What is sustainable finance and what does it ‘mean’ to me?
Climate change, biodiversity loss and social injustice is happening. The natural systems that govern a stable environment are unbalanced and that unbalance is manifesting itself in more extreme weather events – flooding, droughts, forest fires, heat waves – increasing extinction rates, and failing ecosystems.
But why should we be bothered? At the most basic level, climate change will drive up the cost of things as crops are lost, flooding of homes and offices increases insurance rates, or businesses go bust and people lose their jobs. At the extreme level, thousands of people will die from heatwaves, fires, flooding and storms. Cities will be inundated with water from storms and coastal surges, rendered unliveable as homes overheat, railway lines buckle, drinking water runs out and our medical services are overwhelmed.
If we know that these events are going to happen and that burning fossil fuels drives the carbon emissions that are making these changes, why cant ‘we’ choose ‘good’ businesses over ‘bad’ businesses? It comes down to the way in which money is invested or used in businesses and how it flows to an established industry or sector. To divert it away from industries that have been set up, run and invested into for decades requires decisions to be made to make the flow of capital move towards ‘good’ industries and businesses and away from the ‘bad.’
In the built environment we are aware of the steps needed to make buildings net zero in operation – and embodied carbon – to green our cities to make them resilient to the impacts of climate change, and to try to reverse the decline in biodiversity. But we need a collective push and system changes to make it happen quicker.
The financial sector, through sustainable finance, holds enormous power in directing finance to businesses and activities that are making these steps, and to divest away from those that aren’t.
Sustainable finance is defined as investment decisions that take into account the environmental, social, and governance (ESG) factors of an economic activity or project. For example, in the built environment sector this can be net zero carbon buildings, biodiversity net gains and supporting social impact initiatives to name a few.
But how does the finance sector favour businesses that deliver against these objectives and how do you measure this? There are a number of ways that sustainable finance can do this – Green Bonds, favourable interest rates and impact investments are a few, but all need reliable, meaningful, measurable and verifiable environmental and social metrics. An example of this is Great Portland Estates’ £450 million ESG-linked revolving credit facility issued in January 2020, which includes three ESG-linked KPIs aligned with their sustainability strategy [i]. These include:
- Reducing their portfolio energy intensity
- Reducing the embodied carbon of new build developments and major refurbishments
- Increasing the biodiversity net gain across their portfolio.
Linking ‘good’ business to ‘good’ initiatives drives ‘good’ behaviours and there is a lot of work being done in this space[ii]. Metrics are standardised and accepted, reporting frameworks are being set and accepted and monitoring is well established and verifiable.
There’s a realisation from the insurance and financial institutions that the built environment is at real risk from climate impacts. Encouraging both mitigation and adaptation through sustainable finance will reduce the risk of those ‘assets’ being damaged or no longer desirable because of their poor environmental performance.
Biodiversity, climate-linked ESG reporting and TNFD-compliant disclosures must be science based, reliable and capture standardised and quantifiable data that are material to the operations of a business.
To do this, we need to prescribe valuation methods that are sector and geographically specific whilst encouraging engagement between all actors, from those responsible for top-down drivers (regulators, banks, insurers) to bottom-up action (asset managers and owners), in order to set appropriate standards for what and how we measure.
To identify this, we need to think about what data actually matter – how does nature interact with our built spaces in the context of a changing climate – to deliver tangible benefits.
If portfolio managers are able to leverage an understanding of how social and natural capital flows influence the efficiency of their asset management processes, then they can be confident of improved financial ROI e.g. capturing data on ecosystem service delivery (natural capital stock value flow) through nature-based solutions can evidence predicted improvement in physical asset performance. Data outputs through capturing ecosystem service delivery can include:
- Surface water attenuation volume – leveraged with some utility companies through rate reductions
- Carbon savings – used from both GHG Protocol reporting and operational energy saving perspectives (CO2e and £)
- Biodiversity gains – tenants are happier and healthier around nature, with biodiversity providing a raft of other performance benefits.
Understanding such flows can therefore capture externalities that deliver significant (otherwise unrecognised) cost savings or provide marketable insights, alongside enabling compliance with emerging and future standards.
Figure 2: Conceptual model showing interactions between business, nature, climate and finance.