Sustainable finance

Overview

Sustainable finance is the set of practices, standards, norms, regulations and products that pursue financial objectives while taking into account environmental, social, and governance considerations. It is often used interchangeably with Environmental, Social & Governance (ESG) investing. It is important to distinguish between ESG integration for better risk-adjusted returns and the broader field of sustainable finance that also includes impact investing, social finance and ethical investing. A key idea is that sustainable finance allows the financial system to connect with the economy and its populations by seeking a growth objective. The long-standing concept was promoted with the adoption of the Paris Climate Agreement, which stipulates that parties must make "finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development." In addition, sustainable finance has a key role to play in the European Green Deal and in other EU International agreements, and its popularity continues to grow in financial markets. In 2015, the United Nations adopted the 2030 Agenda to steer the transition towards a sustainable and inclusive economy. This commitment involves 193 member states and comprises 17 goals and 169 targets. The UN's Sustainable Development Goals aim to tackle current global challenges, including protecting the planet. Sustainable finance has become a key cornerstone for the achievement of these goals. Various government programs and incentives support green and sustainable initiatives. For instance, the U.S. Environmental Protection Agency (EPA) provides grants and low-interest loans through its Clean Water State Revolving Fund for projects that improve water quality or address water infrastructure needs. The Small Business Administration (SBA) also offers loans and grants for green businesses.

Terminology

Specific terminology is used to clarify concepts and ideas utilized in discussions about sustainable finance. The United Nations Environment Programme (UNEP) defines three concepts that are different but often used as synonyms, namely: climate, green, and sustainable finance. Climate finance is a subset of environmental finance, and mainly refers to funds which address climate change adaptation and resilience, climate mitigation, and a just transition. Green finance has a broader scope, covering the same ground as climate finance but also covers other environmental issues such as biodiversity protection. Sustainable finance includes the same scope as green finance, but adds environmental, social and governance (ESG) domains in its scope. It is therefore the broadest term, covering all financing activities that contribute to sustainable development. The terminology of sustainable finance has evolved over time alongside policy frameworks and market practices. A review study in 2026 demonstrated that early research primarily used fragmented concepts such as ethical finance, socially responsible investment, and environmental finance, before the gradual consolidation of the field around ESG-based sustainable finance. Their periodization clarifies the differences and similarities between the rival terms (carbon finance, climate finance, environmental finance, green finance and sustainable finance). The authors distinguish three main periods: The first period ("forerunners") spans from the 1970s to 2010. During this time, the theoretical foundations were established, and following the publication of the Brundtland Report (1987), the first green financial instruments and the first targeted research emerged. The establishment of the Green Climate Fund (2010) was followed by the second period ("early phase") spanning 2010-2021 and includes eras of carbon, environmental, and climate finance. Collectively, this constitutes the era of early sustainable finance research, which lasted until 2021, the year of COP26. This is followed by the third ("mature phase") which spans 2021–present, and is characterized by green and sustainable finance.

