Sustainable Finance is responsible for the new paradigm in the financial market, which redirects financial flows towards sustainable investments.
According to the European Commission sustainable finance "is understood as finance to support economic growth while reducing pressures on the environment and considering social and governance aspects.
Sustainable finance also encompasses transparency on risks related to ESG factors that may impact the financial system, and the mitigation of such risks through the appropriate governance of financial and corporate actors".
The evolution of sustainable investment (SRI) is explained by 4 drivers. All of them reflect the most important issues for the society at a given moment.
The history of SRI started with social goals. This driver reflected the movement against the Vietnam war, the launch of the 1st SRI mutual Fund in 1971 and the most important SRI approach until now: exclusion criteria (the practice of choosing or excluding investments from a portfolio based on ethical criteria, which means the exclusion of companies supporting Vietnam War).
Then it evolved to ethical-drivers. This driver reflected the movement against the apartheid in South Africa, and another SRI approach: active ownership (Shareholder advocacy uses the voting rights associated with stock ownership to promote a change within the company. Anti-apartheid organizations used this strategy to get companies to pull out of South Africa in the early 1980s). As a result of this practice, in 1993 De Klerk administration took steps to end apartheid, when $625 billion were screened to exclude investment in South Africa.
After it evolved to governance screens. This driver was related to the impacts of the financial crisis in 2008 and provided a reminder of the interdependence between societies, economies and financial markets. It was connected with corporate accounting scandals in the US and Europe.
Finally, the SRI concept evolved for climate change screens. This last driver “Fossil fuel divestment” corresponds to a recent movement which appeared to pressure the players of the financial market to divest in entities with significant fossil-fuel-related activities.
According to PRI (Principles for Responsible Investment) - a UN initiative launched in April 2006 that puts investors working together in order to comply with the six principles of responsible investment:
Responsible investment is an approach to investments that aims to incorporate Environmental, Social and Governance (ESG) factors into investment decisions, to better manage risk and generate sustainable, long-term returns.
The idea is to have investors with enough information that allows them:
- to implement a sustainable investing program, excluding companies involved in controversial issues;
- to support the most sustainable companies, focusing on environmental, social and governance (ESG) exposures, and/or to use ownership to engage with those companies;
- to report its activities by becoming signatories of the Principles for Responsible Investment (PRI).
According to the latest data from the Global Sustainable Investment Alliance, sustainable responsible investment (SRI) totals 35.4 trillion US Dollars (AuM - Assets under Management) corresponding to 36% of the total market. Europe and the US continue to hold the largest shares of total SRI assets(2020 data). It is estimated that this figure represented 40 trillion US dollars in 2020, and that this figure will increase by 10 trillion every two years (Source 2020 - ESG Data Integration by Asset Managers: Targeting Alpha, Fiduciary Duty & Portfolio Risk Analysis). See all the details here.
The 6 principles of responsible investment:
- 1: We will incorporate ESG issues into investment analysis and decision-making processes.
- 2: We will be active owners and incorporate ESG issues into our ownership policies and practices.
- 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
- 4: We will promote acceptance and implementation of the Principles within the investment industry.
- 5: We will work together to enhance our effectiveness in implementing the Principles.
- 6: We will each report on our activities and progress towards implementing the Principles.
The 7 investment strategies of the Sustainable Investment evolution (SRI)
In Europe, according to EUROSIF (the main European organization responsible for promoting sustainable and responsible investment), SRI investment is based on 7 investment strategies (Best-in-class; Sustainability themes; Norm-based screening; Integration of ESG factors; Exclusions; Impact investing; Engagement and voting).
- Negative Screening: The exclusion of a company from a given SRI fund or index is based on one or more specific ESG criteria;
- Norm-based screening: Inclusion depends on an analysis of the companies and other issuing organizations, according to their compliance with international norms and conventions;
- Best-in-class screening: The inclusion of a company is based on its performance compared to the best examples within a given universe;
- ESG integration: The systematic and explicit inclusion of ESG factors in a financial analysis process by asset managers.;
- Corporate engagement: The position of investors on ESG issues, requiring companies in which they invest to improve their practices;
- Sustainability-themed investing: Inclusion is related to themes or assets involving sustainability;
- Impact investing: specific investments, usually carried out in private markets, for the resolution of social ot environmental problems.
The growth of SRI investment is closely associated with the creation of sustainable products, most notably the evolution of sustainability indexes. These indexes assess the ESG performance of company practices based on the various methods created by information suppliers ('sustainability raters'). For further details press here.
The responsible investment also promotes the development of the green bonds. The main goal is to have capital flows that support the development of a more environmentally friendly, low-carbon and climate-resilient economy. For further details press here.