7 challenges of sustainable finance to correct global inequalities
- The sustainable finance boom may have unintended consequences in developing countries.
- High-income countries overwhelmingly dominate sustainable funds.
- Obstacles to sustainable investing in developing countries include debt constraints, dependence on hydrocarbons and lack of ESG reporting standards.
Despite the recent increase in global demand and supply for sustainable finance, the financing gap for the Sustainable Development Goals (SDGs) has actually widened, primarily in countries already furthest behind on the Agenda. 2030. Is this just a consequence of the COVID-19 crisis? Or has the system failed to channel sustainable finance to where it is most needed?
Sustainable finance and inequalities between countries
Image: OECD
The integration of sustainability into finance and investment is an opportunity to be seized and a trend to be encouraged. However, early evidence suggests that inequalities remain and that unintended consequences, unless addressed, could actually slow our collective progress towards the SDGs.
Challenges of sustainable finance to achieve the SDGs
Here are seven risks or challenges that require our urgent attention, and suggestions on how to mitigate them.
1. Until now, the quest for sustainability has amplified global inequalities in access to finance.
While high-income countries (HICs) already held 80% of global assets under management, they now account for 97% of newly created sustainable investment funds. Sub-Saharan Africa accounts for 1.5% of total green bonds by number and only 0.3% by value. The good news? Increasing the use of innovative sustainability-related financial tools could make some developing countries more attractive to investors (e.g. sustainable bonds, debt swaps) and benefit from financing commitments (e.g. , the $100 billion COP15 climate pledge).
2. The high demand for sustainable stimulus financing and the upward pressure on interest rates linked to stimulus packages in the PREs could affect the ability of other countries to attract capital.
Low-Income Countries (LICs) with limited fiscal space and strict debt sustainability constraints could only devote 2.5% of their GDP to stimulus packages during the COVID-19 crisis, compared to 16% in the PREs. At the same time, 56% of African countries whose sovereign rating was downgraded in 2020, compared to a global average of 31.8%. LICs therefore have much less leeway to try to finance their sustainable recovery. A truly global stimulus package was needed to stem both COVID-19 and its economic consequences, but only 1% of HIC stimulus packages were directed at non-domestic issues. This calls for more policy coherence, avoiding ‘beggar-thy-neighbour’ policies and embracing the full interconnection of SDGs and economies to address the root causes of global crises with adequate financing for development.
3. Divestment from unsustainable projects, or projects not labeled as sustainable, could have major implications for resource allocation and geopolitical balance.
There is a heated debate between proponents of “exclusionary investing” (i.e. avoiding certain sectors or activities with unknown or low sustainability scores when constructing a portfolio) and supporters of “buy brown and help it go green”. Mineral energy materials (23%) and hydrocarbons (49%) accounted for nearly three quarters of sub-Saharan Africa’s exports and a quarter of government revenue between 1995 and 2018. Divestment from certain sectors on which countries still depend heavily for job or wealth creation should be combined with support for adjustment (e.g. skills) and diversification (e.g. increased efforts to create a pipeline of sustainable, bankable and scalable projects, and identify new production and export opportunities to take advantage of the energy transition).
4. Persistent barriers to investment and capacity constraints prevent developing countries from benefiting from sustainability efforts.
These include insufficient depth of financial markets or lack of capacity to demonstrate compliance with sustainability standards (e.g. lack of data or reporting mechanisms). The size of stock markets represents more than 110% of GDP in the PREs, compared to 60% in upper-middle-income countries (LMICs) excluding China, and less than 40% in lower-middle-income countries (PRITI). This requires additional capacity building in the area of finance and investment climate, as well as support for reporting and monitoring sustainability.
5. The absence of environmental, social and governance (ESG) information in most developing countries could mask potential opportunities and aggravate income bias in investment decisions.
Around 90% of a country’s sovereign ESG score is explained by its level of development, and failure to take this bias into account in investment decisions could potentially divert flows towards PREs to the detriment of the most poor. The push for sustainability could give new impetus to the long-awaited reform of credit and risk ratings, as well as to the fight against the laundering of SDGs in HICs, which unduly diverts investors from emerging markets. The use of innovative financial and risk reduction instruments, such as results-based reward mechanisms or blended finance, should be further explored.
6. Despite (or as a result of) the desire for sustainability, the mismatch between the needs and the supply of sustainable financing could worsen.
Political or commercial priorities could conflict with the universality of the SDGs. In the field of development cooperation, the search for sustainability has largely benefited energy and transport infrastructure projects in the form of loans in the MICs, while grants to LICs and funding for certain essential sectors have decreased. Even in priority areas, such as the environment, 70% of climate funds and 93% of private finance mobilized are devoted to mitigation projects in the MICs – not enough goes to adaptation, and only 8% and 2% funds go, respectively, to at least -developed countries (LDCs) and small island developing states (SIDS) heavily impacted by climate change. Budgets, development and financing strategies aligned with the SDGs, such as integrated national financing frameworks (INFFs), could help better match sustainable financing needs with what is available.
7. The proliferation of sustainability standards could create additional barriers to finance and investment in developing countries, adding significant compliance costs.
With more than 200 sustainability initiatives or stakeholder coalitions, the proliferation of sustainability standards is not just confusing markets; it also places a heavy burden on countries trying to attract sustainable investors from different backgrounds, for example by forcing them to conform to different taxonomies. In the absence of definitions and harmonized standards, the interoperability of systems taking into account local contexts is an absolute necessity. The participation of developing countries in the development of international standards is also necessary to ensure that they are suitable for all, without diluting their ambition.
Global economies are already absorbing the costs of climate change and an outdated business as usual approach. Scientific evidence and the dislocation of people highlight the urgent need to create a sustainable, inclusive and climate-resilient future.
This will require nothing less than a transformation of our current economic model into one that generates long-term value by balancing natural, social, human and financial conditions. Cooperation between different stakeholders will be essential to develop the strategies, partnerships and innovative markets that will drive this transformation and enable us to raise the trillions of dollars in investment needed.
To meet these challenges, Financing sustainable development is one of the four focus areas of the World Economic Forum’s 2019 Sustainable Development Impact Summit. A series of sessions will highlight innovative financial models, pioneering solutions and scalable best practices that can mobilize capital for the Sustainable Development Goals around the world. It will focus on the conditions that public and private institutions should create to enable large-scale financing for sustainable development. It will also explore the role that governments, businesses, investors, philanthropists and consumers could play in coming up with new ways to finance sustainable development.
Aligning finance and investment with the SDGs will only truly work for people and planet if we strive to improve both their sustainable impact and equal access for countries and sectors that follow the dynamics of sustainability. A “just” transition calls for a renewed public-private partnership for sustainable finance with (i) a commitment from sustainable public and private investors to systematically include in their portfolios frontier investments outside of PREs and major MICs – with objectives qualitative and quantitative, and (ii) a commitment by governments to promote and facilitate these investments, including through development cooperation and integrated national SDG financing strategies.
