In the new year, after the US election, I am reminded of the dangers of over-research while I prepared to do a piece on sustainability financing. What follows is still part of the discussion today, as are business-based principles which hopefully will still hold true in future.
For sustainability to count in business we need two things, over what I would call the moral impulse to do so, which is an imperative if we want to avoid unwittingly stepping into a Mad Max future:
With these basic pieces in place, creative destruction takes place, and the best solutions win.
For the context of sustainability, we need a slight but important modification as the end-goal in this case is to create systems that contribute to prosperity in perpetuity or as long as needed, as a simplified but essential statement.
This implies a rethinking of existing business practices and a new framework in future, starting at the base with more holistic accounting methods. This and the SDGs have been the stated vision for a while, and so, the question is how does sustainability get financed today?
I prefer to detail mechanisms only here, rather than the underlying strategies to get to sustainability, as these diverge for almost everyone, with everything from Net Zero to Nature Positive et al. Another disclaimer: An open question is whether markets such as we know them today are truly free, rather than structurally driven to reflect ideology, rewarding cronyism and dumping externalities.
Let us look at the major “styles” of pathways out there today, and how these can make markets evolve in the long term.
We can start by describing how a firm or a person decides to spend capital to reach a certain outcome under some risk.
Rather obviously, the frequently decisive factor is one of a financial return, capturing value created from the spent capital. Discount rates allow comparison between different projects in different times, and the risk factor weighs attractiveness within the same time periods.
These choices respond to market conditions. Entrepreneurs, the recipient of capital, by definition have ideas that lead them to attempt to value-capture within those market conditions. So while their success can shift entire market structures (eg by being disruptive, cheaper, faster than the existing solution) this is rare for sheer technical improvements, and can be hard to predict ex-ante without a strong conviction or some asymmetric info, or a long enough horizon so that financial return can be deferred. Competition is often not far behind, making any ascendancy short-lived.
Another area of ongoing interest in is that of contracting ahead to reach desired outcomes, thus linking financial reward with the broad benefits identified by the contractor, in the best of cases reshaping markets to take on sustainable dynamics that were otherwise out of reach in the short term. Impact Investing is fairly well-known, but the challenge is to have the discipline of a credible model for the expected benefits.
Another big bucket is the practice of lending money with a comparatively tighter scope than investing as above. This includes green bonds that finance a specific project, such as green infrastructure, with a “risk-free” fixed payout. The commitment involved limits this mainly to institutions with the influence and resources to make such an arrangement attractive for the bonded, and investors willing to forgo potentially higher returns elsewhere.
One entity able to do development at greater scale than the individual and more ideologically than the private sector is Government, building in objectives that go from electoralism, societal or geopolitical ends.
Europe has the Green Deal, and as of now, the Environmental Protection Agency (EPA) in the U.S. gives grants for projects that help advance policy and/or scientific objectives, such as greenhouse gas (GHG) reduction, destined to create the foundations of new greener approaches. On first impression, it seems onerous for grantees to apply for, with many bureaucratic guardrails and reporting requirements that gum up the disbursement of what is ultimately the taxpayer’s money.
Given the upcoming U.S. political transition, a change in approach looks all but certain, regardless of the soundness of the investments made so far. This also means that the Environmental, Social and Governance (ESG) metrics reported by the private sector, already putting some in a state of knee-jerk revulsion at the mention of the acronym, are eventually likely to be comprehensively rejected on principle, which is unfortunate.
While this is a setback for transparency and auditability, it’s also a chance to repackage those important dimensions into a more tangible expression of value; as an added benefit, the more rigorous the definition is, the more greenwashing abuses are harder to conceal within corporate ambiguity or imperfect financial accounting.
This would be more the approach of Carbon Collective, which uses “traditional” retail investing, with its established systems of valuation and market, with the stated ulterior motive of driving green shareholder activism.
Here I wanted to list out the possible ways that projects designed to follow sustainable principles can be supported at the outset, despite barriers including possible lower financial returns and ongoing institutional changes. For the long term, science gives an indication where we are headed, and therein lies what will eventually matter.