What is a Green Finance Strategy and why is it essential for your enterprise?
In stark contrast to five years ago, sustainability and climate-change risks are very high on the corporate agenda these days. It has become a priority for enterprise communication and chief executives. So, we can see today how institutions increased their green commitments in 2020, compared to 2019. At a more granular level, in 2020, cumulative green finance commitments surpassed the $1 trillion mark since the Paris Agreement was signed. This is a major milestone, which materializes the ability to deliver on unprecedented flows of green finance. Adaptation finance continued to grow, increasing by 42% over 2019 and more than fivefold compared to 2016 to reach $27.5 billion. Here comes the questions: why is there a growing interest in green finance strategy and what does it mean for your company?
Green Finance Strategy: definition
Although the term is increasingly used in many countries across the world, there is no single, agreed definition of what constitutes green finance. It can refer to products and services, managing environmental risks, organizational strategies, organization’s themselves, as well as investment sectors, industry initiatives and policy instruments.
The most working definition of green finance in the national and international context explains a green finance as a strategic approach to incorporate the financial sector in the transformation process towards low-carbon and resource-efficient economies, and in the context of adaptation to climate change.
This is a broad definition which acknowledges the different dimensions of the concept of green finance, while retaining an overarching focus on enhancing and sustaining the natural environment, and managing current and future environmental risks. It highlights
and recognizes the two-way nature of the relationship. Finance and investment can help or harm environmental outcomes, while the environment can also positively or negatively impact the performance of investments or financing activities.
Why is Green Finance strategically important?
Green finance is important because it facilitates and supports the flow of financial instruments and related services for the development and implementation of sustainable business models, investments, trade, economic, environmental and social projects. As the financial sector plays a key role in promoting sustainable economic development through its intermediation and risk management functions by channeling investments into the real economy, the interconnectedness of these two sectors is critical.
Building on lessons learned from the 2006–2009 global financial crisis, global warming, and the need for more sustainable business practices, green finance initiatives also aim to achieve the 2030 Sustainable Development Goals (SDGs), shifting the focus from creating value for shareholders (economic) to creating value for stakeholders (economic, environmental, and social).
Green finance is the future of the financial sector through innovative financial mechanisms and supporting investments in projects with positive and sustainable externalities.
How can companies work on sustainable finance?
For being at the forefront of a powerful movement to GFS, some of the largest and most influential institutional investors and enterprises add environmental, social, and corporate governance (ESG) standards to their criteria for capital allocation. As long-term stewards of capital, they recognize a mandate to consider whether the companies they own today will maintain a strong connection both with their customers and extended communities as environmental and social challenges increasingly impact the way we live and work. They also recognize that companies that commit to addressing these urgent issues stand to realize greater business opportunities in the future — and thus will achieve higher returns for their long-term shareholders.
How are finance people leading the change?
While the companies realize the importance of green finance strategy, the financial department would be wise to watch how investors and thought leaders are feeling. In their telling, sustainable finance is quickly becoming one of the biggest issues facing the financial world, and corporate disclosure on climate-related risks is the crucial first step in achieving a sustainable financial system. For CFOs, who will play a pivotal role in putting sustainable finance principles into practice, it’s a time of great opportunity — and change.
EU Strategy of financing the transition to a sustainable economy
The essence of the green finance topic was also discussed at the government level. And in July 2021 the European Commission adopted an ambitious and comprehensive sustainable finance strategy to help improve the flow of finance towards the transition to a sustainable economy. Building on the 2018 Action Plan, the new strategy proposes actions across the financing chain in four policy areas: transition finance, inclusiveness, resilience and contribution of the financial system and global ambition. The EU will examine the credibility of financial services firms’ net zero pledges, in particular the extent to which further guidance is necessary to ensure that firms’ voluntary pledgesare credible and measurable. The strategy confirms that EU firms should expect climate risk stress testing to become part of business-as-usual supervisory processes.
The renewed strategy in 2021 sets out an extensive programme of actions that will further integrate and embed sustainable finance considerations across the financial services sector. The number and complexity of topics warrants early action from firms, and necessitates sustainable finance remaining at the forefront of senior management priorities.
What role do technology and finance play in this transition?
During the transition to sustainable finance, one of the key challenges faced by the global financial system today is to mobilize private capital to support sustainable growth and a stable financial system. To overcome this challenge and get ahead, companies should be seeking an improved understanding of how digital finance can accelerate the greening of financial flows. Access to high-quality and comparable data will be vital to increase opportunities for more sustainable investments. In this case, data is the backbone of investment decision-making: investors need help to understand how companies may fare as the environment changes, regulation evolves, new technologies emerge and customer behaviors shift. They need to better understand and quantify risk as well as returns. Increasingly, CFOs and investors are looking for ways to measure the impact of their portfolios and set benchmarks.
Going forward, it is widely expected that technologies like AI, machine learning and natural language processing will be used to both generate and evaluate GFS data.