Cracking the Code to Decarbonizing Finance

May 19, 2023

Financial institutions serve as the keystone to decarbonizing the global economy in efforts to ultimately minimize the impacts of climate change. Nearly all companies rely on investors to drive growth and innovation. By influencing the alignment of capital flows with decarbonization pathways, financial institutions have both the power and the responsibility to drive a continuum of environmental, social and governance (ESG) management strategies across every sector. For financial institutions seeking this catalytic role in the global ESG transformation, it is important to first solidify their own strategy and approach to decarbonization.

The amount of capital needed to reach a net-zero economy depends on various factors, such as the pace of the transition, the scale of investment required, and the specific technologies and infrastructure needed to achieve net zero emissions. Estimates vary widely, but a recent report by the International Energy Agency (IEA) suggests that achieving net zero by 2050 would require at least USD 90 billion in public funding to be raised by 2026. This funding would be used to complete a portfolio of demonstration projects for technologies that could be commercially ready by 2030 and contribute to achieving net-zero emissions by mid-century. This represents a significant increase in investment compared to current levels, but the IEA also notes that the benefits of this investment, in terms of reduced climate risks, improved health outcomes, and enhanced energy security, would far outweigh the costs.

The basics of sustainable finance

What are sustainable investments?

The Sustainable Finance Disclosure Regulation (SFDR), as part of the EU sustainability legislations, has established a more comprehensive sustainability reporting framework for financial entities to disclose on their ESG data. This regulation provides a common language to define a “sustainable investment” as one that contributes positively to an environmental or social objective, providing that there is no harm to any environmental or social objectives and that the reporting company follows good governance practices.

What is the UNEP FI?

Meeting the UN’s Sustainable Development Goals (SDGs) and the Paris Agreement requires increased capital flow toward sustainable or environmentally conscious activities. The United Nations Environment Program Finance Initiative (UNEP FI) seeks to provide potential action plans that expand sustainable finance to meet these climate goals. The initiative brings together a wide network of investors, insurers, and banks to collectively drive action across the entire financial system to enhance the sustainability of global economies. Financial institutions should use the guidance set forth by the UNEP FI as they work towards decarbonizing finance and navigating climate risks.

What is GFANZ, and how does it fit in?

The Glasgow Financial Alliance for Net Zero (GFANZ) is one of the newest players to take the stage. GFANZ is a worldwide partnership of prominent financial organizations dedicated to expediting the process of decarbonizing the economy and has a crucial role in advancing sustainable finance. As a global coalition of leading financial institutions committed to accelerating the decarbonization of the economy, GFANZ has the potential to catalyze significant change in the financial sector. By promoting the integration of ESG factors into investment decisions, GFANZ can drive capital towards sustainable investments that support the transition to a low-carbon, climate-resilient future. Furthermore, GFANZ can help to build market confidence and improve transparency through the development of standardized reporting frameworks, enabling investors to better assess the sustainability performance of companies and financial institutions.

Utilizing a sustainable investment strategy

When making investment decisions, investors have a lot to consider and prioritize in terms of which investments hold the greatest value. To dive deeper into these considerations, Schneider Electric and Women Action Sustainability (WAS) partnered to perform research with some of the world’s largest financial institutions. The purpose of this research was to better understand the drivers and challenges financial institutions are experiencing as they seek to integrate ESG criteria into investment decisions.

Across the board, investors are becoming increasingly interested in integrating ESG criteria as they make investment decisions. The majority of respondents gave ESG a rank of 9 out of 10 in terms of its importance when making investment decisions. Digging a layer deeper into the many topics under the scope of ESG, the research showed that climate change, diversity and inclusion, and corporate governance made their way to the top of the list.

While commitments to sustainable investments are making headway, challenges still remain around how financial institutions will bridge the gap between commitments and action. In speaking with financial institutions, we have identified several key challenges to addressing ESG issues, four of which were acknowledged by at least half of the respondents:

Measuring impact (75%)
Lack of baseline data (60%)
Large heterogeneity of ESG reporting standards (50%)
Incorporation of ESG performance in ROI (50%)

At the core of these challenges lies the need for accurate and informative data.

What role do targets and commitments play in sustainable investing?

Targets and commitments play a critical role in measuring climate action progress and holding institutions accountable for their sustainability performance, helping to build trust and confidence in the financial system. By setting ambitious targets and making external commitments, the financial sector can play a pivotal role in promoting sustainable development and addressing the urgent challenge of climate change. Regulations and the need for strong commitments around ESG drive positive action by creating a level playing field for companies and financial institutions, incentivizing them to prioritize sustainability and take meaningful steps toward reducing their environmental impact.

Where data drives impact

What is the role of data in sustainable finance?

Data plays a significant role across the lifespan of a sustainable investment. Each company’s decarbonization strategy and climate goals are unique and may reflect sector-specific guidelines or standards. This adds a level of difficulty for investors and funds attempting to compare one company against another, resulting in difficult investment decisions. Without access to reliable and comparable data, these early investment considerations will only continue to blur for investors, investees, and banks alike. Further, data-based solutions can provide insights on key performance indicators across an entire financial institution.

What data should an organization track?

Accurate data has the power to enhance an organization’s performance, and thus the performance of investment portfolios. However, knowing what data to collect can be a difficult first step in making the leap to prioritize ESG criteria. The key here is knowing what ESG topics are most important to the business and narrowing in data collection, management, and analysis where it is most actionable. Simply put, having more data is not always better if it doesn’t lead to valuable insights and the ability to drive a positive change.

Sustainable finance in action: four recommendations for strategic ESG integration

Start small and take action: When it comes to sustainable finance, starting small is better than not starting at all. Begin by identifying the most important ESG topics and taking action to address them, rather than waiting for a perfect solution.
Prioritize data collection and reporting: When investment decisions are based on accurate and verifiable data, they have the potential to make the greatest positive impact on sustainability.
Collaborate for greater impact: The power of partnerships and collective action should not be underestimated. Collaborative efforts will prove to drive sustainable change at scale.
Continuously optimize: As the ESG landscape continues to evolve, adapt the short-term actions in order to generate the greatest long-term impacts from ESG investments.

This article was written by Cristy House, Private Equity Practice Lead and Ally Temple, Sustainability Analyst for Schneider Electric.

As the Private Equity Practice Lead for Schneider Electric Sustainability Business, Cristy and her team support private equity and global investment banks with portfolio and fund level strategy. They also work directly with real estate and infrastructure funds to proactively manage their ESG risk.