ESG and sustainable finance: What do you need to know? (2024)

The term sustainable finance is becoming increasingly important, as regulatory pressures and investor preferences push environmental, social and governance (ESG) factors up the agenda.

Sustainability in finance has been on the radar for investors and banks for some time, and increasingly, it's becoming a priority issue for corporates. Organizations are increasingly alive to the role of sustainable finance in helping them to:

• Meet investor expectations on ESG
• Protect their reputations
• Ensure regulatory compliance
• Explore the commercial benefits of sustainability

If this is an area of focus for your organization —or you think it should be —what are the crucial areas for consideration? What do you need to know about sustainable finance?

What Is ESG and Sustainable Finance?

Sustainable finance is the term used to describe financing and investment decisions that consider environmental, social and governance (ESG) issues.

You may hear it referred to as sustainability finance, responsible investment, socially responsible investing, social investment, socially conscious, 'green,' ethical or impact investing.

Sustainable finance has already gained traction, moving from the niche to the mainstream. The signatories to the United Nations' Principles for Responsible Investment have assets under management of over US$100 trillion as of 2020.

What's the Difference Between Sustainability and ESG?

Sustainability can be quite a broad term, referring to anything organizations are doing to improve their corporate social responsibility performance. ESG is slightly more granular and specific, focused on three areas: environmental, social and governance.

Often, 'sustainable' and 'environmental' are conflated, and indeed, many organizations' sustainability policies center on environmental risks and impacts. Many sustainable investment strategies major in environmental factors when it comes to finance, though the environment is not the sole consideration in sustainable finance.

Sustainable finance can therefore be an umbrella concept, while ESG is more specific. And financial sustainability is something separate, relating more to a business's ability to sustain itself than any efforts to be more socially and environmentally responsible.

Why Is Sustainable Finance Important?

There are numerous reasons why, when it comes to driving greater sustainability, finance is important.

• For the planet —there is a growing recognition of businesses' impact on the environment and their responsibility to tackle this. Investing in projects and companies that positively impact the environment is one way to drive forward the environmental agenda.
• For the greater good —as we've noted above, sustainable finance goes beyond ESG considerations and covers financing that addresses business integrity as a whole, benefiting communities, customers, an organization's entire supply chain and its larger ecosystem. Again, investment in organizations that support and advance ethical business practices plays a significant role here.
• Sustainable finance makes commercial sense. The imperative for more ESG-focused finance may be altruistic, but the business benefits can be tangible.

With 64% of US consumers making buying decisions based on companies' ethical standpoint, it's no surprise that environmental considerations are moving into mainstream finance and lending; sustainable banking is no longer a fringe concern.

Whether it's climate, conservation, and environment-led financing, or investment that focuses on social and ethical concerns, there are sound business reasons for embracing sustainability in finance.

You may be a bank providing capital, an adviser recommending investments, or a corporate looking to embrace sustainable finance in your financing and investing or adopt more ethical business practices to become a more attractive investment.

Economic considerations are so central to our world that making financing sustainable is a core component of building a more sustainable ecosystem. Finance is a lever that can truly drive change —and a growing recognition of this is fueling growth for organizations that take a proactive approach to ESG-led and sustainable finance.

What Is the Sustainable Finance Disclosure Regulation?

The European Union's Sustainable Finance Disclosure Regulation (SFDR) came into effect on 10 March 2021. It forms one stream of the EU's work on a European Green Deal. It focuses on ensuring that financial providers —businesses like fund managers, insurers and banks —disclose their commitment to sustainability.

Its rules for financial market participants aim to deliver consistency and transparency in sustainability reporting, compelling businesses to report on how they have integrated sustainability risk ''mitigation'' into their processes and considered any adverse impacts on the sustainability of their activities. It hopes to make such information public, consistent and comparable, and importantly, to prevent 'greenwashing,' the practice of exaggerating environmental credentials in order to improve business reputation or gain competitive advantage.

SFDR is part of a much wider push ''by the EU'' to drive capital towards more sustainable investments. The Union's 2030 Agenda for Sustainable Development aims to push c €1trillion into green investments during the next decade, create more consistency within the climate-related information financial-market participants provide and help those businesses genuinely addressing sustainability to gain a competitive edge.

Who Does SFDR Apply to?

The regulation applies to financial services institutions, including banks, insurance companies, pension funds and investment firms.

And while SFDR is an EU initiative, there are instances where US financial market participants will need to comply:

• Any asset manager that raises money in the EU will need to comply, even if they are based in the US
• Any investment manager or adviser based outside the EU who currently, or plan to, market their products to clients in the EU
• Any business in the US that also offers funds in the EU

As OpenInvest notes, 'Even if you aren't directly affected by these regulations, SFDR is changing the future of ESG investing.' The conversations started by such regional regulation influence the direction of travel, making SFDR and the wider movement it represents relevant to financial and investment firms wherever they are based.

Full details of SFDR and its requirements are available on the European Commission website.

How Can We Advance Sustainable Finance Within Our Organization?

If this has motivated you to take a more proactive stance on sustainable finance, where should you start? Having the intent to create a more sustainable approach to finance is the springboard; if your business has committed to being more sustainable, this will give you the impetus you need to get started.

Once you've made this commitment, there are numerous sources you can tap into for support and inspiration. Organizations like the ''WWF have teams dedicated to bringing together organizations, investors, regulators, lawmakers and financial services companies.

Be focused, with clear objectives and tangible KPIs. Deloitte note that 'ESG is becoming the common language of sustainable finance;' this is helpful for organizations looking to put their sustainable finance objectives into action. ESG, as we saw above, is the more focused relative of sustainability, providing a structure and framework for your efforts.

Focusing your sustainable finance initiatives around ESG imperatives will provide clear parameters, enabling a more targeted approach. Putting in place robust governance and processes to drive your programs is vital, and this is where Diligent can help. Our suite of governance solutions for financial services organizations helps businesses to tackle ESG objectives in a structured way, with confidence that goals and metrics are based on reliable data.

Find out why Diligent's financial services governance solutions are trusted by 82% of financial institutions in the Fortune 100, how our ESG Solutions can help bring focus and rigor to your ESG initiatives and how to take the first steps towards more sustainable finance in your organization.