Green bonds

Green bonds are any type of bond instrument where the proceeds or an equivalent amount is exclusively applied to finance or re-finance, in part or in full, new and/or existing Green Projects. In other words, they are loans issued in the market by a public or private organization to finance environmentally friendly activities. Their growth is consistent; GSS+ (Green, Social and Sustainability bonds and Sustainability-linked bonds) reached a volume of $170 billion in 2018 and $653.5 billion in 2025. The aim of this type of bond (finance) is to encourage the financing of green projects by attracting more capital to support sustainable development. According to empirical studies, the high demand for this type of bond provides it with a lower yield than its standard equivalent. Scientists recommend including this climate factor in the risk assessment of bonds. The aim is, on the one hand, to increase the borrowing cost of brown bonds which can fund carbon-intensive projects and de-incentivise their investment by increasing the weight of climate risk. On the other hand, the goal is to reduce the weight of risk of green bonds in order to stimulate investment and potentially encourage banks to reduce the interest rate of these bonds. From a legal point of view, green bonds are not really different from traditional bonds. The promises made to investors are not always included in the contract, and not often in a binding way. Issuers of green bonds usually follow standards and principles set by private-led organisations such as the International Capital Market Association (ICMA)'s Green Bond Principles or the label of the Climate bond initiative. The Paris agreement on climate change highlighted a desire to standardize reporting practices related to green bonds, in order to avoid greenwashing. To date, there are no regulations requiring the borrower to specify its "green" intentions in writing, however, the EU is currently developing a green bond standard which will force issuers to fund activities aligned with the EU taxonomy for sustainable activities. This standard is expected to be a voluntary standard, operating alongside other voluntary standards, with academics and practitioners raising the policymakers' awareness to the dangers of imposing it as a mandatory standard. The European Union has already created its own "Next Generation EU Green bonds framework" to use green bonds to raise part of the funds for the Next Generation EU project. This project promises an investment of 750 billion euros in grants and loans (at 2018 prices), by the European Commission, aiming to revive the post-COVID-19 economy in the 27 EU member states. Up to 30% of the budget will be raised by issuing green bonds, which results in up to 250 million, and a total of 14.5 million had already been raised by January 2022. This will make the European Commission the largest issuer of green bonds. On 21 December 2024, the European Union Green Bonds Regulation comes into force, allowing the issue of "European Green Bond" (or "EuGB") by companies, regional or local authorities and EEA supra-nationals. Empirical studies show that the risk of greenwashing is present and may wrongly induce investors to accept lower rates of return than for brown investments. Indeed, theoretical research grounded in Bayesian game theory demonstrates that greenwashing is rational behaviour for value-maximising investors given the insufficiency of a credible regime regulating the use of green labels. The standardization of this taxonomy would reduce the criticism of greenwashing that can be attributed to this type of obligation and enhance clarity and transparency in their use. Rating agencies should focus more on this type of risk in order to identify and quantify it better.

Taxonomy of sustainable activities

Because energy transition is a broad concept and sustainability or green can apply to many projects (renewable energy, energy efficiency, waste management, water management, public transportation, reforestation...), several taxonomies are being established to evaluate and certify "green" investments (having no or very little impact on the environment). In 2018, the European Commission created a working group of technical experts on sustainable finance (TEG: Technical Expert Group) to define a classification of economic activities (the "taxonomy"), in order to have a robust methodology defining whether an activity or company is sustainable or not. The aim of the taxonomy is to prevent greenwashing and to help investors make greener choices. Investments are judged by six objectives: climate change mitigation, climate change adaptation, the circular economy, pollution, effect on water, and biodiversity. The taxonomy came into force in July 2020. The taxonomy is seen as the most comprehensive and sophisticated initiative of its type; it may inspire other countries to develop their own taxonomies or may indeed become the world's 'gold standard. However, when the disclosure regime comes into effect in January 2022 there will still be huge gaps in data and it may be several years before it becomes effective. The classifications of fossil gas and nuclear energy are controversial. The European Commission asked its Joint Research Centre to assess the environmental sustainability of nuclear. The results will be investigated for three months by two expert groups before the commission makes a decision on the classification. Natural gas is seen by some countries as the bridge between coal and renewable energy, and those countries argue for natural gas to be considered sustainable under a set of conditions. In response, various members of the expert group that advises the European Commission threatened to step down. They stated they see the inclusion of gas as a contradiction to climate science, as methane emissions from the natural gas form are a significant greenhouse gas. The UK is working on its own separate taxonomy.

Green-supporting factor on capital requirements

To encourage banks to increase green lending, commercial banks have been proposing to introduce a "Green-supporting factor" on banks' capital requirements. This proposal is currently being considered by the European Commission and the European Banking Authority. However this approach is generally being opposed by central bankers and nonprofits organisations, which propose instead the adoption of higher capital requirements for assets linked with fossil fuels ("Brown-penalizing factor").

