As policymakers are strengthening the regulatory framework to foster sustainable transition, banks and financial institutions are also called upon to play their part in choosing to invest in sustainable businesses. This scenario has led to the rise of green finance.
The expression green finance, which is part of the broader field of sustainable finance, refers to financial instruments through which "environmentally sustainable" development, energy transition and the fight against global warming are promoted.
Climate change poses significant risks to businesses around the world: extreme climate events (such as floods, wildfires, and drought) can have a significant impact on businesses, as they can result in supply chain disruption, loss of assets, and even damage to office buildings or industrial facilities.
However, extreme climate events are not the only risks to business continuity: the supply chain interruptions that have happened in recent years have underlined the importance of having a sustainable procurement strategy.
Green financing refers to the practice of providing financial support and investment for projects that promote environmental sustainability and address climate change. It involves directing funds towards activities that have a positive impact on the environment. Some examples of green finance include renewable energy projects, energy-efficient buildings, sustainable agriculture, and clean transportation systems.
The main goal of green financing is to mobilize capital and encourage the transition to a low-carbon and more sustainable economy. It goes beyond traditional financing by incorporating environmental factors into investment decisions and considering the long-term risks and opportunities associated with climate change.
Green financing encompasses a range of green financial assets and products designed to support sustainable projects and initiatives. A company or organization who wants to implement a green financing strategy can use different green financing instruments, including loans, grants, bonds, and equity investments.
Financial institutions, such as banks, development agencies, and private investors, play a crucial role in providing capital for green projects. Governments also have an influence through policies and incentives that encourage the adoption of sustainable practices and attract investments in green initiatives.
Last, but not least, technology is also crucial for green finance, both in the analysis of potential green investment and in boosting transparency along the supply chain. While ESG solutions help organizations with the first aspect and are nowadays known as enablers of a more sustainable finance, another exciting advancement is the integration of blockchain technology in green finance. Blockchain offers transparency, traceability, and enhanced security, which are crucial in verifying the environmental impact and authenticity of green finance transactions. It can streamline processes, reduce costs, and improve efficiency in areas like carbon credits trading and sustainable supply chain financing.
When developing a green financing strategy, several factors need to be considered to ensure its effectiveness and alignment with sustainability goals, such as:
Market demand and trends. Assessing market demand and trends is essential to identify viable green projects. Understanding consumer preferences, industry dynamics, and market trends can help identify areas of growth and potential investment opportunities. Conducting market research and engaging with stakeholders can help gain insights into market demand and potential risks.
Stakeholder engagement. Successful green financing strategies require collaboration and engagement with various stakeholders. Engaging with investors, financial institutions, government agencies, and communities is crucial to understand their perspectives, expectations, and needs. Stakeholder engagement helps build trust, gain support, and ensures the strategy aligns with the broader sustainability objectives.
Reporting and transparency. These aspects are essential for the credibility and integrity of green financing. In order to track and communicate the environmental impact and financial performance of the financed projects it is important to establish clear reporting mechanisms. Furthermore, it is vital to ensure transparency in project selection, due diligence processes, and investment decisions to build trust among investors and stakeholders.
By considering these factors, organizations can develop a robust and effective green financing strategy that aligns with sustainability goals, attracts investors, and contributes to a greener and more sustainable future. Let’s find out more about which types of risks need to be considered and how the regulatory framework impacts on businesses and organizations.
The EU Regulation 2088/2019 on sustainability‐related disclosures in the financial services sector defines ESG risks as “an environmental, social or governance event, or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment arising from an adverse sustainability impact”.
Environmental risks are tied to issues such as climate change mitigation and the transition to climate neutrality, i.e., to a zero-emissions economy, as well as issues related to the preservation of biodiversity, pollution prevention and the circular economy.
Social factors refer to issues related to inequality and inclusion, labour relations, investment in training and community welfare, as well as respect for human rights.
Governance issues are linked to various aspects of the corporate governance of public and private institutions. These aspects play a key role in ensuring that social and environmental considerations become part of their decision-making processes, for example through diversity policies in the composition of boards of directors, the presence of independent directors, employees’ relations and remuneration, and much more.
Find out what are ESG risk and why they are important
Climate change and environmental degradation are sources of structural change that affect economic activity and, in turn, the financial system. The European Central Bank (ECB) has published guidelines to help banks better identify these risks and manage them.
According to the guidelines, climate-related and environmental risks can be broken down into two main risk drivers:
environmental degradation, such as air, water and land pollution, water stress,
biodiversity loss and deforestation
indirectly, from the process of adjustment towards a lower-carbon and more environmentally sustainable economy
These risk drivers can impact economic activities directly - for example, resulting in lower corporate profitability or the devaluation of assets - or indirectly, through macro-financial change.
Climate change and sustainability goals set by the European Union - such as the goal to achieve carbon-neutrality by 2050 - have led European lawmakers to undertake a review of the legislative framework on sustainable finance.
