The November G20 meeting will have sustainable finance high on the agenda. The starting point for the discussion will be a new G20 report, that identifies the greatest barriers impeding private capital for sustainable investments.
When 20 finance ministers from the 20 biggest nations huddle up, the business community should take seat on the bleachers. The 2018 G20 summit will take place in Argentina in November this year, and one of the main issues the 20 finance ministers will discuss is how we can accelerate private sustainable investments.
It has long been recognized that sustainable investments coming from private actors are an absolute prerequisite for meeting the UN Global Goals and the Paris Agreement. Despite a line of new political initiatives and the introduction of new financial products in recent years, deployment of private capital for sustainable investments remains limited. The EU Commission estimates a yearly investment gap of at least US$ 209 billion to achieve its climate and energy targets by 2030.
An attentive reader might have noticed that for once, concerns about economic profit is not what is giving potential investors cold feet.
A newly published Synthesis Report from the G20 Sustainable Finance Study Group – the starting point for the 20 finance ministers’ discussion – identifies the five greatest barriers impeding private investment in sustainability.
In short, the main barriers are lack of internalization of environmental and social factors and the fact that sustainable investments have longer return horizons than business-as-usual investments which distort assessments of risk and return. Further, inadequate taxonomy and insufficient sustainability-related analytical capabilities are limiting private finance as investors are unable to identify and understand the business case for sustainable investment.
An attentive reader might have noticed that for once, concerns about economic profit is not what is giving potential investors cold feet. It is in fact the combination of these five barriers that has an inhibitory effect on the expansion of private capital in sustainable finance. The G20 report concludes: “Some or all of these factors can result in missed financing opportunities for sustainable projects, suboptimal asset allocations, or in unintended negative impacts on sustainable development outcomes.”
Why isn’t math adding up?
To meet the SDGs, the World Economic Forum estimates that an annual US$ 8 trillion in sustainable investments is needed between now and 2030. Judging by the performance of the global economy, the money should certainly be available. Measured by gross world product, global economy was approximately US$ 75 trillion in 2016 – nearly ten times times the amount needed. Add to the equation that investments in the SDGs is expected to generate an estimated US$ 12 trillion in market opportunities. The finances to close the gap are there. So why is math not adding up?
The five greatest barriers
If economic restraints are not holding back deployment of sustainable private capital, then what is? The G20 report outlines five barriers that are currently standing in the way:
- Lack of internalization of environmental and social factors causes a distorted risk/return assessment. When investors treat positive and negative sustainability-related outcomes as externalities, they are not factored into the risk/return profile which results in underinvestment in sustainable projects.
- Misaligned return horizons reduce the availability of financing to the more long-term sustainable projects. A characteristic of sustainability-oriented investments is they deliver financial (and non-financial benefits) over longer periods of time than business-as-usual industry benchmarks. They also have higher upfront costs represented by capital and operational expenditure.
- Lack of information and information asymmetry makes investors spend more time searching for sustainable projects and thus reduce financial flows to them. The challenge is that some sustainable development outcomes are not fully transparent or are hard to assess due to the lack of definitions, information disclosure and the specific analytical capacity in the financial industry.
- Lack of general clarity for identifying sustainable investments arising from a shortage of consistent and reliable labeling of sustainable assets.
- Insufficient sustainability-related analytical capabilities impede private investments because financial institutions are still in the early stages of developing methodologies and tools to identify and assess financial risks associated with sustainable investments.
What is the way forward?
These five barriers do not mean that sustainable finance is doomed. The G20 report proposes three voluntary options that can be deployed on a country-by-country basis that could unleash private capital.
- Option 1: Create sustainable assets for capital markets by making available the long-term capital from institutional investors to refinance the growing pool of sustainable loans on banks’ balance investment portfolio.
- Option 2: Develop sustainable private equity and venture capital. It is beneficial to overcome the lack of funding for the development of sustainable technologies and business models by early-stage companies and small and medium-sized enterprises.
- Option 3: Explore potential applications of digital technologies to sustainable finance. There is enormous potential in tapping into the opportunities arising from current applications of digital technologies to facilitate the deployment of sustainable finance.
While the countries’ individual circumstances, priorities and needs must and will be taken into account, one common denominator presupposes the implementation of the three voluntary proposals; they aim to push for a shift in mindset. closing the financial gap and overcoming the five barriers requires the private sector to change its perception of these new types of investments, shift their return horizons to the long term, and look more closely at how new technologies and digital solutions can facilitate the growth of sustainable investment.
If legislative incentives are on the rise, the private sector should start changing their mindsets and get their hands out of their pockets – preferably their checkbooks too.
Even though the proposals in the G20 report are presented as voluntary, the private sector needs to realize that because this issue is on the agenda at the coming G20 summit, it will have an impact. And if legislative incentives are on the rise, the private sector should start changing their mindsets and get their hands out of their pockets – preferably their checkbooks too.