Q+A: U.N.’s Iain Henderson on nudging the financial sector toward sustainable investment

This topic will be discussed at the Global Landscapes Forum Luxembourg on 30 November 2019. Learn how to join the event here.

WASHINGTON (Landscape News) — Efforts to establish a sustainable framework for the economy over the past 10 years have not fully engaged the financial sector, failing to ensure hard won U.N. environmental and development targets for 2030 will be met, according to a new report.

It is now widely recognized that government funding is insufficient to cover the cost of meeting the U.N. Sustainable Development Goals (SDGs) and the 2015 Paris Agreement to keep global warming in check. Private sector financing is vital to meeting these goals.

“Despite ongoing challenges, there is some cause for optimism,” said Iain Henderson, Head of International Cooperation at UN Environment’s “Inquiry into the Design for a Sustainable Financial System,” which released the new report, “Making Waves: Aligning the Financial System with Sustainable Development” to summarize a four-year research program.

“Progress has occurred on many levels, but it is difficult to measure with a single metric,” Henderson said in an interview with Landscape News ahead of the Global Landscapes Forum (GLF) Investment Case Symposium in Washington, where 250 delegates discussed the challenge of how to finance restoration of more than 2 billion hectares of degraded land worldwide – a footprint larger than South America – to address socio-environmental concerns.

Financially, land degradation is estimated to cost the global economy as much as $4.5 trillion a year, while benefits of restoration are an estimated $84 billion a year.

“In financial markets there is evidence of scaling up sustainable finance – the emergence of new products such as green loans and the proliferation of green bonds – alongside new fund investment vehicles, new tools, new networks and new methodologies to better understand risk,” Henderson said.

Green bonds are currently the most visible of these products. Since 2012, when green bonds were starting to grow more rapidly, the market expanded from almost $10 billion in 2013 to more than $40 billion in 2015. Last year, green bond issuance hit a record $160.8 billion and could reach $250 billion this year, according to the Climate Bonds Initiative.

The UN Environment inquiry, which was initially established for a two-year period and due to its success was extended for a further two years until 2018, observed that there is considerable momentum in aligning financial systems with sustainability outcomes, but much still needs to be done to pivot from momentum to transformation.

“In 2014, sustainable finance meant ‘resilience to financial crisis, rather than capital allocation aligned to wider environmental social and economic goals,” the report states. “Now ‘a sustainable financial system’ has a more profound meaning – that of a financial system that serves the transition to sustainable development.”

“Beyond innovations in the market, we’re also seeing policy progress at national level, at regional level and also at international level,” Henderson said.

Globally, the economic system is based on a flow of money swirling through financial markets to generate economic growth, trade and employment.

In recent years, even the G20 — members oversee 85 percent of the world’s economic output, two-thirds of its population, 75 percent of international trade and 80 percent of global investments in research and development — have begun to address financial concerns related to the SDGs, climate change and inclusive entrepreneurship in fiscal and monetary policies.

This is a positive change, according to the report, which states that there is ample evidence indicating the financial system is out of step with sustainability efforts.

“One key theme that emerges at the policy level is the more systematic approach to sustainable finance that we are starting to observe,” Henderson said. “We’re seeing movement from ad hoc, tactical innovations to more systemic strategic plans or sustainable finance ‘roadmaps’ in many countries, which is encouraging.”

Q: How do you measure the impact of the work done to date on aligning the financial system with sustainable development? 

A: It is very hard to measure with any single metric, but there is evidence of progress on lots of different levels ranging from the architecture of the market to financial flows. In financial markets there is evidence of scaling up sustainable finance, which can include products such as green loans and also new tools along the investment chain. We are also seeing trends such as consolidation among ESG (environmental, social and governance) data providers which is another sign that mainstreaming is starting to take place. We are seeing policy progress at national level (including countries such as the UK, China and Indonesia), at regional level (such as the EU) and also at international level (such as the Network of Central Banks and Supervisors for Greening the Financial System and the FSB Taskforce on Climate-related Financial Disclosure).

Q: Is it possible to make a “one-size-fits-all” approach for countries? Can conferences such as the GLF Investment Case Symposium wield any influence over sustainable enterprises?

A: There are lots of examples of change, but there is no one size fits all approach. Countries have very different motivations, needs, barriers, capacity issues and financial systems. This means that the starting points on their sustainable finance journey can be very different, even if some of the conclusions they reach are quite similar. Have a look at this report for some recent examples of alignment of financial systems with sustainable development from the G20 members. These examples look at progress against the seven options the G20 finance ministers and central bank governors endorsed for scaling up green finance at the G20 Leader’s Summit in 2016. The GLF would probably fit into either/both of options three and six. Ultimately, we want to see a progression along a continuum that has dialogue and policy at one end to flows in the market at the other, which hopefully contributes to impact on the ground.

Q: What is the likely trajectory of sustainable finance in the coming years?

