“Not only corporations, governments and NGOs, but major asset owners and asset managers are increasingly aware of ESG issues, and they demand for more responsible investment.” — Associate Professor Liang Hao

In Brief

1. Sustainable Finance is a new field of finance that prioritises environmental and social impact goals. Fundamentals like capital allocation, diversification and value maximisation continue to play a role, albeit, with a new twist.


2. Greenwashing is a major concern, with many companies or investors falsely claiming to be sustainable for marketing purposes or to reap financial benefits. By looking closely at the intentionality, returns and measurability of an operation or investment, one can better evaluate the truth behind these claims.


3. The criterion of measurability has proven to be especially challenging, but steps are being taken to unify fragmented sustainability reporting standards and make ESG disclosure easier and more comprehensive for organisations.

In 2021, the top ten most expensive environmental disasters cost over US$1.5 billion each. Hurricane Ida in the United States tops the list at US$65 billion in damages (Christian Aid Report, 2021). With climate change being a key driver behind such frightening figures, it is no surprise that the principle of accountability is being widely incorporated across industries, including the finance sector. Financial authorities, investors and fund managers are changing their perspectives on where and how their money is being invested, leading to the rise of ‘Sustainable Finance’: a new field of finance that prioritises social and environmental impact goals.

What is Sustainable Finance?

Associate Professor of Finance Liang Hao shares that Sustainable Finance can be seen as a new ‘industry’ with new jobs, and new regulations and frameworks. Economic, Social and Governance (ESG) performance ratings are developed by third-party rating agencies to help managers and investors gauge how sustainable a business or an investment really is. Meanwhile, frameworks such as the United Nations Principles for Responsible Investment (PRI) have been set up to encourage and help investors make better and ‘greener’ decisions, while regulators and financial institutions are mandating the disclosure of information like greenhouse gas (GHG) emissions and board gender diversity in the name of transparency.

For the ‘responsible investor’, the fundamentals of finance are viewed with a different lens. Prof Liang explains that capital allocation decisions are made with environmental concerns and social movements in mind, while the practice of diversification might see an investor moving away from   'brown’ assets (e.g. those dependent on coal, oil and gas) and towards ‘green’ assets (e.g. electric cars, renewable energy). Value maximisation, which traditionally emphasised financial gain, now looks at the welfare of all stakeholders, including the environment, a point of view that while theoretically appealing, has proven to be difficult in practice.  

The problem of Greenwashing

This approach comes with many challenges but the one that investors are most concerned about is the issue of greenwashing. This is where a company claims to be socially and environmentally conscious (for marketing purposes, or to gain financial benefits) while in reality failing to make any notable sustainability efforts. With no universally accepted measure of ESG and no mandate at present for companies to be audited externally, it is difficult for investors to know the truth behind the claims.

Prof Liang, therefore, offers three criteria that one can use to assess an operation or investment’s commitment to sustainability: Intentionality, Return and Measurability. 

3 criteria for navigating greenwashing 

1. The intentionality of the company or investor refers to their commitment to making a positive environmental or social impact. Their intent can be signalled through the joining of networks such as the UN Principles for Responsible Investment (PRI), UN Global Compact, or Net Zero Asset Owner Alliance, and by disclosing clearly the specific changes they aim to achieve.  


2. Companies still need to produce profits while investors still expect a decent return on their investments, but they might accept a lower rate in exchange for sustainability impact. Research by Barber, Morse and Yasuda (Journal of Financial Economics, 2020) found that internal rate of returns (IRRs) for impact funds are 3.4-4.7% lower than traditional funds, though numbers vary across studies. The sweet spot between blending social and financial returns depends on investors’ own utility function, but is a clear indication of their commitment to the cause.  

    

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3. In terms of measurability, Prof Liang stresses that a company’s operation or an investor’s action needs to be both verifiable and measurable. This means that their claims should be assessed by an independent auditor, and the metrics used to measure sustainability should be “clear, meaningful, transparent and capable of being compared to others.” 

The challenge of measurability 

The final criterion is the most challenging for a number of reasons. Ratings generated by third-party ESG agencies tend to be incompatible with each other, while issues of transparency and inconsistency continue to exist. Meanwhile, the abundance of standards and policy frameworks being developed by international organisations, governments, non-governmental organisations (NGOs) and commercial frameworks causes confusion on the ground since each focus on a different aspect of sustainability. The final challenge is the difficulty in measuring the ‘net impact’ of an operation or investment since a variety of social, environmental and financial impacts might be at play at any one point in time.

While the solutions to these complex problems will take time and a great deal of co-ordination, promising steps are being made in the meantime. A recent example is the International Sustainability Standards Board (ISSB) developed by the International Financial Reporting Standards (IFRS) Foundation. With the aim to create a global baseline for disclosure standards, there is hope that investors can soon make better informed investment decisions based on companies’ sustainability-related risks and opportunities. According to Prof Liang, one limitation of this new framework is that it focuses on the outside world’s impact on the company and its financial performance, and prioritises the welfare of investors over other stakeholders. For that reason, he views it as a complement rather than a replacement for the existing Global Reporting Initiative (GRI) framework, which is more outward looking and considers all stakeholder perspectives.

Using an Impact-Weighted Accounts Framework (IWAF)

To play a part in tackling these challenges, the Singapore Management University (SMU) and Imperial College Business School set up the Singapore Green Finance Center (SGFC) to co-develop a more holistic, transparent and comparable ESG impact reporting and measurement framework. Together with its partners from the Harvard Business School, Rotterdam School of Management, Impact Institute and the Impact Economy Foundation, the SGFC has been working on the Impact-Weighted Accounts Framework (IWAF) which aims to expand the traditional performance measurement from financial capital to the other ‘capitals’ in a firm’s financial statements: manufactured capital, intellectual capital, social capital, human capital and natural capital. With these, organisations can compile Integrated Profit & Loss (IP&L) Accounts and Integrated Balance Sheet (IBaS) that take all stakeholders into consideration. Prof Liang shares that by taking the extra step to customise and adapt the IWAF to suit the unique needs of Asian organisations, the SGFC offers companies in the region a bespoke approach to ESG disclosure, thereby making accountability and sustainable finance as a whole easier to achieve.