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Are you interested in the role of finance for sustainability?

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Our summary today works with the article titled Too risky – The role of finance as a driver of sustainability transitions from 2022 by Björn Nykvist and Aaron Matlais, published in the Environmental Innovation and Societal Transitions journal. This is a great preparation to our next interview with Josh Dry in episode 204 talking about efforts to transform the financial sector. Since we are investigating the future of cities, I thought it would be interesting to see how transitions towards sustainability can be mirrored in the financial sector. This article investigates what motivates the sector and how to govern a faster transition.

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Welcome to today’s What is The Future For Cities podcast and its Research episode; my name is Fanni, and today I will introduce a research paper by summarising it. The episode really is just a short summary of the original paper, and, in case it is interesting enough, I would encourage everyone to check out the whole paper. Stay tuned until because I will give you the 3 most important things and some questions which would be interesting to discuss.

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Sustainable and ethical investing emerged in the 1970s and expanded in the 1990s with ethical mutual funds, positioning the finance sector as a significant force in promoting sustainable economic transitions. Financial institutions have the potential to drive shifts towards sustainability by incorporating environmental, social, and governance – also known as ESG criteria into their investment strategies. However, despite increased ESG adoption and assets, the real impact on achieving a sustainable economy is debated. Questions remain about the finance sector’s commitment and the actual effectiveness of these practices in effecting environmental and social change, highlighting the need for a more profound exploration of financial actors’ roles in fostering systemic sustainability transformations.

The Multi-Level Perspective (MLP) framework views transitions as interactions among niches (innovation sites), regimes (current systems), and landscapes (broad trends). Finance, once overlooked in MLP, is now seen as vital for sustainability transitions, impacting various sectors by promoting or obstructing change. Recent research underscores finance’s role in enabling systemic shifts towards sustainability, suggesting that integrating sustainable finance practices could greatly influence global economic transitions, consistent with MLP’s focus on the interplay between innovation, systemic structures, and broader trends.

Sweden’s financial sector, a leader in sustainable finance and an early adopter of green bonds, is examined for its role in sustainability transitions. Interviews with banks, pension funds, and asset managers revealed the drivers and obstacles of sustainable finance, including economic incentives, regulatory impacts, and challenges. The research, through anonymized discussions, aimed to understand how tools like green bonds influence the movement towards sustainable projects, focusing on the interplay between risk, reward, and progress in sustainable finance.

Customer demand drives financial institutions toward sustainable finance, with investors increasingly favoring green options, nudging the sector to see sustainability as a strategic focus. However, this shift is challenged by the sector’s emphasis on risk-adjusted returns and a cautious stance towards riskier sustainable projects, exemplified by the preference for low-risk green bonds. The growth of sustainable investments is hindered by risk aversion and a shortage of viable projects, underscoring the importance of public-private partnerships and policy measures to enhance sustainable finance efforts.

In sustainability transitions, financial support evolves from high-risk investments by founders and venture capitalists in the early stages to more secure, lower-risk financing methods like private equity and bonds as projects scale. This shift underscores the challenges in raising capital for novel solutions, particularly as the need for funding grows alongside the transition’s progression. The tendency for later-stage investors to prefer established players over new entrants exacerbates the difficulty in financing innovative, sustainable solutions. This preference for established actors reflects a broader systemic inertia, limiting the finance sector’s potential to support transformative sustainability projects. Despite the growth in green bonds, which are seen as a way to fund sustainable projects, they often carry the same risk profile as traditional bonds, suggesting a limitation in their ability to significantly accelerate sustainable finance beyond existing practices.

The renewable energy transition illustrates how financing mechanisms have largely remained consistent, with public support playing a crucial role in reducing risks and enabling the use of conventional finance methods. This indicates that while the importance of sustainable finance has been recognized, the methods of financing have not fundamentally changed to support riskier, early-stage sustainability projects. The discussions emphasize the need for improved risk-sharing between the private and public sectors to facilitate more significant investment in sustainability. This involves creating models of risk-sharing that can support the transition in sectors where transformation is most challenging, suggesting a need for greater public sector leadership in initiating large-scale, sustainable projects. The dialogue highlights a dual approach: enhancing policy measures to improve the competitiveness of sustainable options and fostering private-public partnerships to drive innovation and investment in sustainability transitions.

Sweden’s finance sector, while valuing sustainability, is primarily focused on maximizing returns, leading to a cautious integration of sustainability measures. This focus, coupled with regulatory norms favouring stability, necessitates clear policy directions and public initiatives to effectively signal market shifts towards sustainable investments. Historical evidence, such as the support needed for renewable energy developments, shows that policy backing is critical, as financial innovation alone cannot drive significant sustainability changes. Progress relies on enhanced collaboration between government policies and financial mechanisms, highlighting the importance of innovative risk-sharing approaches. Policymakers are called to establish clear sustainability strategies, encouraging the finance sector to engage more deeply with sustainable investments, thereby supporting the sector’s significant role in achieving future sustainability goals.

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What was the most interesting part for you? What questions did arise for you? Do you have any follow up question? Let me know on Twitter at WTF4Cities or on the wtf4cities.com website where the transcripts and show notes are available! Additionally, I will highly appreciate if you consider subscribing to the podcast or on the website. I hope this was an interesting paper for you as well, and thanks for tuning in!

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Finally, as the most important things, I would like to highlight 3 aspects:

1. Sustainable and ethical investing, notably with the rise of ESG criteria, positions the finance sector as a pivotal force in driving sustainable economic transitions.
2. The integration of finance in sustainability transitions, especially in sectors like renewable energy, requires clear policy directions and innovative public-private partnerships to overcome inherent risk aversion.
3. Sweden’s leadership in sustainable finance, especially through green bonds, demonstrates its role as a positive example for financial sustainability efforts globally.

Additionally, it would be great to talk about the following questions:

1. In light of the growing emphasis on ESG criteria, how can investors and financial institutions ensure these factors genuinely contribute to systemic sustainability transformations?
2. Considering the finance sector’s crucial role in sustainability transitions, what innovative strategies could further leverage its impact beyond traditional green investments?
3. What role do you believe public policy should play in accelerating the finance sector’s transition towards more sustainable practices?
4. How do you envision the future of sustainable finance evolving, particularly with the challenges of aligning risk and return with sustainability goals?

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