What do we mean when we say ‘green finance’ and what are the impacts of the different elements of ESG?
The term “Green Finance” boils down to any kind of financial activity which focuses upon environmental sustainability as its prime goal. The term has a wide range of environmental objectives, such as investing in sustainable development projects, funding for cleaner energy sources, pollution control, biodiversity protection, and so on. One of the key elements of green financing is to make investment and lending decisions upon the assessment of the environmental risks associated with the projects. With the onset of pandemics and major market disruption around the globe, more and more investment houses are incorporating ESG practices into their investment decisions.
ESG and its value
Portfolios incorporating ESG practices tend to give higher returns due to their resilience against market disruptions. ESG factors consist of environmental, social, and governance factors. Environmental criteria incorporate elements such as energy efficiency, waste disposal management, greenhouse gas emissions and deforestation. Social factors on the other hand, include employee diversity, health and safety, working conditions, and human rights. Finally, governance factors include business ethics, tax strategy, board diversity and structure. This set of criteria guide investors in screening potential companies to invest in. Financial services like JP Morgan Chase and Bloomberg take ESG approaches into consideration while reviewing and publishing their annual reports.
Day 3 of COP26, put a spotlight on green finance and investors, where Amazon owner Jeff Bezos pledged to allocate 2 billion dollars to land restoration, which can help in improving the fertility of land, job security, creating employment, and promoting economic growth.
With over 130 trillion dollars of capital from 450+ firms across 45 countries, The Glasgow Financial Alliance for Net Zero is set to transform the current economy into a green one. The UK government believes that this huge pool of cash can help with the shift from coal to electric cars and accelerate tree implantation.
Another such instrument is the “Green Bond”, which was brought into the picture in 2008 by the World Bank to raise capital for climate and environmental-related projects. These bonds are used to finance renewable and clean energy projects. Such securities, along with some tax benefits, are issued by borrowers to finance projects that will have a sustainable impact on the environment.
Green financing and developing and developed nations
While developed countries are thriving on this goal, developing nations are still in a nascent stage. Green bonds constituted only 0.7 per cent of all the bonds issued in India since 2018, and bank lending to the non-conventional energy constituted about 7.9 per cent of outstanding bank credit to the power sector, as on March 2020. By doing away with illicit practices due to weak enforcement to increase integrity of financial markets and exploring opportunities for green investments by enhancing knowledge and leveraging existing platforms, developing countries can pave a way towards building a robust green finance structure.
In the Philippines, for example, the catalyst for sustainable finance was Super Typhoon Yolanda 2013, one of the strongest typhoons ever recorded, which caused immense destruction on populated lands, attributed to the critical role played by financial institutions in providing disaster relief and recovery support. The Central Bank of the Philippines, Dept. of Finance, along with the Securities and Exchange Commissions, joined hands in driving green and sustainable finance initiatives. Not only financial institutions but also governmental bodies and citizens have a major role to play in bringing the concept of green financing to existence.