.

Social:

Both ReFi and SuFi do consider social factors when it comes to investment decisions. The main difference is the access to capital. In SuFi, intermediaries (banks, investors) are needed to get (and shift) capital.

ReFi promotes strengthening financial inclusion. This means that individuals and businesses have access to valuable and affordable financial products and services that meet their needs — transactions, payments, savings, credit, and insurance — delivered responsibly and sustainably.

ReFi claims to involve local actors and accessibility for everyone across borders due to the decentralization through technology. Ultimately, this might lead to a shift of power and responsibility. This goal is essential, considering that nearly 1.5 billion people in emerging economies don’t have access to formal savings and credit.

ReFi does not need the intermediaries — and therefore the traditional financial market players, to close the climate finance gap. SuFi relies heavily on intermediaries and sees the financial market as part of the solution.

Economic:

As we have seen in the introduction, the potential for SuFi is massive. It appears easier to shift to “finance for sustainability” instead of “finance for regeneration”, for which a complete mind shift is a fundamental requirement.

Nevertheless, by 2030, the cryptocurrency market is predicted to have grown from USD 1.54 billion in 2022 to USD 13.17 billion. But currently, no data shows whether ESG factors are considered in current cryptocurrency investments. We can hope that crypto-investments towards regeneration, or at least ESG consideration, are also on the rise.

Wrap up and outlook

In conclusion, ReFi and SuFi are same same but different. In theory, ReFi can serve the four major functions the financial market currently performs. Ideally even better. Regulation is coming, and the social factors are a huge advantage.

But the mind shift needed for a regenerative economy is a burden for scaling ReFi. Tackling this burden is possible with the help of politicians and regulators. Otherwise, ReFi will remain in a niche.

My wish is a beneficial coexistence of SuFi and ReFi.

Let’s hope we have all learned from the delayed breakthrough of Sustainable Finance and that Regenerative Finance comes much faster — we do not have 30 years to close the finance gap.