Sustainable Finance is typically defined as the investment, financing and management of assets that have in consideration not only its financial returns but also its broad long-term impact, namely in social or environmental terms.
This broader perspective on the outcomes of investments comes from long ago, being rooted in the ethical principles of borrowing and lending of some of the world major religions. More recently, and for a long time, the Friedman doctrine that “The Social Responsibility of Business is to increase its profits (…) conforming to the basic rules of the society” ruled the understanding of the corporate function in capitalist societies – to businesses what is for businesses; to governments what is for governments. But events like the ozone depletion in the 1980s, Chernobyl nuclear disaster (1986), the apartheid in South Africa (until the earlies 1990s), and the increasing negative effects of climate change and pollution have brought to the forefront the discussion about the role of corporations in our societies. This reflection culminated with a landmark decision of the very influential U.S. Business Roundtable to reframe the Purpose of a Corporation to be that “Companies should serve not only their shareholders but also deliver value to their customers, invest in employees, deal fairly with suppliers and support the communities in which they operate”.
We can now find in our societies a large, developed spectrum of sustainable investing (sometime also called responsible investing): from philanthropy, where the focus is on social or environmental impact and not on return, to impact investing, where in addition to this impact some financial return is also expected, to the more sustainable investing, where financial returns take the lead, but there is also focus on long-term value, namely by using ESG (Environmental, Social and Governance) data in the investment decisions.
The difference between sustainable investing and the more conventional (à la Friedman) investment is getting blurrier. For instance, BlackRock, the largest Asset Manager in the world, defines “ESG integration (…) [as] the practice of incorporating financially material ESG data or information into our firmwide processes with the objective of enhancing risk-adjusted returns of our clients’ portfolios. This applies regardless of whether a fund or strategy has a sustainable or ESG-specific objective.” This just naturally means that all financially material information should be used, independently of its type – and so including ESG data.
Nowhere the line between sustainable and conventional investing is blurrier than when we talk about climate change. It is a topic of the upmost relevance for our society, and now inescapabl relevant for any corporation too and, therefore, for investors. Climate change is happening, whether we like it or not. The transition to a low-carbon economy is happening, whether we manage it well or not (though it will be much cheaper if we do). We can see it coming through technological innovation (that delivers green energy at an increasingly cheaper cost), government policies (e.g., the IRA in the U.S. or the Green Pact in Europe), consumer preferences (e.g., electric cars or circular economy) or even legal challenges to polluters in courts. This transition will have a significant and permanent impact on virtually every firm and any industry anywhere in the world. The opportunities and risks coming from this transition are large – and nobody can afford to ignore them. So, almost by definition, any information about climate change is financially material and therefore needs to be incorporated in the financial analysis of any firm. Sustainable investing is the new conventional investment – and the circle is closed. This change in paradigm – especially on what energy transition is regarded – is already happening in full force; for now, encompassing the larger corporations, but soon arriving at any small firm in your neighbourhood. For instance, the European Union – leading the legislative effort worldwide – is working, namely through the banking system and legislation like the CSRD (Corporate Sustainability Reporting Directive), to influence how small and medium businesses manage the transition to a low carbon economy.
To provide an order of magnitude for these investments, in terms of Assets under Management worldwide, the Global Sustainable Investment Alliance estimates that the global sustainable investment market (ESG investments) was USD 30.3 Trillion in 2022, with Europe leading the way with about half of it. This constitutes about 30% of total managed assets worldwide.
From a more industrial perspective, Bloomberg estimates that green investment on the transition was about USD 1.8 Trillion in 2023 (up 17% from 2022), or about 2% of the world GDP. But the IEA (International Energy Agency) estimates that these numbers must grow to about USD 5 Trillion by 2030 if we want the energy transition to align with the Paris Agreement goal of keeping global warming well below the 2ºC from pre-industrial levels. In terms of investments, the global leader has been clear: though currently the biggest polluter, China is leading the way in terms green investments, with almost $700 billion in 2023, more than the E.U. and the U.S. combined. The race to win this new industrial revolution – and its source of huge new opportunities for economic growth – is on, with the different economic blocks trying to position their industries well in this race. The costs of ignoring or delaying these investments are also incredibly high as more frequent and acute climate extreme events, with significant and unequal economic and social costs, occur.
As we navigate through these issues, two fundamental questions emerge: Is our society fostering the needed debate about the urgency and the trade-offs of the transition? Are our companies well-informed and positioned for the transition?
Have a great and impactful week!
António Baldaque da Silva
Professor of Finance (Adjunct) at CATOLICA-LISBON
Ex-BlackRock MD, Global Head of BlackRock Sustainability Lab (NY and LDN)