Sustainable finance needs a strategy

Quo vadis Earth? The pursuit of relentless growth in a planet with limited resources, our heavy dependence on fossil fuels, the continuous growth and development of technology on a scale never seen before, climate change and mass migrations. These are only few of the growing global concerns unsettling decision-makers worldwide.

Trust in business is on its way to reach an all-time low. To the loss of faith in political institutions, and in being able to achieve better welfare and advance socially and economically, people are throwing businesses in the same bag. Losing societal trust means losing clients, so the bottom line inevitably suffers. 

For businesses, on the other hand, maintaining quality standards but, at the same time, adapting their models and operations to societal needs are crucial elements they can no longer ignore. Or, put it differently, both sides need to set up common goals. 

In some cases, this calls for fully rethinking how business is done which, in turn, requires flexibility to adapt mission and vision to current people demands and the less-and-less silent claims of the planet. We seem to be on the right track, however. ESG criteria and their growing importance reflect that investors are increasingly aware of the environmental and social consequences of both corporates and government actions. 

Criteria, nevertheless, are benchmarks, not actions. Nobody said that the path towards sustainability in business was going to be easy. According to this article from 2019 that looks at Europe’s 50 largest companies, 78% of them did not report climate and environmental risks adequately, and 42% omitted potential environmental or climate-related information for their sector. Despite these revealing numbers, businesses can play a key role in changing the tide on global concerns. To embed sustainability in their core, they need to move from vision to strategy and from strategy to execution. 

In this article, we deep dive into how financial services, especially investment firms, can make a difference in society by embracing “sustainable finance by design”, namely, the design and implementation of a solid sustainable finance strategy that matches business priorities. It also elaborates on the steps to take to make that happen.

Sustainable finance and COVID-19

Before the “coronavirus” hit and spread throughout the world, the growing interest in sustainable finance was already undeniable. The global pandemic hasn’t changed that. If anything, it has given a boost to the ESG criteria implementation in business, increasing the demand for ESG-based investments and their influence in investment portfolios. Tackling environmental issues has climbed higher on the to-do list of governments and companies alike. 

The pandemic, considered a one-of-a-kind global health crisis, is testing economies, health systems, governments’ preparedness and social resilience, bringing their flaws out in the open. It has also shown that the lack of coordination has detrimental consequences. Each country has been struggling to keep the infection numbers down, and to flatten the curve and ensure that hospitalisation rates don’t spike out of control. However, a coordinated approach at regional level would have brought a better crisis management outcome.  

At the same time, the virus strengthens the strategic importance of sustainable and impact investment, especially in emerging markets. A silver lining in the midst of a 2020 clouded by COVID-19. 

In fact, if there are ill winds that blow any good, the coronavirus crisis is one of them for sustainability matters. Indeed, this crisis’ unexpected aftermath is the strengthening of the importance of sustainable finance and impact investment in global markets. 

The COVID-19 crisis has increased investor attention to corporate ESG management, particularly when it comes to business operational and strategic resilience, employee health and safety and workforce policies. Responsible corporate governance is in the spotlight.

Taxonomy is (still) in charging mode but actions shouldn’t wait

To help financial services steer private capital to long-term activities and projects that benefit the environment, the European Commission (EC) published its taxonomy for sustainable finance in December 2019. It’s an essential piece of the greater puzzle called the Action Plan on Financing Sustainable Growth, also issued by the EC in March 2018. 

Simply put, and according to this BBVA article, taxonomy is a classification instrument to help determine which activities are classified as sustainable. It’s important to note that virtually every industry has a role to play in the transition to a low-carbon economy. The taxonomy is meant to serve as a guideline for businesses interested in starting their green journey and contributing to a healthy planet Earth. As Arturo Fraile, Regulation Manager at the BBVA Research explained, “we’ll use it [taxonomy] to understand if investments, financial products, and financing activities align to the criteria it defines and to what degree”. 

See, one of the most challenging issues of sustainable finance has been the lack of standardised definitions that allow for the design of financial products that follow its criteria and limit any risk of disaligment. From the fundamental question “what is sustainability? to “what is a sustainable activity?” finding a definition that fits all countries and businesses has been a challenge for the European institutions. It sometimes feels like a slow-moving process despite the urgency of having clear guidelines for businesses to meet their investors’ demands.

Until now, market demands have outpaced the speed to define clear taxonomy. The current economic crisis caused by the COVID-19 pandemic is pushing many investors to reevaluate both short and long-term portfolio strategies, and investment firms to reevaluate their sustainability priorities. 

On 18 June 2020, the European Parliament adopted the Taxonomy Regulation. In a press release published the same day, the EC stated that:

It will help create the world’s first-ever “green list” – a classification system for sustainable economic activities – that will create a common language that investors can use everywhere when investing in projects and economic activities that have a substantial positive impact on the climate and the environment.

Even though this is a major step, there is still a way to go. According to the TEG report published in March this year, the taxonomy will be fully finalised in 2021/2022. Indeed, there are technical screening criteriathe so-called delegated actsyet to come, which will develop the taxonomy further. 

However, another piece of law, the Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector sets the deadline for financial firms to disclose sustainable investment products on 10 March, 2021. Among others, they have to report on how their operations consider sustainability risks and mitigate sustainability impacts and how they communicate sustainability-related information about their investment products. 

So, how can businesses design and implement a solid sustainability strategy while waiting for the taxonomy to be fully ready to go?

