Can the finance sector step up as an agent of change in sustainability?

THE finance sector has long been a laggard in addressing sustainability. Recently, that seems to have changed. Environmental, social and governance (ESG) investment is booming. Net-zero alliances have been established for asset owners, managers, banks, insurers and advisers. But this is no panacea. If the huge power of financial organisations is to be harnessed to drive a different future, there is so much more to address than the uptake of ESG.

The key opportunity for finance sector players is in realising the potential of investing not just in a business, but for the wider health of a system.

This may sound ambitious, but a window of opportunity has opened. The concept of "finance is neutral" has been debunked. The climate crisis has provoked recognition that finance has a role in driving carbon emissions - and reductions - and a responsibility to act. In "systems speak", agency is now recognised. The principle that finance is a shaper of change can now be applied to more than just greenhouse-gas emissions.

Beyond ESG

Most conversations on sustainability within finance focus on uptake of ESG, a term used as shorthand for the wide range of environmental, social and governance "non-financial factors" that could affect financial returns and should be integrated into financial decision-making. ESG assets are forecast to hit one-third of global assets under management by 2025, or US$53 trillion. Europe is leading the way, with the US catching up. Japan and other Asian nations are anticipated to follow.

Part of ESG's rapid growth is down to its success at selling itself as a way to mitigate (financial) risk and/or boost (financial) returns. And therein lies the limitation of ESG in driving system change: it serves, rather than shifts, the existing goals of the system.

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ESG in public markets is often about rearranging portfolios. It affects stock holdings, without changing the fundamentals of the economy. Another major problem in this ESG era is the neglected "S". World Benchmarking Alliance data reveals just 1 per cent of large businesses screened meet even basic social standards. There is a lack of acknowledged responsibility for human rights abuses through the value chain back to financiers.

So ESG is mainstreaming, but it is not changing the system. What could? At the "niche", we identify 3 dynamic trends:

1) Impact investing intentionally seeks out - and measures - net positive impact, such as contribution to the UN Sustainable Development Goals

This is a fractional subset of ESG or responsible investing, defined by its active focus on the "delta", or the added environmental and social value delivered by financing selected businesses. Various impact investing "tribes" range from the green finance movement and hyper-local social investors, to multimillion development finance initiatives engaging in blended finance.

2) Judging "good investment" not on whether it is better than before, but on whether it keeps the economy within necessary thresholds

The Science Based Targets initiative and 2DII are the most well-known technical approaches to applying thresholds to financial institutions so far, but others are emerging in what is a contested discipline that reflects a critical principle of how to judge - and compare - performance, with r3.0 and Kate Raworth's Doughnut Economics leading the charge.

3) Influencing the rules of the game

While corporate lobbying to protect vested interests continues, we are also seeing finance actors actively calling for better sustainability-driven regulation. COP26 saw a number of financial players urging governments to both change the incentives for private sector behaviour and regulate it more tightly. Elsewhere, investors have vocalised their frustration at the potential watering down of the EU green taxonomy, and delays to the social taxonomy.

These 3 trends feed into a fourth shift for financiers as agents of change, and perhaps most significant: Acting to influence change at a system level by intentionally investing for the health of the economy, environment and society.

System-level investing is a term coined by The Investment Integration Project, to define "the intentional consideration by investors of the bigger-picture environmental, social or financial system context of their security selection and portfolio construction decisions". It is the difference between assessing the sustainability risks and impacts of individual assets or enterprises, and seeking to assess the risks and impacts of the market on such issues.

And, critically, it is about using this assessment to influence change, recognising it as central to, rather than in conflict with, enhancing long-term investment returns. System-level investing can use any or all of the 3 trends above. Indeed, all 3 are likely needed to drive positive impact. Examples of what this looks like include:

• Investors pressuring firms to mitigate behaviour that, although profitable for the individual company, damages the market overall.

Consider Shareholder Commons' Fox News resolution, in which shareholders were asked to vote in support of insisting Fox stop spreading disinformation about climate and vaccinations. The argument is that the majority of Fox's shareholders hold shares across the wider market and, therefore, benefit from a well-functioning market. If a company spreading disinformation undermines that market functioning, the result is a bad outcome for such shareholders, even if lucrative for the individual company.

• Engaging with standard setters to inform international standards, in order to adopt these into their own investment processes.

Consider the Coalition for the International Platform for Climate Finance, led by Aviva Investors, which is calling for a new financial architecture to leverage public and private finance into the carbon transition.

• Revisiting the responsibility investors have in multiple jurisdictions to maintain "market integrity".

There is potential to widen responsibility from its current focus on matters such as bribery and corruption, and to incorporate wider sustainability matters that threaten market integrity.

System-level investing could also be seen in investor actions to transition other systems (such as food or energy). In the US, diverse investors are actively shaping the transition to regenerative agriculture. Akiptan, for example, is a Community Development Finance Institution of the Sioux community, with a mission to "transform Native agriculture and food economies" by delivering creative capital, leading paradigm changes, and enhancing producer prosperity.

In South-east Asia, finance players are joining with Forum for the Future and other protein actors to explore the shift from "protein engineering" to a "protein visionary" approach that addresses equity and sustainability in the entire protein system, from diverse production to affordable nutrition.

Promising, but...

While these examples are promising, it is still rare that financial players taking a systematic agent-of-change approach.

Our conclusion? If these trends are to truly shape a different future, there needs to be a more fundamental remodelling of the financial architecture. None of the trends listed above are (yet) truly challenging the fact that only a fraction of the world's population is served by global capital flows - the same capital flows within which all of the above trends operate.

To quote Gillian Marcelle, a blended finance advisor experienced in economic development and capital mobilisation, there must now be a "widening of the solutions space" across all of the trends cited above.

It cannot be about extending an unsustainable financial infrastructure, moulded by a handful of countries, to the rest of the world.

Other voices and ideas must be incorporated. And more substantially, we need different models and mechanisms capable of acting as alternatives to - rather than niches within - the mainstream.

Caroline Ashley is global programmes director and Emilie Goodall, affiliate, Forum for the Future. This article first appeared in Forum for the Future's The Future of Sustainability: Looking Back to Go Forward opinion and commentary series. Forum is an international non-profit, which for 25 years has been working in partnership with business, governments and civil society to accelerate the transformation towards a just and regenerative future.