Sustainable finance is a rapidly growing field that seeks to align financial markets with the goal of building a more sustainable and equitable global economy. Despite its growing popularity, there are several barriers that can impede the development of sustainable finance and limit its ability to drive positive change. You’ll discover three of the biggest obstacles to sustainable investment in this article, along with how the sector is attempting to overcome them.
ESG reporting and data
Financial information, risk information, opportunity information, and operational information are all readily available from public corporations. This data is triple-checked for correctness as part of regulatory supervision required by the U.S. Securities and Exchange Commission (SEC). However, since sustainable investment is still a relatively new concept among the general public, reporting rules are not standardized.
Furthermore, data might be false if standards and reporting procedures are not in place. Investors begin to ask whether businesses are cherry-picking their ESG data. This is only to highlight the need for industry experts to put more effort into visualizing a company’s breadth of influence rather than implying that all (or even most) businesses are skipping over crucial plot points.
Despite these difficulties, we see a significant improvement in the way that businesses provide ESG data. Just take a look at the S&P 500 companies: in 2011, just 20% of them submitted ESG reports, but that percentage rose to 90% a decade later. Additionally, ratings agencies are improving, with the majority—if not all—revealing how they assess assets. Governments are paying attention as well; in Europe, the EU Sustainable Finance Disclosure Regulation (SFDR) was passed with the intention of making investment information more understandable for end users.
Although gathering data and reporting on sustainability measures is a significant and difficult challenge, progress is being made.
Monitoring market activity
You put a lot of effort into earning your money, so when you invest, you want it to repay you. Since sustainable investing is still an investment, investors could be reluctant to sacrifice performance. Unfortunately, it’s hard to imagine making money while supporting sustainable businesses.
However, despite continuing worries, performance is not always hampered by sustainable investment. The apparent “cost” of using sustainable business strategies is a prevalent misconception. How is it possible that performance will meet the standard if corporations invest more money in sustainability issues?
The issue is not as simple as it may seem since value creation and sustainability may coexist in certain situations. Researchers at Harvard Business School discovered that organizations that perform well on material sustainability concerns outperform those that do poorly in a landmark study on the topic of ESG materiality.
Additionally, investments in firms with strong sustainability performance outperform (by share price) their inferior counterparts even when sustainability problems were not deemed to be relevant. At the very least, underperformance isn’t always related to sustainable investments, even while previous performance isn’t always a reliable predictor of future outcomes.
With more foundational education, a larger audience will eventually be able to get beyond the barrier of market performance and focus on the possible problems associated with businesses that don’t adhere to key sustainability standards. Given the growing pressure from investors, institutions, and regulators, being on the wrong side of momentum may undoubtedly result in headwinds.
Doubt about changing anything
Investors may not think that an ESG approach is beneficial. They can believe that they are insignificant and unable to affect change. When faced with enormous issues like racial injustice, conserving our seas, and electrifying millions of cars, it might be intimidating.
Although the mental process is clear, the reasoning is faulty. Given enough time, little efforts may result in significant changes. In the United States, 17.1 trillion dollars—or one out of every three dollars under professional management—were invested in sustainable investing techniques at the beginning of 2020. This is an increase of 42% from 2018.
The biggest publicly traded firms in the world have now made a commitment to achieving net zero ambitions. Proxy votes in favor of sustainable business practices are growing increasingly popular, and activist investors are becoming elected to the boards of multibillion dollar businesses.
Large corporations and rating agencies are beginning to break down the effects of sustainable investments from a macro perspective into manageable units. With the use of technology, investments can now be broken down into reports that show their actual effect. These reports may show how many trees a portfolio is planting, how much pollution is being reduced overall, and how many single-use plastic water bottles are being avoided.
The skepticism is sometimes warranted since there is still more to be done, particularly in terms of reporting openness. The availability of more data, however, is beginning to cause the attitude to change. If investors are ready to talk to a professional adviser or go into publicly accessible research, they may find thousands of unique insights.
Failure to deliver immediate returns
Finally, many sustainable finance initiatives may face resistance from companies and investors who see these as costly and unnecessary. Companies might see it as a burden and may not see an immediate return on investment, while investors may perceive sustainable finance as a higher risk investment. To overcome this barrier, it will be necessary to educate companies and investors on the long-term benefits of sustainable finance, such as the potential to mitigate risks and increase resilience, and to design sustainable finance initiatives that align with the needs and interests of different stakeholders.
There are still obstacles to sustainable investment, which might deter investors from participating. These obstacles include data and reporting, false assumptions about investment returns, and a lack of discernible investor effect. While many organizations are laying out their plans for a future that is more sustainable, it will require a coordinated effort from all parties involved—governments, regulators, business experts, and investors—to really make progress.