Definition of sustainable finance

It covers all initiatives aimed at encouraging companies and asset management firms to take extra-financial criteria into account. These criteria are based on three ESG pillars: environment, social and governance. They cover environmental issues (pollution, climate, biodiversity, etc.), social aspects (particularly with regard to just transition) and good governance practices (director training, executive compensation criteria, diversity within governance bodies, etc.).). With the development of European regulatory dynamics (duty of care, SFDR, DNSH), the analysis of ESG criteria in investment practices, a prerequisite of SRI, is set to become a ‘minimum requirement’. Of course, socially responsible investment strategies can also go beyond regulatory requirements, adapting to the investment philosophy of the investor, who chooses according to his or her willingness to use the various tools at his or her disposal. These tools can range from this strict analysis of ESG criteria, through thematic investments, to exclusion or commitment strategies.

Green finance focuses on the fight against climate change, environmental issues and, in particular, the energy and ecological transition [1]. To meet these objectives, it relies on several types of tools: so-called ‘green’ thematic funds, green bonds(loans used to finance ‘green’ projects), carbon pricing (through taxation or a carbon market), and taxation.[1] https://www.economie.gouv.fr/facileco/finance-durable

It is an investment or financing strategy that aims to accelerate the fair and sustainable transformation of the real economy, by providing proof of the positive effects generated by the investor[2].To do this, it relies on 3 pillars: intentionality, additionality and impact measurement. It is based on the desire of financial players to generate a social or environmental benefit that meets the Sustainable Development Goals (intentionality pillar ) and to be able to measure it (impact measurement pillar).[2] https://institutdelafinancedurable.com/wp-content/uploads/2021/09/Finance-for-Tomorrow-Definition-de-la-finance-a-impact-Septembre-2021.pdf

Solidarity finance links savers who are looking to give meaning to their money to companies and associations with strong social and environmental benefits, which they finance by subscribing to solidarity savings products (e.g. Fair). The aim is to finance projects or investments that are important for society, but which would not otherwise find the investors needed for their development: integration activities linked to employment, social and housing issues, international solidarity and the environment.

With regard to climate change, economic and financial players are exposed to significant risks, generally classified into three categories[1]:

• Physical risks = direct losses associated with damage caused by climatic hazards (and risks linked to biodiversity loss) on economic players. (such as the impact of drought on agricultural harvests, or the loss of infrastructure following a cyclone or earthquake).
• Transition risks = the economic consequences of implementing a low-carbon economic model. Analyzing transition risk means measuring the impact on financial assets that will result from the implementation of a low-carbon economic model (such as the issue of ‘stranded assets’, the 80% of known fossil reserves that should remain in the ground to limit global warming to 2°C[2]. According to IRENA, the value of stranded assets linked to fossil fuel production capacity would be between $12,000 billion and $19,500 billion by 2050)[3].
• Liability risks = compensation to be paid by a legal entity deemed responsible for the consequences of climate change (linked to regulations, notably due to a breach of duty of care).

[1] Cf. e.g. Finance for Tomorrow’s 2019 report ‘Climate Risk in Finance’[2] See ‘Unburnable Carbon’ , Carbon Tracker[3] cf. IRENA, Global Energy Transformation 2019

The Institut de la finance durable clarified the concepts in this 2024 report:CSR is the contribution made by companies to the principles of sustainable development. It is defined by the European Commission as ‘a concept that refers to the voluntary integration by companies of social and environmental concerns into their commercial activities and their relations with stakeholders’.The aim of a CSR policy is to go beyond strategic economic objectives by integrating environmental and social externalities, with a view to overall performance combining financial and extra-financial aspects. The risk/profitability pairing capable of informing the company’s market value is evolving towards a risk/profitability/sustainability triptych, expressing the company’s intrinsic value.CSR has been given an international standard to give it its first guidelines: ISO 26000. Published in 2010, this standard represents a global consensus on CSR, and can therefore be used as a basis for assessing companies’ commitment to sustainable development.SRI is an investment strategy that involves integrating ESG criteria into the selection process for companies or projects to be financed.Responsible investors base their decisions on ESG criteria.ESG criteria are the pillars of extra-financial analysis of a company or project: environmental, social and governance.The Governance criterion verifies, among other parameters, transparency, the functioning of the board of directors, compliance with deontology, ethics, the fight against corruption, respect for consumers, etc.The Environment criterion mainly concerns climate issues (mitigation, adaptation) and resource management (preservation of biodiversity, water management, waste management, water and air quality, etc.).The Social criterion takes into account, in particular, compliance with labor laws and conventions, the principles of non-discrimination and the fight against inequality, accident prevention, skills development and training, compensation policy, social dialogue, etc.

