If you want to explain sustainable finance to your mom, you will come across the need to do that in the simplest terms. That’s why we thought of creating this article. Based on the results we share in this article; you will be able to explain sustainable finance to your mom quite effectively.
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What is the definition of sustainable finance?
Making investment choices that incorporate not just financial returns but also environmental, social, and governance aspects is part of sustainable finance. It’s a wide phrase with numerous meanings depending on context, and it’s sometimes used interchangeably with “green finance.”
Sustainable finance, according to the European Union, is “financing to promote economic development while lowering environmental constraints and taking into consideration social and company governance factors such as inequality, human rights, management structures, and executive compensation.” It lists numerous environmental factors, such as climate mitigation and adaptation, biodiversity protection, and the circular economy.
However, these environmental advantages are simply one facet of green finance. The Convention on Biological Diversity (CBD) defines financing of green governmental policies, such as renewable energy feed-in tariffs, as well as “financial system components that deal especially with green investments,” such as green bonds and funds.
According to the United Nations Framework Convention on Climate Change, climate finance is a subset of sustainable finance that “seeks to promote mitigation and adaptation initiatives that will address climate change” (UNFCCC). It might be “local, national, or international,” with funding coming from “public, private, and alternative sources.”
What is the significance of sustainable finance?
One of the most essential strategies to counteract climate change is to restore our planet’s landscapes. Forests and agriculture account for more than 30% of the answer to climate change, yet they get just 3% of climate funding.
At the international level, ambitious restoration objectives have already been established, with the Bonn Challenge seeking to restore 350 million hectares worldwide by 2030, and the United Nations Decade on Ecosystem Restoration having taken off and is redoubling efforts to gather money for restoration.
According to a recent assessment by the Nature Conservancy, mankind would need to spend an extra USD 600 to 800 billion per year by 2030 to reverse the biodiversity disaster. That’s on top of the anticipated USD 2.5 to 3 billion per year required in the Global South to accomplish the Sustainable Development Goals.
From the local to the global level, closing that vast financing gap will need a concerted effort by the public and private sectors. The onus is on politicians and bankers to respond to the challenge as the sixth mass extinction accelerates and global warming sets new records. Corporations are the greatest source of climate-related money, thanks to their CSR programs and investments in renewable energy, transportation, and infrastructure, among other areas. Banks account for a significant percentage of the financial resources available for green initiatives.
What drives sustainable finance forward?
International financial institutions can help scale up green investments by experimenting with innovative financing methods, diverting money toward sustainable development via instruments like green bonds, and influencing global financial governance to promote sustainable development more. Green investment banks and development banks, for example, offer money for initiatives relevant to sustainability and development, respectively.
ICMA says worldwide institutions such as the United Nations, the OECD, and the G20 not only contribute limited cash, but also set the international agenda on sustainability concerns and assist organize funding sources. Climate funds, such as the Green Climate Fund, Adaptation Fund, Global Environment Facility, and Climate Investment Institutions, are international funds that are supported by donations from specific countries for climate change adaptation and mitigation programs.
The amount of public financing designated for green projects, as well as institutional support for them, is determined by national governments. They may also help with the development of specific domestic investment instruments like national climate and environmental funds.
Through policies and regulations, central banks and regulatory bodies may also influence the financial industry to make green investments. Another key category of private-sector financiers is institutional investors, such as pension funds, sovereign wealth funds, and insurers.
Green and sustainable investments are often offered on stock markets. The Luxembourg Green Exchange (LGX), for example, is a specialized market for green, social, and sustainable assets. It is part of the Luxembourg Stock Exchange.
Equity and debt are the two primary financial vehicles used in sustainable financing.
Equity finance is the most common kind of investment in the early phases of a project, and investors acquire an ownership stake (stocks or shares) in the enterprise in exchange for their investment. Debt finance becomes the primary investment strategy as a project progresses. Investors provide loans to borrowers, who then repay them with interest.
Loans and bonds are two types of debt financing. A loan is a financial transaction in which money is transferred from a bank to a firm or person, while a bond is a financial transaction in which money is transferred from the public or market to a corporation that issues the bond. Bonds often involve enormous quantities of money (USD 100 million and more) and may be purchased by anybody.
Green investment projects and their supporters participate in a process known as leveraging, which involves lowering a project’s perceived risk in order to attract private investors. Using loan and credit guarantees, as well as investing in junior stock or subordinated debt, are examples of leverage techniques.
Now you have a good idea on what sustainable finance is all about. Investors often use loan or credit guarantees from public finance institutions to mitigate risk. The risk of the investment is transferred from the investor to the institution, which acts as a loan guarantor. Because the lender is taking on less risk, it may charge a lower interest rate on the loan, lowering its capital expenses and boosting profits.
Climate funds and impact investors might assume the most junior debt position in a firm (known as subordinated debt) in non-equity investments to guarantee that they are paid last in the case of a collapse. This, like junior equity investment, mitigates some of the risks for other investors.