This process aims to facilitate and encourage access to the capital market for companies committed to sustainability and to increasingly expand the mesh of disclosure of sustainable investments obligations.
Today, as the process is still ongoing, EU’s legislative framework on green finance stands on three pillars:
Discover the implications of SFDR for businesses
Explore more in depth the EU Taxonomy
Take a more in-depth look at the guidelines for sustainability reporting introduced by the CSRD
Let’s have a closer look at these and other regulatory instruments that guide companies towards a more sustainable finance.
The EU Taxonomy regulation plays a crucial role in the sustainable finance framework of the European Union, serving as a tool to enhance market transparency.
It was developed through a thorough review of European policies supporting sustainable transformation, with a focus on establishing a common language for companies and investors regarding what can be considered "sustainable" activities. This common language enables targeted efforts and investments towards activities that are strategically aligned with the EU's 2030 climate goals.
Effective from 12 July 2020, the regulation has three primary objectives. Firstly, it aims to redirect capital flows towards sustainable investments, fostering sustainable and inclusive growth. Secondly, it addresses the management of financial risks associated with climate change, natural disasters, environmental degradation, and social issues. Lastly, it promotes transparency and a long-term vision in financial and economic activities.
To assist financial market participants, such as asset managers, insurance companies, pension funds, and financial advisors, the regulation provides a set of criteria to determine whether an activity or product can be classified as "sustainable".
According to these criteria, an activity or product can be considered sustainable if it substantially contributes to one or more of the environmental objectives outlined in the regulation, including: climate change mitigation, adaptation, sustainable water and marine resource use and protection, circular economy transition, pollution prevention and reduction, and biodiversity and ecosystem protection and restoration.
Moreover, it should not significantly undermine any of these environmental objectives, comply with minimum safeguards defined in the regulation, and meet the technical screening criteria established by the European Commission.
The regulation outlines the necessary steps for an economic activity to make a substantial contribution or avoid causing significant harm to any of the environmental objectives mentioned. By providing clarity on sustainable activities and products, the EU Taxonomy regulation aims to drive investments towards sustainable practices and facilitate the transition to a more sustainable and environmentally conscious economy.
The Carbon Border Adjustment Mechanism, or CBAM, is a tool promoted by the European Union to address the relocation of carbon emissions. It is also one of the central pillars of the EU's ambitious "Fit for 55%" agenda.
The aim of the CBAM is to align the carbon price of domestic products with imports, ensuring that EU climate policies are not undermined by production shifting to countries with less ambitious environmental standards or by the substitution of EU products with higher carbon intensity imports.
The CBAM is WTO-compatible and encourages the global industry to adopt greener and more sustainable technologies.
Like other sustainability policies, the CBAM will apply to companies in multiple stages. The initial phase, known as the "transitional phase" commenced on October 1, 2023. During this phase, it will only apply to imports of cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen. EU importers of these goods will be obligated to report the volume of their imports and the greenhouse gas emissions associated with their production, without any financial adjustments.
The first report must be submitted by January 31st, 2024, although importers are encouraged to collect data starting from the fourth quarter of 2023.
The CBAM provides flexibility in the first year of implementation, allowing the use of default values for reporting embedded emissions and the option to utilize the monitoring, reporting, and verification rules of the country of production.
The transitional phase will serve as a learning period for importers, producers, and authorities, enabling the European Commission to gather valuable information on embedded emissions and refine the methodology for the definitive period starting in 2026.
From that date onward, importers will be required to purchase and surrender the corresponding number of "CBAM certificates" for the greenhouse gas emissions embedded in the CBAM-covered imported goods.
The functioning and scope of CBAM will undergo a review during the transitional phase, which will be completed before the start of the definitive period. This review will include an assessment of the possibility to expand the scope of CBAM to other goods produced in the ETS sectors (Emissions Trading System).
The CRSD, which stands for Corporate Sustainability Reporting Directive, is a regulatory framework introduced by European lawmakers in 2021 to replace the previous European Non-Financial Reporting Directive (NFRD).
The NFRD had already encouraged many companies, including those not obligated to report sustainability information, to communicate their sustainability initiatives to attract environmentally conscious consumers. But it was not enough.
The main objective of the CSRD is to accelerate the transition towards a more sustainable economy and combat greenwashing practices, where companies falsely communicate their sustainability efforts.
As previously mentioned, the CSRD expands the scope of reporting obligations from 11,000 to 50,000 companies in Europe. Under the new directive, companies with a minimum of 250 employees are required to disclose non-financial information starting from the fiscal year 2023. Additionally, the CSRD proposes to extend the reporting requirements to listed small and medium-sized enterprises (SMEs), excluding microenterprises.
The implementation of the CSRD will take place in several phases. By 2025, the guidelines will apply to companies already subject to the NFRD. In 2026, companies not previously subject to the NFRD will be included. In 2027, listed SMEs, small and non-complex credit institutions, and captive insurance companies will be obliged to report. By 2029, the reporting obligations will extend to third country firms.
