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Defining sustainable finance

Create more economic and social value through financial products and investments that consider sustainability issues.

Sustainability has become a universal buzzword in recent years. It appears just about everywhere - in corporate boardrooms, political discourse, and dinner table discussions. People are sending a clear signal: sustainability matters, and it matters now.

As environmentally-focused regulation and stakeholder demands accelerate, organizations will be expected to make public climate-related targets, including setting sustainable finance commitments. Companies face a precarious predicament—adopt sustainable finance initiatives and potentially misclassify or greenwash information—or avoid changes to business paradigms and run the risk of financial, regulatory, and reputational damages. This blog attempts to make that choice easier by demystifying sustainable finance, revealing insights into its relevance, component parts, product types, market development and outlook.

    Why is sustainable finance relevant?

    Mounting regulatory and financing pressures are placing sustainability at the forefront of the investment world. Climate regulation has propelled the finance revolution. In the US, enhanced SEC climate-related disclosure requirements expected in April 2023 will push organizations to formally adopt sustainability principles. In the EU, new CSRD standards supported by the Green New Deal enforce adherence to strict climate-related rules and targets. Globally, the 2015 Paris Agreement underscored the plethora of countries ready to commit to a greener, cleaner future.

    The investment required to support a decarbonized world is immense. The UN estimates that global investment needed to achieve UN Sustainable Development Goals is between $5T and $7T annually1. The capital demanded dwarfs the capital supplied toward sustainable development2. Given this looming financing gap, coupled with national decrees to achieve climate goals and minimize climate risks, sustainable financing confers an alluring and timely set of solutions.

    What is sustainable finance?

    Sustainable finance is an overarching term referring to the investment process accounting for and promoting environmental and social factors, as illustrated in the image above. While covering a broad swath of activities, we will focus on a subset of sustainable development: environmental or green finance. Environmental finance represents financing focused solely on environmental issues, such as decarbonization and biodiversity loss. It includes an array of financing vehicles that channel capital into green-labeled projects, climate-change mitigation or adaptation efforts. These investment activities are often grouped within socio-environmental financing, which directs financing toward social and environmental issues. The various types of environmental finance are explained below3:

    I . Socioenvironmental finance: Under this type of finance, projects that harm or potentially damage the environment are prohibited from funding. This concept is broader than green finance in that it focuses on economic growth which may not contribute to environmental outcomes.

    II. Environmental/Green finance: This encompasses all types of projects that are concerned with either optimizing environmental benefits or reducing and/adapting to environmental risks.

    a. Climate finance: refers to financing methods that catalyze low-carbon and climate resilient development

    i. Climate change mitigation: includes avoiding and reducing emissions of heat-trapping greenhouse gases into the atmosphere to prevent the planet from warming to more extreme temperatures.

    ii. Climate change adaptation: The altering of our behavior, systems, and ways of life to protect the environment from the impacts of climate change.

    What are sustainable finance product types?

    Sustainable finance comes in many shapes and forms. Despite the myriad of financing options, the predominant financial instruments are in the form of debt and equity, detailed below:

    I. Green equities: shares of equities/stocks invested in companies and/or funds promoting positive environmental outcomes

    a. Green companies: investments in shares of companies advancing positive environmental goals, such as renewable energy or electric vehicle firms

    b. Green funds (mutual and/or exchange traded funds): investments in funds indexed or selected for companies with positive environment footprints, such as funds with only peer leading companies in terms of carbon reduction

    II. Green debt: debt instruments aimed at projects and/or companies combating climate change and environmental degradation.

    a. Bonds: credit issued in public markets to finance projects aimed at positive environmental change.

    i. Green and sustainable bonds: bonds invested in projects with intended environment goals, such as bonds directed for energy building retrofits

    ii. Sustainability-backed bonds: bonds invested in projects where funding is based on achieving certain sustainable linked goals by a certain deadline, such as bonds directed towards renewable energy infrastructure to meet energy consumption reduction goals

    b. Loans: credit issued in private markets aimed at positive environmental change.

    i. Green and sustainable loans: loans invested to stimulate development of environmentally-friendly services and products, such as energy-saving home-improvement loans

    ii. Sustainability-backed loans: loans invested in projects where funding is based on achieving certain sustainable linked goals by a certain deadline, such as energy-saving home improvement loans with covenants based on meeting energy reduction goals.

    Sustainable finance market developments and outlook

    The global sustainable finance market is growing rapidly. Global borrowing by issuing green bonds and loans, and equity funding through initial public offerings targeting green projects ballooned to $540.6 billion in 2021, a 100X increase since 20124. Overall, sustainable assets under management surged from $30.7 trillion in 2018 to $35.3 trillion in 20205. There are no signs of slowing down. sustainability assets may surpass $41 trillion by 2022 and $50 trillion by 2025, constituting one-third of projected total assets under management globally6. As markets continue to grow and evolve, financial institutions and investors alike need guidance to best position themselves for success.

    How can KPMG help?

    Numerous sustainable finance products and services have emerged to serve disparate segments within the financial sector, including asset and wealth management, corporate and commercial banking, investment banking, capital markets, and everyday consumers. Given this widespread market expansion and adoption, financial institutions are increasingly offering sustainable financing products to their customers. With multiple investment options available, the landscape can appear daunting. Partner with KPMG to navigate the murky waters of sustainable finance. With countless areas of expertise, including sustainability reporting, climate risk management, and emissions calculations, we can illuminate the best path forward for your sustainability journey.

    Footnotes

    1. United Nations Global Compact, “UN Alliance for SDG Finance”
    2. UN Environment Programme, “State of Finance for Nature” (May 27, 2021)
    3. UN Environment Programme, “Definitions and Concepts” (2016)
    4. Reuters, “Global green finance rises over 100 fold in the past decade” (March 31, 2022)
    5. World Economic Forum, “How sustainable investing will become the norm” (February 2, 2022)
    6. Bloomberg, “Sustainability May Surpass $41 Trillion Assets in 2022, But Not Without Challenges, Finds Bloomberg Intelligence” (January 24, 2022) 

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    Meet our team

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    Adam Levy
    Principal, Modeling & Valuation, KPMG LLP
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    Image of Adam Levy
    Adam Levy
    Principal, Modeling & Valuation, KPMG LLP
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    The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. KPMG LLP does not provide legal services.

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