Maintaining Sustainability In Finance

Fatihah Ramzi, DigitalCFO Asia | 7 September 2022

In order for present and future generations to have the resources they require such as food, water, healthcare, and energy, sustainable development must be practiced.

The 2030 Agenda for Sustainable Development, which calls for behavioral change, was created by the United Nations to direct the transition to a sustainable and inclusive economy.

What are the benefits of financing supporting sustainable development? The primary responsibility of the financial system is to direct resources to their most advantageous uses, but a move toward sustainability necessitates a revision of our definitions of what is “productive.” Finance can help direct money into eco-friendly businesses and initiatives, hastening the shift to a low-carbon, circular economy. So sustainable finance investigates how money (investment and lending) integrates with economic, social and environmental challenges.

Finance can support tactical choices regarding the trade-offs between sustainable goals. Long-term investors can guide businesses toward sustainable business practices since investors have power over the organizations they invest in. Last but not least, finance excels at valuing risk and may therefore assist in coping with the inevitable uncertainty surrounding environmental challenges, such as the effect of carbon emissions on climate change. There is room for a new alliance because sustainability and finance are fundamentally future-focused.

Creating A New Business Framework

Over the past few decades, sustainable finance has gone through several stages. Long-term value creation is rapidly becoming more important than short-term profit. Financial institutions should refrain from investing in businesses that have extremely harmful impacts, like tobacco, cluster bombs, or whale hunting, as a first step toward sustainable finance. In fact, several businesses are beginning to include social and environmental factors into their model.

However, for firms to advance, a stakeholder approach to finance must be adopted, with advantages accruing to the larger community as opposed to simply shareholders. Should authorities permit the acquisition of a stakeholder-oriented company by a shareholder-oriented company? Or do we need to safeguard businesses that have made strides toward sustainability? 

The shift from risk to opportunity is another significant trend. While financial institutions have begun to steer clear of (extremely) unsustainable businesses due to risk, the leaders are now investing more in sustainable businesses and initiatives to generate long-term benefit for the larger community.

Adopting Long-term Investment Strategies

Short-termism is a significant barrier to the adoption of sustainable financing. The price of taking action is paid now, but the rewards will come later. Economic activity generally has a long-term effect on society, and in particular on the environment. How then can financial institutions make long-term investments and encourage businesses to adopt sustainable practices?

Introduce “loyalty shares” as an extra incentive for shareholders who have held onto their shares for a predetermined amount of time. This encourages institutional investors to adopt a buy-and-hold approach. It is also an incentive for the efforts made by investors to interact with the businesses in which they invest. 

This focus on environmental, social, and governance (ESG) issues is a strong motivator for businesses to adopt sustainable operating procedures. The corporate sector experiences social and environmental externalities, but the financial sector may put pressure on businesses to successfully handle these externalities.

On the investing front, the organization will benefit from the development of sustainable retail investment funds. Although liquidity is helpful for regular investors, it deters investors from making long-term commitments. T this stringent usability criterion should be replaced with the idea of liquidity, which guarantees that fund managers have a proportionate amount of control over capital inflow and outflow. This can also include a withdrawal cap for fund shares.

Most industries must put all of their efforts into building a more sustainable future. Financial institutions have a significant impact on funding and raising public awareness of sustainability-related issues, whether through enabling the development of alternative energy sources or by assisting companies that employ ethical and sustainable labor practices. Companies will find themselves sustaining their progress towards becoming a more financially sustainable business by starting with these two modifications to their internal model.