The Corporate Sustainability Report, as required by the CSRD, includes various elements such as a description of the company's business model and strategy, its policies on sustainability issues, identification and mitigation of negative impacts, management of sustainability-related risks, and the necessary KPIs for reporting.
To prompt businesses to adopt sustainable practises, in February 2023 the Commission adopted the Corporate Sustainability Due Diligence Directive (CSDDD).
Its purpose is to promote responsible and sustainable corporate behaviour while embedding human rights and environmental considerations within companies' operations and corporate governance.
According to the directive, companies are obligated to identify, address, prevent, mitigate, and account for any negative human rights and environmental impacts. These impacts may include issues such as child labour, worker exploitation, pollution, and biodiversity loss, both within the company's own operations, subsidiaries, and value chains.
The directive applies to three group of businesses:
Furthermore, Group 1 companies must develop a plan to align their business strategy with limiting global warming to 1.5 °C, in line with the Paris Agreement. The directive also introduces directors' duties to establish and oversee the implementation of due diligence, integrating it into the corporate strategy.
While the obligations do not directly extend to SMEs, they may still be indirectly impacted if they are part of the supply chain of an organization subject to the directive.
In addition, in June 2023 the Commission has launched a proposal for a “Sustainable finance package”, a list of measures which aims to support companies and the financial sector by encouraging private funding of transition projects and technologies and facilitating financial flows to sustainable investments.
In addition to promoting accountability and, consequently, incentivizing the adoption of virtuous behaviours, the sustainability regulatory framework aims to motivate banks to consider ESG risks in investment decisions.
Articles 73 and 74 of the CRD require institutions to implement internal governance arrangements, processes, and mechanisms to ensure effective and prudent management of the institution. This requires knowledge and monitoring not only of current risks, but also of those that could jeopardize the sustainability of the business model in the future.
As the ECB’s guidelines state, institutions are “expected to monitor, on an ongoing basis, the effect of climate-related and environmental factors on their current market risk positions and future investments, and to develop stress tests that incorporate climate-related and environmental risks”.
In addition, the CRSD introduced the concept of double materiality, according to which institutions must consider environmental and social factors affecting the business, as well as the impact of the business on environmental, social and governance issues.
The scope of the analysis cannot be underestimated, due to the impacts these risks may have on the business model, but also because of the size of the challenge. It is, however, a necessary analysis, not only to meet the targets and obligations imposed by policymakers but also to make sure to build investment strategies and portfolios that can ensure the stability of the business model and foster its growth.
Overall, while green finance offers significant advantages in terms of environmental sustainability and economic opportunities, there are still several challenges that need to be addressed in order to ensure the long-term success of a green financial strategy.
The advantages of adopting such approach relates to several aspects of the business include:
ESG digital platforms can help institutions to collect relevant ESG data, evaluate and compare the sustainability of potential investments. These are solutions that automate the process of collecting and analysing ESG data from companies, returning an overall sustainability score, as well as for specific business areas.
The accuracy of the analysis performed is crucial to the selection of businesses aligned with sustainability requirements. This is why it is important to choose solutions based on accurate, up-to-date, and in-depth data, adhering to international standards.
In addition, since obligations are not the same for all market stakeholders, the data collected and the analysis tools must be customized to the needs of financial institutions and banks.
Synesgy has developed a digital platform to measure the environmental, social and governance impact of companies, banks, and insurance companies.
The framework enables the analysis of businesses' ESG ratings which are collected through a standardized process that considers both general ESG indicators and specific industry requirements, as well as national legislations.
Synesgy’s questionnaires are based on timely and rigorous references to global ESG market regulations (such as UNGC, GRI, UN 17 SDGs, EBA LOM, and EU Taxonomy for Sustainable Activities) and are certified by the CRIF Rating Agency (CRA), which is recognized at the European level.
The accuracy of the information provided is ensured through an automated Alert system that detects inconsistencies and by reoccurring checks carried out by Synesgy’s consultants.
Learn how Synesgy can help the financial and banking sector
Synesgy’s platform allows for an easy visualization of the score obtained in the 5 macro sections of the questionnaire: Business, Environment, Social, Governance, and Sector. ESG scoring is provided along with a report that highlights areas of the business that need more attention and suggests an Action Plan to address critical issues.
The platform allows to analyse your own ESG rating, but also to compare suppliers’ and potential investments’ ratings. Through careful and certified analysis of ESG indicators, Synesgy allows Banks and Insurance companies to:
This trusted approach allows Synesgy to issue a certificate in green and sustainable finance at the end of the assessment, which allows the organization to demonstrate its commitment towards sustainability, with all the advantages we have seen. Synesgy’s consultants are always available to guide companies in transforming the complexity of the ESG ratings and reporting into competitive advantages. Find out how!