Traditional finance focusses on financial return, considering the financial sector separate from both society and the environment. In contrast, sustainable finance considers financial, social and environmental returns in combination. In a new essay, I provide a framework for sustainable finance highlighting the move from the narrow shareholder model to a broader stakeholder model. Here he presents the key arguments.
Sustainable development is a holistic concept with three aspects: economic, social and environmental. Humanity is facing numerous sustainability challenges. Looking at the environment, we see climate change, land-use change, biodiversity loss and depletion of natural resources all destabilising the earth. And on the social front, poverty, hunger and a lack of health care reveal that many people live below basic social standards.
Sustainable development means that current and future generations should have the resources they need, such as food, water, health care and energy, without overwhelming the earth’s natural processes. To guide the transformation towards a sustainable and inclusive economy, the United Nations has developed the 2030 Agenda for Sustainable Development, which will require behavioural change.
Why should finance contribute to sustainable development? The main task of the financial system is to allocate funding to its most productive use, but a shift to sustainability means changing our ideas about what is “productive”. Finance can play a role in allocating investment to sustainable companies and projects and thus accelerate the transition to a low-carbon, inclusive and circular economy. So sustainable finance considers how finance (investing and lending) interacts with economic, social and environmental issues.
In this allocation role, finance can assist in strategic decisions on the trade-offs between sustainable goals. Moreover, investors can exert influence over the companies they invest in, so long-term investors can steer companies towards sustainable business practices. Finally, finance is good at pricing risk for valuation purposes, and can thus help to deal with the inherent uncertainty about environmental issues, such as the impact of carbon emissions on climate change. At their core both finance and sustainability look to the future, so there is scope for a new alignment.
About the Author
Dirk Schoenmaker is a Senior Fellow at Bruegel and a Professor of Banking and Finance at the Rotterdam School of Management, Erasmus University. He is author of “Investing for the Common Good: A Sustainable Finance Framework”, Bruegel Essay and Lecture Series, Brussels.The essay can be downloaded at: http://bruegel.org/2017/07/investing-for-the-common-good-a-sustainable-finance-framework/