Shifting the Social Licence from Corporates to Financial Institutions

Despite increased recognition of the urgency of the climate emergency, and the benefits of dedicated action, the world still does not invest nearly enough in key sectors for the sustainability transition such as agriculture, land use, energy, climate mitigation and adaptation and health.

There is an estimated financing gap of $2.5–3 trillion per year to achieving the Sustainable Development Goals1 while an estimated $4.4 trillion a year is needed for the next 30 years in the energy sector alone in order to meet the goals of the Paris Agreement.2

Lack of capital is not the problem. Retail investors alone hold more than $110 trillion in investments3 and, of the estimated $91 trillion of investible capital held by institutional investors in global capital markets, over $9 trillion is held in negatively-yielding bonds.4 The crux of the challenge is to shift available capital to projects and companies that develop solutions in critical areas and seek to achieve social and environmental progress.

This failure to direct capital to sustainable activities is beginning to receive more criticism from wider society. There are growing campaigns for more accountability over investments and higher levels of sustainable finance such as the Make My Money Matter campaign.

Individual consumers are starting to make their voices heard too with protests regularly drawing attention to the role of finance in funding environmental destruction such as when the Extinction Rebellion targeted branches of Barclays in spring 2021.5

The coming of age of the millennial generation signals a potential influx of investors who are more committed to sustainable investments than their parents were. Some $68 trillion is expected to transfer to millennials in the next quarter of a century6 and they have expressed strong interest in aligning investments with their values and shifting their money into sustainable investment options at a rate twice the average.7

Millennial investors and millennial finance professionals are starting to challenge the industry status quo and calling for an industry-wide paradigm shift towards generating long-term returns for a healthy planet and an equal society.8

This, in turn, is pushing aspects of the ‘social licence to operate’ – the acceptance of a company or industry's business practices by its employees, stakeholders and the general public – from companies onto the institutions that finance them. Light is increasingly being shone on investors’ actions and their role in exacerbating harm or improving public good. Divestment movements have grown in scale and power seeking to pressure investors to reduce, or at least accurately price, their holdings in sectors ranging from coal to intensive meat and dairy.9

To maintain their social licence to operate, those in the finance industry must target their investments at companies with a positive social and environmental impact. Consumers can play a role in making sustainable investment the new normal. As disruptors within the sector look to upend business-as-usual financing models, providing investment options that look beyond financial return instead, incumbents will be challenged to match this ambition or risk losing ground and legitimacy.

Burgeoning client demand is helping to push up the interest of institutional and retail investors in responsible investing. According to the CFA Institute, 76 per cent of institutional investors and 69 per cent of retail investors have an interest in environmental, social and governance (ESG) investing, though only 19 per cent and 10 per cent of institutional and retail investors currently invest.10 The two main reasons they cite are to manage investment risks and meet client demand – with the latter becoming significantly more important in the three years from 2017–20.11

The past few years have also seen an upswell in private financial institutions committing to net-zero emissions targets. More than 120 financial institutions had joined the Race to Zero Campaign as of May 2021,12 and in December 2020, 30 asset managers, worth more than $9 trillion in assets under management, formed the Net Zero Asset Owners Alliance.13

The Glasgow Financial Alliance for Net Zero Emissions,14 recently launched by the UN Environment Programme Finance Initiative and the Financial Services Taskforce of the Sustainable Markets Initiative, is also supporting an industry-led alliance that convenes 87 asset managers representing $36.95 trillion in assets under management, 42 banks with $28.5 trillion and 58 asset owners with $7.4 trillion to advance the transition to net zero emissions by 2050.

This interest in environmental and social change is indeed beginning to translate into tangible financial commitments with growth seen in sustainable and ethical investing opportunities. Positive signs are appearing with the value of global assets using ESG data to guide investment decisions reaching $40.5 trillion in 2020 – almost doubling since 201615 – while there is also a growing trend towards more interest in social challenges as seen through the greater issuance of social bonds.16

While the growth in awareness of the failings of the current financial system is encouraging, the scale of corrective action needs to be ramped up and, at present, many commitments remain just that.17

To make sure these commitments amount to more than just 'greenwashing' – or an excuse to maintain the status quo by using offsets – realistic targets are needed that break the move to net zero down into granular steps.18

Within the Science Based Targets initiative’s Banks, Diverse Financial and Insurance groups, while 82 organizations have committed to net zero, only one has actually set a target as of May 2021.19 Continued pressure and clear action pathways are required to ensure high-quality investments are made in the activities needed to create a low-carbon economy and financial institutions don't just continue with business-as-usual while offsetting their emissions. Indeed, a measurement and progress tracking system could be established to monitor the real investments made compared to the communicated plans.

Ultimately, to make positive impact a goal of the investment system, we need to mainstream demand for it. Building consumers’ understanding of the power of their investments to shape a sustainable future can help stimulate demand for products that go beyond basic ESG-screening. Engaging with public relations and communications professionals to showcase examples of success could also help to drive new narratives around new definitions of value.

At present, positive actions in the impact-investing space remain fragmented and small in scale compared to the change needed. The paradigm under which investments are evaluated needs to change to one in which social and environmental goals are foundational considerations for all financial actors. Interventions by major players, such as government regulators, institutional investors and the banking sector, may be needed to make genuinely impactful investment the new normal.