Mandatory and voluntary disclosure

In addition, another tool and some standards lie in reporting and transparency. In 2015, the Financial Stability Board (FSB) launched the Taskforce on Climate-related Financial Disclosures (TCFD) which is led by Michael Bloomberg. The TCFD's recommendations aim to encourage companies to better disclose the climate-related risks in their business, as well as their internal governance enabling the management of these risks. In the United Kingdom, the governor of the Bank of England, Mark Carney, has actively supported the TCFD's recommendations and has called on several occasions for the implementation of obligations for companies in the financial sector to be transparent and to take into account financial risks in their management, notably through climate stress tests. In France, the 2015 Energy Transition Law requires institutional investors to be transparent about their integration of Environmental, Social and Governance Criteria into their investment strategy. Nevertheless, empirical research has shown the limited effect of disclosure policies if they remain voluntary. In addition, in October 2022, the Corporate Sustainability Reporting Directive was adopted. This new reporting rule will apply to all large firms, whether listed on stock markets or not. Therefore, around 50,000 companies will be covered by new rules, compared to about 11,700 with the former set of rules. More precisely, the impact of an organization on the environment, human rights and social standards will be introduced in this CSRD. Indeed, this reporting directive asks for more detailed reporting requirements thanks to common criteria, in line with the EU's climate goals. The commission will adopt the first set of standards by June 2023 after that, the aim of the commission is to enlarge more and more companies to this set of standards. Indeed, from 1 January 2026, the rules will apply to listed SMEs and other undertakings, with reports due in 2027. However, SMEs can opt out until 2028. Thanks to this new set of rules, the EU has become a front-runner in global sustainability reporting standards.

Green monetary policy

Policymakers, through their green monetary policies, help speed up the adoption of sustainable finance by supporting the development of investment instruments and fund structures tailored specifically to sustainable finance, creating incentives for investors, and establishing a regulatory agenda to standardize ESG measures of performance. According to the EDHEC 2019 survey, European investors wanted more ETF products in the areas of socially responsible investing, and for strategies using factor indices. By late 2024, ESG ETFs reached over $640 billion in assets.

Green Central Banking

The term "Green Central Banking" refers to the critical role that central banks must play in achieving zero-net-emissions targets and mitigating climate change. By adjusting their monetary policies into “green monetary policy” and capital requirements, central banks can redirect investment into green financing.

Network for Greening the Financial System (NGFS)

In 2018, under the leadership of Mark Carney, Frank Elderson, and Banque de France Governor Villeroy de Galhau, eight central banks created the Network for Greening the Financial System (NGFS), a network of central banks and financial supervisors wanting to explore the potential role of central banks to accompany the energy transition. This network has nearly 116 central banks and supervisors and 19 observers including the International Monetary Fund (IMF) and the European Central Bank (ECB). Priorities for the NGFS include sharing best practices, advancing climate and environmental risk management in the financial sector, and mobilizing mainstream finance. Several policy options for greening monetary policy instruments have been explored by the NGFS:

Green refinancing operations: central banks can adopt green conditions when banks refinance themselves from central banks, for example by granting a lower interest rate if banks issue a certain volume of loans for green projects. Green collateral frameworks: central banks can restrict collateral eligibility rules by excluding polluting assets, or requiring banks to mobilize a pool of assets that is aligned with net zero trajectories. Green quantitative easing: central banks could restrict their asset purchases programmes to green bonds. The NGFS, through its working group “Workstream 2”, has published new Scenarios for central banks and supervisors in September 2022 in partnership with an academic consortium. The NGFS Scenarios were developed to assess the impact of climate change on the global economy and financial markets. While developed primarily for use by central banks and supervisors, they may be valuable to the broader business sector, government, and academics as well.

European Central Bank's financial commitment to addressing climate change

During the United Nations Climate Change Conference (COP 26), in July 2021, under the leadership of Christine Lagarde and after pressure from NGOs, the ECB committed to contributing to the implementation of the Paris Agreement's aim of “making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development”. (Article 2.1. (c) of the Paris Agreement, 2015) The ECB also announced a detailed roadmap to incorporate climate change in its monetary policy framework. The action plan includes measures to integrate climate-risks metrics in the ECB's collateral framework and corporate sector purchase programme (CSPP) referred to bonds. Christine Lagarde said she was also in favour of developing "green lending facilities" like the Bank of Japan and People's Bank of China.

Action plan of the ECB on climate change

In accordance with its recent decisions, the ECB commits to contributing to the Paris Agreement goals and NGFS initiatives within its mandate by taking the following specific actions:

Integrating climate-related risks into financial stability monitoring and prudential supervision of bank Integrating sustainability factors into own portfolio management Exploring the effects of climate-related risks on the Eurosystem monetary policy framework within our mandate Bridging data gaps in climate-related data Working towards higher awareness and intellectual capacity, also through technical assistance and knowledge sharing

Debate

There are a few concerns and limitations that can be attributed to sustainable finance.