A: While the direction of travel is encouraging, we need to move from incremental to systemic progress to deal with the scale of the challenge we face within a narrow window of time. One crucial area that could help with this transformation is a better understanding of the nexus between digital innovations and sustainability outcomes. Today, digital finance is mainly applied to cost-reducing back-office operations and the provision of financial services delivered through online and mobile payment platforms. It’s exciting to note that other aspects are emerging rapidly, including using big data and AI (artificial intelligence) to inform financing decisions, and the growing use of AI and the IoT (Internet of Things) in global value chains and drive new business models. Many of today’s financial sector business models could be disrupted in the face of digital finance-based innovations, opening new opportunities but also requiring an appreciation of the market and policy implications.

Q: How do you see this unfolding?

A: Digital finance is already relevant to financial inclusion, particularly in enabling fast and secure, low-cost movements of citizens’ money. Big data and AI are also beginning to serve the sustainability agenda more broadly however, by enabling low cost, zero-collateral lending to SMEs (small and medium enterprises), for example. Similarly, high resolution supply-chain relevant satellite data can now be acquired, processed and layered into financing decisions at a fraction of the cost of what was possible a decade ago opening up many potential new opportunities. Digital finance is also being used to shape citizens’ behavior at scale. In China, a company called ANT Financial has released an app called ANT Forest, for example, uses incentives passed through mobile payment platforms to get over 200 million Chinese citizens to reduce their carbon footprints and has triggered a massive reforestation programme.

Q: Where is most of the investment in sustainable finance directed?

A: By many measures, sustainable land use finance is a bit of an “orphan topic” that sits in the shadows of areas like renewable energy or energy efficiency. Data is hard to find, but UN Environment highlight in the 2017 Emissions Gap report that the land use component of biodiversity has the potential to deliver over 35 percent of cost effective mitigation by 2030 but receives under 3 percent of public mitigation climate finance. This clearly needs addressing as the 2030 (SDG) Agenda is going to be almost impossible to deliver if we don’t get to grips with sustainable finance in areas that we know are tricky, but vital.

Q: How can companies be encouraged to comply with sustainable business practices? The paper says that many companies are now on side with sustainable/green finance ideology, but how can they be encouraged to live up to these ideas?

A: I think companies are all a little different. Companies with a strong brand that faces consumers might think and act differently to one buried in the middle of a complex supply chain. Beyond the ideas most often talked about, I think one simple but key area we can work on is starting to focus more on how we communicate. The language of different groups of actors can be quite different and I think there are some quick wins in terms of improving communications. The other exciting area follows on from my previous point about the digital space and the potential of demand side levers sure as the ANT Forest app.

Q: How is private finance encouraged to take up sustainable investment habits – what are the main incentives?

A: There are many internal or external reasons any one financial institution might integrate sustainability into their decision-making. Internally, some might see its use as a communication tool, others a risk management tool, others a way of building on the increasing body of evidence that aspects of sustainability generates superior risk-adjusted returns. External incentives are also at play and these take many forms. Some examples include pressure from investors and other stakeholders, which is in part due to processes like the TCFD (Task Force on Climate-Related Financial Disclosures). Another example is that banks in China can now borrow from the Central Bank a full percentage point lower if they are considered very “green.”

Q: The market for green bonds has grown substantially in recent years – what are your views on this?

A: While the scale and speed of green bond innovation has been very encouraging, they still represent a tiny segment of the fixed income market (just over 0.1 percent of the total global fixed income market), so we still have work to do and need to continue to look for systemic levers for change. While there are some unequivocal benefits to the green bond story, there is also a growing critical voice trying to understand the true impact of certain types of green bonds and their contribution to a 2-degree trajectory. From another angle, they have been a very useful case study of how change happens, and their development is due to the interplay between market actors, development banks, and policymakers. Policy signals at national and international level have helped trigger market innovation but there is also a clear feedback loop from the market back to policymakers.

Q: Could you expand on that?

A: What I mean is that ambitious market activity confirms to policymakers and regulators that transformational behavioral and policy changes are in fact feasible, especially when these signals originate from mainstream sector leaders around the world. I think this is quite an instructive lesson for how change happens at scale. What is also noteworthy about green bonds is the “ripple” effect that they have contributed to. We’re starting to see innovation in related products, such as green loans or green ETFs (Exchange Traded Funds), and an ecosystem of connected products, tools and funds develop as the market starts to mature.

Q: Will we see a similar development of funding for landscape restoration that we saw in recent years with renewable energy? 

A: I think it is hard to imagine funding for landscape restoration following an identical trajectory as the barriers, revenue streams and contexts are very different. Challenges such as land tenure, or covariant risks have different implications in the land use space and many of the business models are not as developed. Another key differentiator is that costs curves might not fall in the manner that we have seen across the renewables space, which is intrinsically linked to investment patterns.

Q: Are companies taking advantage of “catch phrases” on “green” and “sustainable” initiatives to appeal to consumers or are they actually enacting changes?

A: I think a healthy debate on green washing is critical, and the role of civil society and an open mind is of paramount importance. There are many ways to measure a company’s approach to sustainability and this is an evolving field but I always think it is interesting to see how and what percentage of senior management’s performance appraisal is linked to some sort of sustainability key performance indicator.