Finance the ‘Decade of Action’

Sustainable finance flows

There is a strong need for an alignment of financial sources – public, private, national and multilateral – to get the EU to where it needs to be. In recent years, the financial sector and policymakers have therefore stepped up their efforts to help improve the finance flows towards the transition to a sustainable economy. Notably, during COP26, over 160 financial institutions with more than USD 70 trillion in assets joined forces through the ‘Glasgow Financial Alliance for Net Zero’ (GFANZ) to steer the global economy towards net zero emissions and deliver on the Paris Agreement goals by committing to set science-aligned interim and long-term goals to reach net zero no later than 2050. [2] This is an encouraging effort, showing these financial institutions’ commitment to take their much-needed role in facilitating the sustainability transition.

At the level of policymaking, in July this year the European Commission adopted an ambitious package of measures to help improve sustainable finance flows. [3] The measures aim to enable a reorientation of investments towards more sustainable technologies and businesses and should thereby help the EU reach its climate and environmental targets. Among these measures, the EU Taxonomy is an important one, as it provides for a science-based common definition of what economic activities can be considered sustainable. Next to that, disclosures of sustainability data will provide information to make informed sustainable investment decisions. Lastly, the development of investment tools including sustainability benchmarks, standards and labels should make it easier for financial institutions to align their investment strategies with the EU’s climate and environmental goals.

ESG risks

Whereas most of these measures are centred on the investment opportunities arising from the transition, the financial sector should also pay attention to the risks associated with such transition or lack thereof. Financial institutions can be affected by both physical and transition-related sustainability risks (often referred to as ESG – environmental, social and governance – risks) either directly or through their business activities. Physical risks – such as climate- and weather-related events, destruction of the environment and loss of ecosystem services – will become more prevalent and extreme in nature if the transition is slow to progress. The transition in itself, however, can also give rise to risks as policy implementation, technological developments and changing consumer preferences can lead to certain economic activities becoming uncompetitive or being phased out. ESG risks thereby have the potential to materialize into financial risks at many levels and over multiple, including long-term, time horizons. An adequate and effective management of such risks therefore increasingly becomes a prerequisite for financial institutions to remain resilient to the defining global challenges of our time.

Financial institutions should thus consider how to align their financing with the Paris Agreement and Sustainable Development Goals, while avoiding a build-up of ESG risks. When doing so, it will be able to unlock its potential to effectively finance the Decade of Action.