Unraveling the Mystery about Sustainable Finance

Sustainability is indisputably one of the hot topics in this decade, and it has penetrated almost every industry, not to mention the financial industry. The term “sustainable finance” is popping up everywhere in the financial news, during our lectures, and even in the discussions you overheard in the corridor, but what is it really?

As every inquisitive student does, you ask an expert to unravel the mystery.

Emma Sjöström is a researcher at SSE specialising on sustainable finance and ESG investment. She is also the director of the Sustainable Finance Initiative at Misum, a multi-stakeholder research environment at SSE. With her, we will dive into the topic of this fascinating topic.

How did you start working with ESG and sustainable finance personally?

My first job was to work for a gallery for antique carpets and tapestries in New York, and then I moved on to IBM, also in the US. During that time, I started to think about working with corporate social responsibility. I figured that research could be fun, and that’s how I ended up doing ESG research here at SSE. Mainly, I do my research on the financial market from the perspective of organisational behaviour, because I believe it is important to understand sustainable finance from different types of disciplines rather than just from financial economics. Also, the reason that I got attracted to the financial market is because it can be a platform for change and a force to influence corporations. It is interesting to explore the mechanisms that may cause corporations to improve their sustainability work.

How is sustainable finance implemented in practice? 

There are several ways of implementation depending on your motivations. One way to do that is to exclude certain companies from your portfolio, for instance, it can be companies from the fossil fuel industry or tobacco industry. The underlying reason could be that you don’t think that the operations of these companies are not in line with your values, or that you don’t think they will be profitable enough in the future.

There are also different asset classes. When it comes to equities, you can go to annual shareholder meetings, file shareholder resolutions and become an active owner in order to influence the company towards a more sustainable way. If you are a fixed income holder, you can condition your bond investment on the company improving their work with sustainability issues. If you are a private equity investor, then you may even have a board seat and can have a strong influence in how they should run their company.

What does the process of financing a sustainable city project look like? 

We have conducted a research project on this, because cities are very important in the context of the sustainable development goals.  Our first step was for us to assess to what extent a lack of funding is even an obstacle for municipalities to reach their sustainability goals. The next step was to understand if private market investment, for example via pension funds and other investors, would have a role to play in filling the funding gap.

For this project, we have interviewed a set of investors and nine Swedish municipalities who have emitted green bonds. It turns out that the municipalities did not see access to external funding as a hinder to achieve sustainability goals. They can borrow cheaply now that interest rates are low, and many investors are keen to direct capital towards “sustainable cities”. However, one challenge is that cities are only allowed to use external funding for capital expenditures, not operational expenditures. In other words, municipalities can borrow money to build a school, but they are not allowed to borrow money for hiring the teachers.

Since a few years back, green bonds are designed to focus on the environmental aspect, while the social bonds focus on areas such as unemployment or health. However, a more holistic view might be required for a sustainable city project. Initially, we were thinking that there could be an interest for a new type of product, a “sustainable city bond”, where the proceeds would cover both the social and environmental aspects related to such projects.

The response we got was that “we are not there yet”, because social bonds are perceived to be more difficult to design than the green bonds, since social aspects are typically harder to quantify and monetize

Is the well-established welfare system that we have in Sweden a reason for the difficulties we experience with implementing social bonds?

Certainly, the well-established Swedish welfare system can be a reason for the lack of interest in social bonds given that people are so used to the mindset that the government should take care of the social aspect in the society. Thus, it is sort of a taboo to start involving private money into solving social problems.

What are the industries that need to be changed with green financing?

Many sectors would need investment to transition to a more sustainable economy, for example, some of the most CO2 intensive industries include energy, transport, agriculture, steel and cement. For green bonds, where the proceeds are earmarked for green activities, the issue seems to be that the asset base is not large enough. That is, the investors are willing to invest but there is not a lot to invest in.

One way to create more investable opportunities might be to lower the risk by, for example, the government stepping in with guarantees or in other ways to help de-risk. Moreover, private equities play a critical role here as well since they have gone from a more opportunistic approach towards a more long-term approach, to actually staying in a portfolio company for a longer period of time to help them make a transformation rather than just exist and sell.

What are the common financial instruments used in this field?

 Sustainability can be applied to a lot of different asset classes, but the discussion is often about listed equity. On the fixed income side, there are bonds and labelled-bonds (green bonds, social bonds, sustainability-linked bonds, etc.), and green loans. The EU Taxonomy for sustainable activities can hopefully serve as a good guideline for investors who want to steer their capital towards sustainability. Yet, there are several issues with that as well. One issue is that the EU Taxonomy is just a green taxonomy right now and we need it to be more encompassing, which is the plan but that will take some time. Also, it is hard to draw a line with 100% certainty to distinguish what is green and what is not green, since there will always be things that are debatable on that aspect.