Regulation for a Sustainable Economy – putting finance at the service of our planet

There is a quiet revolution in the investment world and it is getting louder.  Whilst there have been funds labelled as “green” or “ethical” around for years, increasing demand from investors for public accountability and transparency around environmental and social issues has led to a boom in responsible investing.  And, in the last couple of months, the willingness of regulators to put sustainability at the heart of their economic plans has become apparent.  Could this be a glimpse of a new economy?

A Global Issue

Last month, a final report was published of the findings from the UN Environment Inquiry into the Design of a Sustainable Financial System “Making Waves: Aligning the Financial System with Sustainable Development” .  The inquiry’s aim was to advance options to improve the financial system’s effectiveness in moving capital towards a green and inclusive economy.  The report noted that “huge progress on reforming the global financial system over the last four years has started to deliver desperately needed financing for sustainability and [has] set up the next wave of action”. However, despite the positive shift of private capital into investments that help protect the people and the planet, the report warns that current financial flows are still nowhere near enough to deliver the trillions of dollars needed each year to finance the Sustainable Development Goals and the Paris Agreement.

These sums cannot be met by public money alone and the report states that national action in economic policy is critical in reaching these goals.

Step up the regulators

The report recognises China’s new Guidelines for Establishing a Green Financial System as being the world’s most comprehensive set of national commitments, covering priorities across banking, capital markets and insurance. It also notes a growing number of countries have ambitious plans  in development (Indonesia, Mongolia, Morocco and Switzerland).

More relevant to the Impact Investment team here at Nesta (at least until Brexit mixes things up again), is the news coming out of Europe.

In March 2018, the European Commission adopted an action plan on sustainable finance with three main objectives:

  1. direct more capital towards sustainable investment, in order to achieve sustainable and inclusive growth;
  2. manage financial risks stemming from climate change, environmental degradation and social issues; and
  3. foster transparency and long-termism in financial and economic activity.

Last month, it was announced that draft EU law is expected to be tabled in May, with the aim of  setting out classes of sustainable economic activities, defining what is green and what is not. EC Vice-President Vladis Dombrovskis’s most recent speeches have also featured Europe’s green ambitions as well as proposed laws that will task asset managers, insurance companies and pension funds to incorporate environmental, social and governance factors into their investment decisions.

He states:

“We need to put finance at the service of our planet. This is why the European Union has presented a strategy for green and sustainable finance”.

The hope is that these changes in legislation will help increase the awareness of sustainability risks, and steer more funding towards green and sustainable projects.

However, as we are well aware from our experience in impact investing, readiness to label something as “ethical”, “green” or “impact” varies as much as the evidence used to make those claims. When there are no recognised standards or measurements, how can stakeholders really be sure where their capital is being deployed? We hope that the European legislation will provide a clear basis for these types of brand.

This year has also seen the expedited revision of the European regulations on Social Enterprise and Venture Capital funds (EuSEF and EuVECA).  The aim of these regulations was to provide a common EU framework for marketing of funds which aim to:

  1. enhance the growth and innovation of small and medium-sized enterprises in the EU; or
  2. support companies with the explicit aim of having a positive social impact, rather than only maximizing profit.

These labels were intended to be important tools in meeting the EU’s agenda for growth and jobs in the current decade.  However, take up under the original regulations was low, so the European Commission brought forward a review process and have amended the regulations to make them accessible to more managers, increase the size of enterprises in which the funds can invest, and prohibit any fees on cross-border registration.  It is hoped that these brands will now take off and provide investors with some certainty about the impact that these investments seek to achieve.

These proposals and prioritisation indicate national and supranational support for a sustainable and inclusive future economy, which is exciting for the impact investing community.

Top-down or Bottom-up

Whilst the news from the legislators is welcome, cultural change cannot come quickly enough from the bottom up.  Investors and enterprises themselves could be taking their own steps to shift capital into a more sustainable and inclusive economy.

The press is full of reports of new impact investment strategies being born out of investor demand for environmental, social and governance (ESG) factors being incorporated into managers’ investment strategies.  However, this should not just be a tick-box exercise of identifying a few features that warrant the relevant label.  Perhaps all investments need to be measured and scored against the same set of non-financial, ESG criteria, whether seeking to be an ethical investment or not.

What ESG criteria should we use?  Well, the UN’s sustainable development goals could be useful.  Or perhaps we could look to B-Corp as a starting point for an ESG score sheet.

Whatever we choose, it is clear that for a real and effective change in the economy, “green”, “ethical”, “sustainable” and “impact” labels need to be more than just words.