Establishing sustainable finance: Comparing emerging markets and Australia
As efforts are made to establish sustainable finance globally, a look at progress made in emerging markets and Australia shows certain features that may help shareholders better assess their financial services investments. In October 2019, the Sustainable Banking Network (‘the SBN’) and the International Finance Corporation (‘the IFC’) released a report on progress made in emerging markets to advance sustainable finance. The SBN comprises financial sector regulators and banking associations in 38 member countries who have committed to advancing sustainable finance in line with international best practice.
The SBN was created with the assistance of the IFC, part of the World Bank Group, in its work to introduce environmental, social and governance (‘ESG’) standards in developing countries. Due to weaker regulation and enforcement, ESG risks are acute in these countries and it is crucial for regulators and financial institutions to understand the financial implications of those risks.
To measure the progress made by member countries in advancing sustainable finance, the SBN devised a framework based on its members’ practical experiences. The framework is made up of indicators and underlying questions that the SBN believes to be the key components of a national sustainable finance framework and its implementation. Overall, the SBN found that members are taking increasing steps to advance sustainable finance. In particular, the number of members with sustainable finance frameworks and those members moving to implement them has increased. A feature of this progress is peer to peer knowledge sharing among members.
More specifically, members are aligning their frameworks with global standards such as the UN Sustainable Development Goals and the Paris Agreement. More members have developed definitions and guidelines for green financial assets and aligned with the Green Bond Principles and the Climate Bonds Initiative. This facilitates the flow of capital to that sector in emerging markets, but members need to work on how to promote consistency and credibility in those products.
The majority of members are developing guidelines that set expectations for how financial institutions manage ESG risks, including provision for reporting by those institutions, third party verification of that data being increasingly encouraged. However, private sector financial institutions in most member countries have not yet shown comprehensive behaviour change towards sustainable finance.
For this, members need to do more to improve their financial institutions’ limited understanding of ESG issues. They need to establish more robust reporting and monitoring frameworks for financial institutions that require transparency on ESG factors. Overall, sustainable finance needs to be the central focus of supervision by financial regulators.
When examining the state of sustainable finance in Australia, similar themes emerge. The Australian Sustainable Finance Initiative (‘ASFI’) is a multi-stakeholder initiative which has produced an Australian Sustainable Finance Roadmap and, in December 2019, a progress report. According to the ASFI, although sustainable finance markets in Australia are experiencing rapid growth, the financial sector faces challenges in responding to the risks and opportunities posed by ESG issues.
First, within the financial sector, there is a lack of appropriate skills and understanding of ESG related risks and opportunities. ESG issues are often undervalued, considered through a short-term horizon or excluded from decision making. The sector needs accurate and timely information to properly value ESG issues, but there is a lack of quality standardised data that enables comparability and consistent valuation.
Sustainability reporting, along with assurance on those reports, remains voluntary, resulting in concerns over veracity and a lack of comprehensiveness and consistency.
Similarly, while new sets of frameworks, tools and standards are rapidly emerging, they also suffer from a lack of consistency in their content, adequacy and use, all of which inhibits comparability and makes it difficult for investors to integrate ESG issues.
There has been growth in the development of sustainability bond markets and expansion in the range of sustainability-related financial instruments in Australia. However, there is a need for proper definitions of what constitutes a sustainable investment or product. The absence of such definitions inhibits capital flowing to sustainable outcomes.
For this, Australia needs a sustainable finance taxonomy comprising a body of common definitions for sustainable investment aligned with the Paris Agreement and the UN Sustainable Development Goals.
To address all of these challenges, leadership is needed, particularly from Australian financial regulators. Although Australian regulators have not introduced a national sustainable finance framework, they have undertaken a range of focused initiatives that progress with integrating ESG considerations into their supervisory frameworks, requirements and guidance. The Australian Prudential Regulation Authority has issued guidance on climate change. Even so, there remains a lack of guidance around how social and environment risks, outside of climate related risks, should be prioritised.
The state of sustainable finance in emerging markets and Australia shows similar features. A low awareness of ESG issues within the financial sector exists with the difficulty in obtaining reliable information and methods to consider those issues. Along with the need for adequate sustainability-related reporting, all of these challenges require regulators to lead through collaboration and the provision of guidance and regulation.
For shareholders in financial services firms, these developments present an opportunity for these firms to open new markets, improve loan or asset quality and improve their reputations. However, shareholders should assess the relevant policies of these firms, their progress with green finance, their exposure to ESG risks and how they support their customers in managing them. For Australian banks this is particularly important for agriculture and retail mortgages which face risks from more intense storms, floods, drought and heat. Should financial services firms fall behind on these issues they risk being at a competitive disadvantage and attracting the attention of regulators.
Paul Millar is a mentor at Altiorem and a lawyer with a background in International Human Rights. Paul holds a PhD in Law based on research in the fields of Business and Human Rights and Socially Responsible Investment.
Pablo Berrutti is Altiorem’s founder, he has deep investment and financial services experience including responsible investment, risk management, marketing, communications and strategy. He is currently a senior investment specialist for Stewart Investors Sustainable Funds Group and was formally the Head of Responsible Investment, Asia Pacific for Australia’s second largest fund manager.
Originally published in SAFAA Monthly September 2021
