Guest article by Michael Schmidt, member of the Sustainable Finance Advisory Board of the German Federal Government and Managing Director of the Green and Sustainable Finance Cluster Germany
Sustainable finance is not a state, but a dynamic process. It is a path with the aim of making the financial system as a whole sustainable and at the same time enabling the financing of the socio-ecological transformation.
How did sustainable finance begin? What role do the various initiatives with their many acronyms play? What have the initiatives achieved? How should Sustainable Finance develop further?
Climate protection agreement as a starting signal
The Sustainable Finance Journey began in 2015. Of course, sustainability in the financial sector existed much earlier. But the triggers for the use of the term “sustainable finance”, regulation and the emergence of market initiatives were the two major global agreements of the world community at the time: the Sustainable Development Goals (SDGs) and the Paris Climate Agreement.
These two sets of goals show the importance of sustainable finance in a wider context of global challenges. These naturally include climate change, unchecked population growth with limited resources (keyword: planetary boundaries) and, last but not least, revolutionary technological changes (keyword: digitalization).
Challenges that are complex and require urgent action at the same time – a difficult combination. Addressing complexity requires the solution-oriented interaction of as many perspectives as possible. Multi-stakeholder approaches are the method of choice for this. However, they are laborious and take time. In the opinion of many climate researchers, however, we do not have this time when it comes to climate protection. Decisive and swift action seems to be called for in order to limit global warming and its devastating consequences for people. However, quick results are best achieved when a small, well-coordinated team is focused on finding solutions. This is the dilemma between complexity and speed, also for the various initiatives.
A variety of initiatives emerge
In the wake of 2015, many initiatives emerge to work towards achieving the SDGs and climate goals. This is the time when the TCFD, the Task Force on Climate-related Financial Disclosures, and a number of global networks on sustainable finance were created, many of which were initiated by decades-old United Nations institutions such as UNDP, UNEP FI and older sustainability initiatives such as the PRI and the UN Global Compact. New initiatives include, in particular, the various “Net Zero” alliances, which will be brought together at COP 26 in 2021 under the umbrella of the GFANZ (Glasgow Financial Alliance for Net Zero). Furthermore, the NGFS, the Network for Greening the Financial System, is an influential international platform of central banks and supervisory authorities whose analyses, particularly on climate scenarios, are incorporated into concrete supervisory work as best practice and thus have an impact on the strategy and risk management of financial institutions.
And with the establishment of the “High Level Expert Group on Sustainable Finance” at the beginning of 2017, the EU Commission began to focus on the financial sector in order to use it as a lever for achieving the climate targets and the SDGs through regulatory measures, recognizing its allocation and multiplier function.
The recommendations of the HLEG’s final report were largely adopted by the EU Commission in its ten-point “Action Plan: Financing Sustainable Growth”, which still forms the starting point for the regulatory works in Sustainable Finance today, including in particular the Taxonomy Regulation, the Disclosure Regulation and the CSRD and CSDDD Directives. The EU regulatory initiative has attracted worldwide attention and imitation, and the idea of the taxonomy has virtually become an export hit.
Progress, but also room for improvement
What have regulation and the various market initiatives achieved? In my view, one major success is that sustainability has entered the mainstream. Today, sustainability issues are on everyone’s mind, in almost all very different functions in companies in the financial industry as well as in the real economy. This is a great opportunity: experts from different disciplines are not only dealing with the implementation of regulatory requirements in their area of responsibility, but also with the utilization of sustainability for the further development of strategy, products and processes.
However, the regulation itself is in need of improvement – and the different perspectives of practitioners can contribute to this. The EU Commission’s approach appears complicated, lacking in coherence and so far quite limited in its intended effect. Several sets of regulations have been launched with little room for experimentation and different regulatory instruments, which were and are not always coherent in terms of timing and content, leave questions of implementation unanswered and – against the backdrop of greenwashing concerns – cause uncertainty.
I also still see challenges for market players in the financial sector, especially in the “front office” – there is still a lack of real penetration of traditional functions, in corporate customer support at banks, in financial advice in the securities business, in financial analysis on the capital market or in portfolio management.
Three key points for the success of sustainable finance
How should sustainable finance develop in order to be successful? I proclaim three maxims for politicians, regulators, supervisors and market players alike:
- Focus on the overall goal, namely the preservation of prosperity in an environment and society worth living in. This means focusing on the climate targets and the SDGs. It is important to emphasize the path to these goals, i.e. to promote transformation and make it visible. Ambitious transition plans with a high level of transparency are essential for this. Measures must have a corresponding impact on real products and production processes. “Impact” should become the overarching philosophy and be measured in key performance indicators. A positive vision with a clear and reliable framework as an orientation that allows market forces to unfold is a decisive basis in politics. Regulation and supervision must simplify the rules and create coherence. To this end, they should also make more use than before of standardization by market players for practical details (e.g. ISO).
- Courage to change: Structural change cannot be successful if change is only seen as a risk or implemented as an annoying compliance exercise. The prerequisite for the courage to change is not only an awareness of a worthwhile goal, but also applicable knowledge. The qualification of employees, as well as management and supervisory bodies, is therefore essential. Furthermore, companies and the financial industry should anchor sustainability goals in their business strategy and key functions and invest in product and process innovation. Structural change should be used as an opportunity to think “outside the box”, for differentiation or simply for survival.
- Tolerance of mistakes: Companies and financial institutions should create a basis of trust that is also forgiving of mistakes. This is because mistakes inevitably occur in unknown ways, a realization that the supervisory authorities should also take to heart. This basis of trust is created through transparency and dialog, i.e. honest transparency and communication about one’s own goals and measures, the measurement and presentation of one’s own sustainability contributions as well as the exchange with stakeholders about what works and what does not. This should also make the greenwashing debate more objective.
Conclusion
In summary, I am convinced that it is worth working – especially in the various sustainable finance initiatives – for a financial system that has internalized and implemented its “purpose” of responsibly supporting companies and consumers in the structural change described above with advice, financing and investment solutions.