Not a week goes by without news on “Sustainable Finance”, but like all new trends, it may be challenging to get a grip on what it means. Could you explain what it is about?
Sustainable finance generally refers to the process of taking due account of environmental, social and governance (ESG) criteria when making investment decisions. In this respect, the investment decision does not only rely on the possible financial return on investment and the usual risk criteria, but also on ESG factors.
In other words, financial decisions have traditionally been driven by the two main criteria mentioned above: return on investment and risk. Sustainable finance goes a step further and, on top of this, “traditional” criteria also consider environmental, social and governance factors. For example, in sustainable finance, topics such as climate change mitigation and adaptation, inequality and inclusiveness or governance policies and executive remuneration, among other matters, are also considered in the investment decision process.
What is the Luxembourg Sustainable Finance Initiative (LSFI) doing to further help financial institutions transition towards sustainability?
The LSFI’s mission is to raise awareness of sustainable finance, and as you mention, help the financial sector transition towards sustainability. In particular, the LSFI has been mandated by the Government to draft and implement the Luxembourg Sustainable Finance Strategy, where our activities are structured around 3 very interconnected pillars.
One of these is Raising Awareness (Pillar 1), which is the foundation to advance sustainable finance. For example, we organise technical webinars to help financial professionals get acquittance with the latest requirements or developments. In particular, over the last months, we have covered the social taxonomy, blended finance or climate risk and measurement. We also have a monthly newsletter where we gather the latest news, publication, regulatory updates and events on this topic, always aiming to ensure the players stay up to date. We also have a website which acts as a central point of information on sustainable finance, including news and publications, as well as an events calendar gathering upcoming events on sustainable finance in Luxembourg and abroad.
We also work towards unlocking the financial sector’s potential (Pillar 2), providing toolkits that can help professionals navigate the sustainable finance journey. On this topic we have developed a section on our website called Take Action, which is currently developed in two parts. The first one focuses on training and includes a mapping of all the training courses available in Luxembourg and some abroad, offering a classification that helps interested professionals to find what might best fit their needs through some filtering options. The second one is on instruments – namely initiatives, frameworks, standards, and tools that are available for finance professionals to embark on or enhance their sustainable finance journey. This section includes definitions of these concepts as well as a comprehensive selection of each of them, explaining when, how and why to use them. We aim to develop more sections in the future.
Within this pillar we are also launching four cross-sectoral working groups. After a mapping exercise of the Luxembourg sustainable finance ecosystem, we identified some topics where to dive deep and try to find solutions to cover existing gaps collaboratively. The first of these working groups was launched last November and covered sustainable finance education and training. In 2023 we will launch the 3 remaining ones: 1) Climate Measurement and Reporting, 2) ESG Data and 3) Innovation and Retail Products.
Last, we also work towards measuring progress (Pillar 3). Last year we coordinated a Climate Scenario Analysis via the PACTA methodology. This week we have presented the study “sustainable finance in Luxembourg: a quantitative and qualitative overview” where we deep dive into the sustainable finance industry, analysing the main ESG strategies implemented through sectoral analysis and asset classification breakdowns, among other dimensions. This study also presents leading sustainable finance investment practices in Luxembourg and describes the current impact assessment framework.
There seems to be a lot of confusion between Sustainable Finance and Impact Investing. What is the difference between both?
To better understand the distinction, I would like to refer to the spectrum of capital which is a concept that classifies the different levels of sustainable finance or the different degrees to which it can be applied.
Following this classification, we can say that sustainable finance lies between traditional finance and impact investing. As I mentioned before, sustainable finance takes into account financial return but also ESG aspects. Impact investing would be situated on the farthest extreme of these different approaches and it could be defined as investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return. Thus, impact investments put great attention into measuring their impact and tracking the progress of this impact over time.
Last year, Greenpeace reported that Luxembourg sustainability funds barely managed to redirect more capital towards a sustainable economy than conventional funds, “failing to contribute to combating the climate crisis”. Have policymakers secured binding standards to fight greenwashing since then?
Sustainable finance is a journey which is under development. While commenting on regulation or its effects is not under the remit of the LSFI, we can say that the regulatory landscape is constantly advancing. There are several regulatory pieces currently in place to foster transparency and enhance sustainable investments, such as the Sustainable Finance Disclosure Regulation (SFDR), the Corporate Sustainability Due Diligence Directive (CSDD), the Corporate Sustainability Reporting Directive (CSRD), or the EU Taxonomy. Regulation is and will indeed be key to ensure standardization and clarity, which are, together with transparency, the foundations to fight greenwashing effectively. As with any other transitioning process, understanding the actual effects of regulation, whether this needs further adjustments and the effects of sustainable finance on the real economy, will require time and appropriate assessments.
Regarding the fight against greenwashing through the current regulatory framework, it is important to mention that greenwashing is a complex term which, in fact, is yet to be defined and clarified: what do we exactly mean by greenwashing and what classifies as such? Ensuring transparency and confronting malpractices is of utmost importance if we want to ensure the transition towards sustainability. However, in the process of assessing and providing remarks to discourage misbehaviors, we should also take into consideration the effort that is being made by many financial players, regulators and civil society, among others. If we simplify this topic, accusing all sectors’ players when some malpractices are underpinned, might be detrimental to the credibility of sustainable finance as a whole and thus the overall advancement of the transition towards sustainability, which is the ultimate goal. In other words: transparency is an absolute must, but the conversation should be broader than referring to a simplified greenwashing accusation, and should focus on putting the effort into finding the actual wrong practices.
Do you believe we will ever achieve a 100% sustainable finance system? Is it realistic?
The LSFI, in collaboration with PwC Luxembourg, has recently conducted a study on sustainable finance in Luxembourg that aims to analyse where the sector stands. Its quantitative part shows that ESG fund AuM represents more than half of Luxembourg UCITS assets (54.6%) and that the majority of Luxembourg UCITS fund AuM are disclosing as per Article 8 and 9 funds (Over 53% of UCITS AuM in Luxembourg) of SFDR. While this shows only a specific financial sector and refers to one geography, it provides a first snapshot of the relevance that sustainable finance is gaining.
I do believe we will reach a 100% sustainable finance system. In fact, sustainable finance needs to become the new norm and I do hope that, in particular, impact investing will become mainstream, possibly in the near future. We need to transition our economy to a sustainable one as soon as possible and finance has a key role in this transition.
However, currently, rather than analysing whether our financial systems will be 100% sustainable and when, we should focus on ensuring that we have the correct foundations and toolkits in place to be able to quickly and effectively transition. In particular, we need to have solid regulation, available quality, granular and standardized data for financial institutions to access, develop and consolidate the required skill set and for all the involved actors to be well aware of what this means and how to achieve it.