Sustainable finance needs a strategy

“Sustainable finance by design” is, quite frankly, an attractive—even flashy—name to tell investment firms that for the development of a product portfolio that embeds ESG criteria and the sustainable finance approach, sustainability in itself has to be part of the business core.

We have developed a simple yet useful framework to adopt sustainable finance by design which includes seven steps. 

Step 1. Materiality analysis before anything else

Materiality means analysing the most pressing issues that the business needs to address. After identifying potential sustainability challenges relevant to the business’ value chain, investment firms need to assess how each challenge could impact business growth, financial performance and brand/client trust, and how important each issue is for internal and external stakeholders. 

It’s imperative that businesses understand what the ESG-related priorities for employees and external stakeholders are. Their concerns and expectations will be the base for the top management to get primary information on the issues to prioritise according to their importance to the company’s mission and stakeholders’ expectations. 

Step 2. Regulatory analysis, crucial step number two

Analyse all the regulatory requirements described in the EU Action Plan. These “measures” will impact how investment firms make investment decisions and distribute financial products, and how they incorporate ESG into their business operations and strategy. It’s crucial to consider and measure both the effect of the business’ products and services on sustainability matters as well as the impact of those matters on their products and services.

Step 3. Determine the strategic positioning of the business

It’s important to keep a clear idea of the business’s vision on sustainability and how to incorporate it, namely at what pace and involvement level.  “We have to walk before we run,” so goes the saying. While the long-term objective is to adopt a fully “green” business strategy and approach, jumping too soon into this mindset might have more consequences than positive results, especially because there are still taxonomy-related gaps. The business will need to balance things out, to define a strategy based on both economic performance and ESG integration. If the business already operates on a full sustainable base (“total integration”), then it’s a grand contributor to an environmentally-friendly future. If it’s not quite there yet, the best solution is to find a centre stage or what we like to call the “opportunity-oriented integration”.

By taking the opportunity-oriented integration approach, businesses enter the “let’s act but cautiously” mode. With it, they align sustainability and business strategies and answer stakeholders’ demands linked to sustainability. However ESG criteria based financial products join the more traditional ones, instead of fully replacing them.  

Step 4. Define what sustainability is for the business as a whole

As we previously mentioned, it’s challenging to find a single way to define “sustainability”. Nevertheless, alignment is key to developing a sustainability strategy. To know more accurately what the business is committing to, start by asking the top management, employees and clients what being sustainable means to them. Whichever strategies and products the company develops on a later stage will need to be in line with the business vision and stakeholders’ definition of sustainability. Analyse the results and compile the definitions that better align with both corporate and sustainable mission and strategy.

Step 5. Set the business’s ESG objectives 

When well managed, ESG goals create business value. They are an opportunity to bring about new financial products, attract new investors and invest in new markets. Also, they allow for better resources management, costs reduction, stakeholder satisfaction and the improvement of business resilience in times of rapid global economy change, or in times of crises like the one we’re living now. The ESG goals embracement is a decisive step that businesses have to take consciously. They are, in principle, set with a long-term perspective.   

Step 6. Articulating both the business and the sustainability strategies

For sustainable financial products and ESG to truly influence the way investment is done, investment firms have to articulate both the sustainability and the business strategies. 

There isn’t a one-size-fits-all formula to make this much needed articulation happen. To some businesses,  unifying both strategies will bring the expected goals and results.  To others, the corporate strategy needs to be reinvented, which, in turn, requires first the review of the vision and mission statements by putting on a sustainability lens. Only then the conception of a sustainability strategy can occur. There is yet a third option, designing a sustainability strategy that will run in parallel to the business one. 

The latter is tempting. Running a parallel sustainability strategy without the burden of reviewing priorly defined strategic plans is simpler yet its implementation may fall unattainable in the medium and long terms. It is risky, also, in terms of comprehensiveness. Sustainability in business isn’t meant to follow a satellite approach. For it to work and be impactful, it needs to be a part of the business core and to be embedded in its vision and mission. 

From our perspective, the first approach is recommendable if the business’s mission and vision were conceived already with sustainability in mind. Otherwise, the second may be the best bet.

Step 7. Set ESG Key Performance Indicators (KPIs) to measure the success (and failures) of the ESG goals

ESG KPIs are used to assess commitment to long-term sustainable wealth creation, a key practice that is becoming more and more important for investors and stakeholders. This is how they learn which KPIs have an impact on the business’s valuations. 

The next and final step is the disclosure of the strategy the business used and the results through non-financial reporting. The Global Reporting Initiative (GRI) includes the first global standards for sustainability reporting, covering a range of ESG impacts. 


What we have seen in past decades is a significant evolution in the field of sustainability and the contribution of businesses into a greener future. But we’re not quite there yet. To succeed in a more sustainable world, businesses will urgently adapt to the needs of society and address the problems that have been unsettling decision-makers around the world.

What we think
Daniel Theobald, Banking Advisory Manager at PwC Luxembourg

The adjustments to the product portfolios triggered by the taxonomy regulation and the customer behaviour requires an adjustment of the strategic parameters and objectives. This opens up the discussion on developing a holistic, strategic sustainability approach that goes beyond Sustainable Finance.

 

Jörg Ackermann, Partner at PwC Luxembourg

We see a changing customer behaviour across borders. Customers expect and specifically ask for sustainable products. It is becoming apparent that customers will also question the sustainability approach of banks in the future. 

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