To obtain the data needed to analyze a company’s ESG practices, one step is essential: reporting. This consists in communicating data in order to capture a company’s performance. To decide what information to report, we need to take into account the concept of materiality.Materiality refers to the relevance or level of importance of an item of information, or data, in terms of the impact it can have on a company’s performance, and therefore on decision-making. There are two types of materiality: financial materiality (or simple materiality) and ESG materiality.

• Financial materiality (outside-in) = aims to identify the information likely to have an impact on a company’s financial performance: it is an analysis of the financial risks for the company. (See the typology of these risks below). It is often described as a simple materiality analysis.
• ESG materiality (inside-out) = aims to identify information relating to the company’s impact on the environment, society and governance.

To optimize a company’s sustainability, the European Union and EFRAG are favoring the combination of these two types of materiality for company reporting under the new CSRD directive.A double materialityapproach therefore implies taking into account both types of approach in one’s ESG strategy: the identification of the risks to which the company is exposed, and the analysis of the effects of its activities on society and the environment.

In reporting, one of the most important pieces of information for companies to publish is their carbon footprint, which enables them to assess and quantify the GHGs emitted by an organization. To calculate them, we generally use a classification based on the GHG Protocol: the scopes. There are 3 scopes, enabling GHG emissions to be quantified at several stages in the value chain.

• Scope 1: This covers all emissions generated directly by the company’s activities (factories, company-owned vehicle fleets, offices, warehouses, etc.).
• Scope 2: This covers indirect emissions associated with the energy consumed during production activities (electricity, heat, etc.).

These two types of emissions are often the subject of monitoring and reduction targets: they are the direct responsibility of the company, and relatively easy to track if you know the energy mix at national (or European Union) level. As processes are optimized and decarbonized, gains on scopes 1 and 2 will be increasingly difficult to trigger.

• Scope 3: This corresponds to all indirect GHG emissions occurring in the company’s value chain (N+2 suppliers and beyond, as well as the use of products by customers). Measuring them is a tricky business. Scope 3 is the subject of numerous discussions aimed at harmonizing calculation methods. This is one of the challenges of the IFD’s work.

Finally, there are discussions about a fourth scope.

• Scope 4 : this covers emissions avoided through the use of substitute products or product recycling. However, a number of points remain to be determined before this notion can be used in a fully operational manner.

Beyond extra-financial reporting , the duty of care is an obligation placed on ordering companies to prevent environmental, social and governance risks linked to their activities and that of their value chain. Embodied in a law since 2017 in France, it will be generalized and applied at European level with a new directive: the Corporate Sustainability Due Diligence Directive or CS3D.The companies concerned will thus have a legal responsibility to be ‘vigilant’ regarding potential abuses linked to human rights and social and environmental issues throughout their value chain. In concrete terms, this means that they will have to carry out assessments to identify risks, take measures to prevent these risks, mitigate their negative impacts throughout their value chain, and publish this information in a due diligence plan.

Each fund has its own investment philosophy, i.e. its own motivations for taking ESG criteria into account, and therefore its own investment targets according to the needs it wishes to meet. Once defined, the investment philosophy implies the implementation of an investment process specific to each fund, enabling it to select the companies and projects that will make up its portfolio.

