Despite decades of research and discussion, we are still looking for a single, established and broadly recognised definition of sustainability. Its meaning varies for different people in different cultures, and global events have shown how interpretations can and will alter over time.
This range of understanding and malleability raises many questions on how we should proceed with transitioning to a more sustainable world. What is a sustainable transition pathway? How should we view transitional businesses that still make money from carbon-intensive industries but invest in renewables? What should the goal of transition finance be? Who makes the decision?
Unlike sustainable or green finance, which raises financing for ‘green’ projects, transition finance seeks to raise capital to transition ‘brown’ industries. Not all sectors can go ‘green’ overnight, but as a critical enabler of climate action, transition finance should be used to help carbon-intensive businesses decarbonise. And although carbon emissions receive much of the attention, deforestation, water shortages and soil erosion are also serious environmental problems that should not be overlooked.
Therefore, in the spirit of the United Nations sustainable development goals, transition finance should include environmental and social objectives, not least because there are often major interrelationships, cross-dependencies and trade-offs between pursuing different environmental and social results.
‘Do no significant harm’ is a principle that European Union regulators introduced to prevent myopic investment procedures that would concentrate on a specific environmental or social target without giving enough thought to other such objectives. However, applying this can be complex.
Capital markets can play a significant role in assisting the sustainable transition. Yet, there is a need for continued discussions among investors, governments and other stakeholders about the eligibility of investments and to develop common approaches with increased coordination to avoid excluding key actors from transition finance.
To enable a more seamless flow of global transition funding at the scale and pace necessary, it is essential to bridge divergences and allay ‘transition washing’ fears resulting from current practices. ‘Green’, ‘blue’, ‘orange’, ‘social’, ‘sustainable’, ‘transition’ and ‘just transition’ investments are appealing to both traditional and sustainable investors, but neither wants to be duped by perceived window-dressing.
Capital markets can act as vital agents of change, but the ability of capital markets to effect change depends on a balance between the certainty and standardisation that financial markets prize and the capacities and priorities of sovereigns at various stages of development and corporates of various sizes.
Climate transition plans are becoming an increasingly popular tool for conveying information on climate-related commitments and actions. Investors are expecting corporates and sovereigns to develop comprehensive plans that are both ambitious and trustworthy. Unfortunately, the quality and detail of these plans that are made available to the public have been inconsistent up to now, making it difficult to evaluate their credibility. However, initiatives such as the UK’s Transition Plan Taskforce are taking steps to define good market practice for climate-related plans.
One area for consideration and to avoid ‘transition washing’ is for investments and business decisions to be aligned with positive SDG outcomes. These objectives are globally accepted and regularly assessed in a transparent, coherent and structured way.
Stock exchanges can play an important role in connecting capital seekers with capital providers by providing a structured, rules-based and transparent marketplace. They could have a primary role in promoting sustainability in capital markets by developing tools and platforms for sustainability-themed financial services and products. They could create an ‘SDG index’ to distinguish this new asset class aligned with the SDGs by reporting for impact – enhancing the quality of disclosures and harmonising reporting standards.
The EU’s latest sustainable finance framework, and several other countries and industry-led taxonomies, requires investments to demonstrate that they do no significant harm. There is broad consensus that the global economy needs to transition and investing in transitional businesses can benefit society. How ‘significant harm’ is defined and how criteria are set will ultimately determine what constitutes a sustainable transition investment.
This topic will be discussed at this year’s DZ BANK capital markets conference at a special UN day on 12 May. This event constitutes a stepping stone in DZ BANK’s collaboration with the UN Economic Commission for Europe on our way to COP28.
Frank Scheidig is Global Head of Senior Executive Banking at DZ BANK.