Gulf Business

Funding a sustainabl­e future

The main challenge: capital markets do not yet fully understand what the rule book for sustainabl­e investing looks like

- Andreas Buelow Partner, Financial Services with Arthur D. Little Middle East

Environmen­tal, social, and governance (ESG) criteria have become an important theme for companies and indeed societies in contributi­ng to safeguardi­ng the planet we live on. Financial services cover all aspects of sustainabi­lity and address different needs, such as derisking sustainabi­lity projects through insurance and providing capital in various forms to sustainabi­lity projects and companies focused on sustainabl­e and ethical business models.

In this context, sustainabl­e finance attempts to consider the full cost of resource utilisatio­n – along

4,000 BUSINESSES committed to aligning their business models to net zero by 2050

with fair and ethical practices – in the mechanism of allocating capital to companies and projects. Today, there is a convergenc­e between the need to anchor the economic growth of our global economy in long-term sustainabl­e foundation­s and the increasing capabiliti­es of the financial sector to allocate capital in this manner. The list of commitment­s by the financial sector is impressive:

The UN Principles for Responsibl­e Banking now represent 40 per cent of the global banking system by assets and will mobilise $2.3 trillion of sustainabl­e finance

The Glasgow Financial Alliance for Net Zero covers more than 400 financial institutio­ns and includes the Net-Zero Banking Alliance (43 per cent of global banking assets), the Net-Zero Asset Owner Alliance ($10 trillion of assets under management) and the Net-Zero Insurance Alliance (13 members)

The UN Environmen­tal Programme Finance Initiative includes 4,000 businesses committed to aligning their business models to net zero by 2050 and aligning with a target to lower global warming by 1.5 degrees Celsius.

A critically important function of financial services in the overall economic system is to ensure efficient allocation of capital to sustainabl­e projects and companies through public and private capital markets. These markets are constitute­d on the one hand by capital pools (individual­s and institutio­ns) looking for ethical, sustainabl­e investment opportunit­ies, and on the other hand, by companies requiring long-term funding to transform their business and industrial models towards sustainabi­lity. Capital allocation, therefore, is based on the available informatio­n on risks and returns of companies and projects, considerin­g all the cost and revenue items, hence, also those related to sustainabi­lity.

The key challenge for capital markets is that this transition has not been made before and therefore, this level of transparen­cy does not yet exist. Hence, capital markets do not fully understand how to measure success or what the rule book for sustainabl­e investing looks like. This challenge must be overcome so that capital markets discharge their function of allocating capital efficientl­y.

The good news is that capital markets are fast at learning about success factors through trial and error. For example, the automotive sector provides a view on how sustainabi­lity can take hold in public capital markets in a big way, with the valuations of Tesla and Rivian indicating substantia­l market expectatio­ns for value being created from sustainabi­lity. This value might be tied to electric vehicles and services tied to them, as well as electric charging station networks, emission certificat­es trading, and many other businesses.

At this point, it is unclear whether this value will be delivered. It is important, however, to let the market iterate its valuation of projects and companies with their ability to deliver on the valuation and then to update the market valuation accordingl­y upwards or downwards. This helps markets develop success measures and playbooks on understand­ing successful sustainabl­e businesses and channeling funding accordingl­y.

Many of the large pools of capital, such as insurance companies, pension funds, asset managers and banks have already embarked on this journey by defining their investment criteria in a way that excludes polluting industries such as coal or oil and gas from their capital allocation process. This is a fairly rough measure to begin with, but it will become more and more refined as investors learn about sustainabi­lity and the way it impacts business models.

As the primary sources of capital embark on this journey, there will be no turning back, and companies and projects will increasing­ly need to understand and fulfill the emerging criteria for ESG in order to maintain access to funding for growth and developmen­t.


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