For SRI, investors have a number of tools at their disposal, enabling them to select companies and projects that are consistent with their investment philosophy.The ‘best’ approaches describe three ways of ranking companies:

• Best-in-universe approach: This consists of selecting the companies with the highest ESG ratings across all sectors. A best-in-universe fund will therefore be subject to sectoral bias, as it will necessarily invest more in ‘sustainable’ sectors such as recycling or renewable energies than in more polluting sectors such as air transport.

• Best-in-class approach: This consists of selecting the best-rated companies in terms of ESG criteria for each sector of activity, without excluding any sector a priori. A best-in-class fund may therefore invest in polluting sectors (such as energy or mining), taking care to select the ‘best performers’ in that sector.

• Best-in-progress approach: This consists of selecting companies that demonstrate the best improvement/improvement plans in their ESG practices. A Best-in-progress fund might invest in transport companies that aim to improve their carbon footprints by going electric, for example.

These approaches can be combined with another selection strategy: exclusion.Exclusions involve removing stocks from a portfolio in order to avoid investing in companies/projects deemed harmful to society. There are two types of exclusion: normative and sector-based.The former involves excluding stocks in companies that do not comply with international law (e.g., the ILO Declaration on Fundamental Principles and Rights at Work), while the latter is based on ethical and strategic reasons (e.g., the desire not to invest in activities such as pornography, alcohol or unconventional fossil fuels).Finally, these approaches can be complemented by another strategy: engagement policies.With a more supportive approach, their aim is for investors to take advantage of their status to steer company policy in line with the values they wish to defend. For example, shareholders can use their voting rights at the Annual General Meeting to propose more ambitious resolutions on sustainable development issues.Say On Climate has been developed in the same spirit. These resolutions, submitted by the company to a shareholder vote and designed to elicit their opinion on the company’s climate strategy and/or its implementation, are interesting tools for establishing a shareholder dialogue.

The annual investment required to finance the ecological transition is estimated at between $2,500 billion and $4,500 billion. To reach these figures, we need to multiply our current investments by 3, or even by 7 if we take the upper range[3] More generally, for the Sustainable Development Goals, estimates of annual financing requirements are of the order of 5,000 billion dollars by 2030[4].[3] IPCC (2022), WGIII Technical Summary (Figure TS.25)[4] UNCTAD Report, September 2023

Investment needs in Europe are estimated at between $400 billion and $750 billion per year. Again, this implies multiplying current investments by a factor of 2 to 4, depending on the scenario. TheEuropean Green Deal Investment Plan (EGDIP) aims to mobilize a total of 1,000 billion euros in sustainable investments over the decade 2020 – 2030.[5]In the latter, the aim is to use a minimum of 100 billion euros over the period 2021-2027 for the energy transition mechanism just to help the evolution of the energy system of carbon-intensive emerging countries[6] (such as South Africa[7]). The European Commission estimates that a further 4,000 billion euros will be needed between 2021 and 2030 to meet the EU’s 2030 commitments, 3/4 of which would rely on private sector investment.[8][5] https://ec.europa.eu/commission/presscorner/detail/en/qanda_20_24[6] Ibid[7] https://ec.europa.eu/commission/presscorner/detail/fr/IP_21_5768[8] https://www.imf.org/en/Blogs/Articles/2023/05/11/europe-and-the-world-should-use-green-subsidies-cooperatively

The financing plan for the ecological transition states that the financing required to meet the commitments of the SNBC III is substantial (+110 billion euros per year for the French economy by 2030 compared with 2021 in the context of achieving fit for 55, +63 billion euros net)[9]. The means to finance this transition exist, thanks in particular to a high level of savings (3200 billion euros of long-term savings in stock, and more than 100 billion additional euros per year in flows, potentially mobilizable). 9.6 billion euros worth of green securities issued by France in 2022: cumulative outstandings of 52 billion. France confirms its position as one of the world’s leading issuers in this market.[9] https://tresor.economie.gouv.fr/Articles/2024/04/04/quels-besoins-d-investissements-pour-les-objectifs-francais-de-decarbonation-en-2030-1