Private capital’s critical role in the sustainability transition

Sustainability has become caught up in the US culture wars, with companies distancing themselves from the term ‘ESG’ in their internal structures and external communication. However, in a Q&A with VitalBriefing, Luxembourg Sustainable Finance Initiative (LSFI) CEO Nicoletta Centofanti argues that private capital committed to sustainability principles continues to have a critical role to play in financing the decarbonisation transition as well as in addressing other environmental and social impact issues.

In the US, many companies, such as Coca Cola, are stripping the expression ‘ESG’ from their corporate reports and internal structures, and organisations are increasingly favouring ‘sustainable finance’ in their external communications. Do you think the concept of ESG is becoming politicised? And does is reflect a shift by financial institutions away from the entire concept?

On the contrary, there is a strong trend towards sustainable finance in Europe, driven in large part by a robust regulatory framework composed of distinct pieces of legislation, such as the Sustainable Finance Disclosure Regulation, Corporate Sustainability Reporting Directive and EU Taxonomy, that address the various actors involved in the transition to a more sustainable future – from businesses to retail financial institutions. 

This legal framework plays a key role in the development of a level playing field in Europe, fostering transparency and standardisation, while ensuring that the shift toward sustainability continues. For the LSFI, this regulatory backdrop provides important context as to why we believe ESG criteria will increasingly become integral elements of companies’ reporting. 

For instance, our Sustainable Finance in Luxembourg 2023 study found that ESG funds made up 67.3% of Luxembourg’s Ucits assets under management, up from 54.6% in 2022.

Is the urgency of climate change swamping other environmental issues that need to be addressed just as imperatively?

Nicoletta Centofanti, CEO, LSFI

Only by a comprehensive understanding of where we are in our transition toward sustainability can we identify the most pressing issues to be addressed. However, there certainly is an emphasis on climate change, and it’s important to assess why that is the case. 

Climate change especially has become more visible over the years, in large part because it is a tangible issue. The UN Intergovernmental Panel on Climate Change reports, for example, clearly depict the relationship between climate change and human action.

Consequently, emissions and climate change have become the focal points when we think about environmental issues. The Paris Agreement goals also helped with this, having placed a particular spotlight on greenhouse gas emissions and climate change.

With so much focus on greenhouse gases, our ability to calculate and measure them has come a long way. Financial institutions, for instance, now have specific standards available such as the Partnership for Carbon Accounting Financials to help them measure the emissions their financing has facilitated.

Our improved ability to track and tackle climate change has made it the poster child issue for sustainability. However, it is just as pressing for other topics to be addressed, as they are equally important and closely linked both directly and indirectly to climate change.

Examples are biodiversity and human rights, an often-forgotten social aspect of sustainable finance. A climate disaster has much further-reaching ramifications than just for the environment – it will have particularly significant consequences for vulnerable populations.  Additionally, climate change effects have a direct impact on biodiversity preservation and species conservation.

But these are aspects that often fall by the wayside because measuring them is difficult and complex – there is no single indicator or formula to do so.

Admittedly, the financial sector is increasingly aware that the whole spectrum of sustainable finance – environmental, social and governance issues – should be integrated when considering investment decisions, so more attention is being given to some of these topics.

In the case of biodiversity, there have been a couple of major developments that support the integration of biodiversity into investment decisions. We now have the Kunming-Montreal Biodiversity Framework, which aims to halt and reverse biodiversity loss by 2030, while the launch of the Taskforce on Nature-related Financial Disclosures is another major step forward.

Another positive development is that the regulatory framework established by the European Union incorporates all the various ESG dimensions – change from the past where often the social impact and governance pillars would receive far less attention than the environment.

Analysis indicates a decline in mentions of ESG on earnings calls by US companies, which peaked in 2021. Is this an ominous sign?

Although an objective look at such numbers may paint a worrying picture, it is far more important to look at ESG practices and trends in the long run – short-term analysis is not conducive to the overall mindset approach ESG investment requires.

The EU’s Corporate Sustainability Reporting Directive (CSRD) will no doubt provide financial institutions with a pool of data to assess their investments better. It will also help direct investment flows toward sustainable enterprises – but that will take time.

Meanwhile, the EU’s framework is helping ensure that sustainable finance continues to develop, and does so in a standardised way. The CSRD is an important piece of this puzzle as it requires private and public European companies, as well as non-EU companies with a substantial presence in the EU, to report on the impact of their activities on the environment and society.

Coming back to Luxembourg, sustainable finance has clearly taken root in our country’s fund industry. Following the economic uncertainty and market turbulence in 2022, Luxembourg-domiciled UCITS ESG funds rebounded to €2.8 trillion in assets at the end of June 2023, according to our 2023 Sustainable Finance in Luxembourg study. They constituted nearly half of the 9,761 active UCITS fund portfolios in the grand duchy, and accounted for 67.3% of the country’s overall UCITS assets under management. 

Social goals are difficult to quantify, and governance issues can be confusing as well. In fact, more broadly, does governance belong in sustainability at all?

Absolutely. Sustainable finance deals with the three major aspects of sustainability: environmental, social and governance. These three pillars are inherently linked to each another, and it is critical that everyone understands this connection.

Just because it is harder to quantify and measure the social and governance components is no reason to separate them from the sustainability umbrella, which would only damage any attempt to address them.

Governance, for example, includes factors such as corporate structure, board composition, business ethics and prevention of corruption. It is the foundation on which every organisation is based – good governance is a fundamental prerequisite for an organisation to adequately handle any social or environmental initiative.

Although assessing governance is different from the evaluation of environmental or social aspects, it still serves as the cornerstone in addressing environmental and social concerns.

For example, the advancement of sustainable finance initiatives and promoting characteristics such as diversity and inclusion within an organisation have their inception within its governing body. There’s no doubt, strong corporate governance is essential for companies to advance sustainability goals within their operations.

European politicians appear to expect the financial sector to do a lot of the heavy lifting to drive the sustainability and energy transition over the coming years. Is that a realistic prospect?

In some ways, it is a realistic expectation. Finance is the engine of our economy, and it has the power to fuel and therefore incentivise trends, as well as to foster innovation. As key allocators of capital, financial institutions have a lot of influence over where investments flow.

Just consider how much private capital needs to be shifted for any real transition toward sustainability to succeed, or to achieve the UN Sustainable Development Goals or the Paris Agreement targets.

To achieve the objectives of the EU Green Deal, the union will need to scale up its investments by two-thirds – about €620 billion more each year up to 2030. This can’t be done solely through public funding; the mobilisation of private capital needs to accelerate as well.

However, the responsibility for the sustainability and energy transition does not fall solely on the financial sector. Collaboration among policymakers, companies, financial institutions and society is also essential to ensure the shift happens – and happen quickly. It needs to be a joint journey and effort open to collaboration and co-operation across sectors and markets. The LFSI’s role includes supporting and fostering this cross-sector collaboration.

Nicoletta Centofanti is an environmental engineer and holds an Executive MBA from Bocconi University in Milan. Nicoletta is a sustainability and sustainable finance expert and has 15 years of experience spanning from environmental and social due diligence, Corporate Social Responsibility review and implementation within companies around the globe, responsible sourcing and sustainable finance. She is committed to support financial players and companies transition towards increased sustainability and impact. Nicoletta is enthusiastic about impact investing, social businesses and Environmental Social Governance drivers. In short, anything that contributes to a better world.

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