26 February 2019 – Kajetan Czyz, Programme Director, Sustainable Finance, reflects on four decades of progress in the field of sustainable finance, which is entering a new phase of maturity. He describes CISL’s recent work in developing practical solutions for investors, banks and insurance companies to proactively encourage, create and exploit the opportunities inherent in the shift towards a sustainable economy.
After nearly four decades, the field of sustainable finance is entering a new phase of maturity. Evolving from ethical investment through financial risk to purpose-driven finance, the industry is now focused on creating practical tools for directing capital away from sources of environmental, social and governance (ESG) problems and towards solutions for a sustainable economy. More work remains to be done, however integration of responsible finance into mainstream practice now seems not only achievable, but inevitable.
All new industries go through several rounds of evolution before they become fully mature and establish themselves properly within their broader surroundings. Sustainable finance is no different. What began as set of very niche products such as ethical investment funds and responsible banking in the early 1980s has now turned into an industry-wide movement. For example, the signatories to the Principles for Responsible Investment represent assets equal to roughly one-third of all assets listed on global stock exchanges.
Since 2010, two trends begun to merge: tCO2-eq began to be widely used as a proxy for climate damage which could be accounted for and priced, and the concepts of the carbon bubble and stranded assets were introduced which clearly demonstrated limits to fossil fuel use. Sustainable finance entered a new era where financial risk, scenario analysis, carbon footprinting, transition risks and opportunities amongst other approaches were developed. These tools were transformative because they translated an environmental issue into the language of finance and gave its practitioners a way of integrating what up to then was an ethical consideration into financial decision-making.
Since late 2015, when the Paris Agreement and the UN Sustainable Development Goals (SDGs) had been agreed there has been a notable shift in focus within the finance industry – from understanding risks to financing solutions. The penny has dropped within the finance sector and the question changed from “is this my problem?” to “what do I do about it?” Although CISL considers that there is much yet to be done to fully implement best-practice ESG risk analysis, and will continue to work on practical solutions in this area, we are actively responding to signals from the industry’s leading companies on the need to develop practical solutions for investors, banks and insurance companies to proactively encourage creating and exploiting the opportunities inherent in the shift towards a sustainable economy.
To this end, last month the Investment Leaders Group launched a set of open-source metrics which allow any investor to calculate their exposure to SDGs. They were purposefully built to be understandable to end investors, be aggregatable across a portfolio and work across sectors and asset types. Although the aspiration is for these metrics to be comprehensive and nuanced, the work includes a version of the metrics which can be calculated with external data without using estimates or assumptions. Although better data would be useful – as of today, it is possible to calculate a fund’s exposure to the SDGs and it is our belief that if it is doable it should be done.
Insurance companies which engage in our annual reporting and benchmarking exercise through the ClimateWise Principles will from this year onwards be using an updated set of questions which will enable them to fully comply with the recommendations of the FSB Task Force on Climate Related Financial Disclosures (TCFD). Apart from an updated disclosure framework ClimateWise has last week published two open-source models which could be used by insurers as well as lenders and investors in identifying physical and transition effects from climate change – both economic risks and opportunities. Both of these frameworks have been commissioned by the ClimateWise Council of CEOs and have been published as open-source to help the broader financial industry adapt to the effects of climate change.
Perhaps one of the most exciting projects currently underway at CISL has been working with banks from the Banking Environment Initiative and others on understanding what services banks will need to be offering through the low carbon transition as their clients’ needs change and importantly what financing products can be offered to bring about the transition more quickly. The project, called Bank 2030, due out later this year, will highlight areas where banks can already make progress on their own as well as lay out areas where cooperation with other stakeholders, such as governments, corporates, standard setters and multilateral-finance institutions.
These initiatives demonstrate ways in which the industry is evolving. Although we are still some time away from fully integrating the financial risks of unsustainably run businesses, there is certainly enough expertise built up over the years for integration and new tools to be developed and applied by the industry. The exciting challenge now is growing the opportunities side of the equation so that the economy may deliver sufficient sustainability solutions to steer us away from the precipice we are currently charging towards. For the leaders these are exciting times, and as for companies who have not started their sustainability journey in earnest yet, time is running out. As Geoff Summerhayes, Chair of the Sustainable Insurance Forum (SIG) underscored during the launch of the ClimateWise tools – many regulators are not only aware of the tragedy of horizons but will be expecting companies they oversee to ensure that tragedy never comes to pass.
