In this chapter, we examine the reasons behind capital markets’ contribution to an unsustainable future, considering the distinction between market inefficiencies and market failures, and suggest five steps for policymakers and regulators to consider: (i) Establish and strengthen international and national frameworks for sustainable finance, (ii) Ensure a greater share of all public sector financial flows are sustainable, (iii) Shift private sector financial flows by adjusting pricing and other incentives, (iv) Improve market information to make the sustainability risks and rewards of financial assets clearer and (v) Educate people about the connection between their personal finances and sustainability.

Far from their image as a boring technical tool of the financial world, indexes are becoming a critical lever for investors to raise market-wide standards and to catalyse sustainable corporate business models. Investors can choose from a wide spectrum of benchmarks to suit their precise needs. The rise of benchmarks and passive investments, then ‘smart beta’ and now the emergence of ‘smart sustainability’ has been a global phenomenon, and the stage is now set for their powerful application in active ownership strategies.

This chapter explores the rationale for a pension fund to integrate sustainability in its investment analysis and decisions, and why engagement is an important tool for an active and long-term investor in creating value for beneficiaries. Based on our experiences this does not neccessarily carry the higher costs traditionally associated with active management, but it will put higher demands on asset managers and analysts to understand and translate new data and information into the fundamental financial analysis. In a time where increasing capital is being allocated to passive index strategies, we argue that active and long-term owners foster corporate accountability and a broader concept of value creation. We stress the importance of developing in-house capacity for engagement and stewardship, as this enables leverage on key industry insights, while at the same time recognising when investor collaboration towards a common objective is more efficent.

Interpretations of fiduciary duty have recently undergone rapid evolution. It is now widely accepted that investors need to take account of ESG or sustainability issues in their investment practices. This chapter analyses the changes in the interpretation of fiduciary duty and the implications for investment practice. It discusses of the traditional definition of fiduciary duty (in particular, the duties of loyalty and care). It then identifies 4 factors – the work of the UNEP and the Principles for Responsible Investment (PRI), the changing legal and policy landscape for responsible investment, the understanding of the financial significance of ESG issues to investment performance, and changes in investment practice – that have challenged and led to change in this traditional definition of fiduciary duty. The chapter then proposes a modern definition of fiduciary duty, a definition where ESG issues are at the heart of the duties owed by investors to their beneficiaries. The chapter concludes with some reflections on whether this modern definition of fiduciary duty is a sufficient response to the social and environmental challenges faced by society today.

Sustainable finance can be viewed as a political concept: it not only facilitates direct financial flows towards a low-carbon and inclusive economy aligned with Europe’s environmental objectives but it also serves as an indicator of how citizens’ personal savings are used. Additionally, it helps to re-legitimise the financial sector for those still outraged by the 2008 financial crisis and its ensuing consequences. To gain back the public’s trust, asset managers will have to do more than just stamp sustainable finance labels on traditional funds. They are going to have to explain their objectives and integration strategy for ESG criteria in financial management. They will also need to explain how they evaluate the financial impact of risks, such as climate change, as well as how they select ESG performance indicators alongside standard financial performance. The European Commission launched its new Green Deal to transform Europe’s economy and shape it for a sustainable future and has included a sustainable finance action plan into this project for the implementation of a Just Transition. The main challenge now is to share this objective with citizens in clear words.

Discusses the development of Sustainable Finance and its context, and the failure of orthodox economics to properly address the issues.

For the financial sector to play its necessary, supportive role in a more sustainable economy, with less resource-intensive and more resilient growth, enduring change is needed in the sector’s system of values, beliefs and behaviours. This represents an opportunity for all players in the financial industry to reinstill a positive purpose in their role in society at large. The rules of engagement of any system are based on implicit or explicit governance principles and driven by leadership actions. This chapter explores three aspects of governance principles. First, the requirements of education, training and qualifications in respect of sustainability issues for leaders and finance professionals, to enable them to take into account the relevant and material environmental, social and governance risks and opportunities affecting their business. Second, the changes needed in the governance framework of financial institutions, with a particular focus on the concept of stewardship. Third, the necessary modifications to director duties in general, so that the intended stewardship action can be effective in rendering the real economy more sustainable over time.

Sets out what central banks can and must contribute to the sustainability agenda, especially on climate change, given their existing mandates and objectives. That includes monetary policy, financial stability, prudential regulation, balance sheet-management and even bank notes. Central banks do not need and should not wait for changes to their legal duties, because climate change is a material influence on all their existing responsibilities. Meanwhile, macroeconomic stability is a pre-requisite for the wider sustainability agenda and so there needs to be a continuing priority focus on monetary and financial stability.

Mobilising capital for a sustainable economy requires action on two fronts. Current capital allocation must be shifted from an unsustainable pathway to a sustainable one and the investment gap must be filled to ensure that sustainable economy objectives are achieved; this includes fulfilment of the Paris Agreement on Climate Change and the UN Sustainable Development Goals. This chapter focuses on the latter issue: filling the investment gap. Primarily, it focuses on the example of tackling the climate change challenge, although these ideas can be applied to the wider environmental and social agendas too. It discusses how to: understand and articulate investment needs; adapt market arrangements using policy to encourage investment; improve the efficacy with which public finance crowds in private finance; and ensure impact through positive real economy outcomes. Throughout the chapter, real-world examples of the 'policy prescriptions' are offered to turn theory into practice.

The EU has spearheaded innovative legislation in 2019 to promote the financing of economic activities to tackle climate change. But the social aspects of tackling climate and environmental problems have received inadequate attention in the legislation. This has resulted in inconsistent legal definitions and unelaborated processes to ensure all economic and climate tackling activities are socially sustainable. In many cases climate changing activities have resulted from, or been combined with, breaching social and human rights. Providing opportunities to citizens and communities to (financially) redress environmental problems is important for a just transition. An integrated approach whereby ESG risks and long term impacts are integrated in all banking and investment decision-making should be urgently taken up by the Commission. Building on existing international standards, voluntary codes and expertise in the EU’s social sector would help to meet the existing challenges. Such EU policy should also be integrated in the EU’s international trade and investment treaties that create the competition from financial players outside the EU which might not integrate an ESG approach.

Sustainable finance has a key role to play in achieving a just transition - in other words accelerating the shift to a net zero and resilient economy in ways that are fair and inclusive. This chapter sets out why a just transition is essential for the scaling up climate action and achieving wider progress on sustainable development. There is also a compelling rationale for action within the financial system to support a just transition. Institutional investors have been leading the way and over 150 institutions with $10 trillion in assets have now committed to take action. Their aim is to avoid systemic risk and deliver on their fiduciary duties. Policy action is aso needed which mobilises both public and private finance, particularly for place-based action. The chapter closes with a set of priority actions for the European Union.

The role of financial institutions in sustainable transitions has been conceptualised for a number of years. There is a growing recognition that traditional approaches are insufficient in the face of new levels of scale, likelihood and interconnectedness of environmental sources of risk. This chapter conducts a review of existing approaches to incorporating environmental sources of risk into mainstream financial risk frameworks. The review generated 14 illustrative case studies from submissions of G20 countries, financial institutions and private-sector stakeholders. The chapter makes several contributions to the research on sustainability transitions. First, it proposes a simple analytical framework for understanding environmental sources of financial risks. That helps financial actors understand and engage with environmental sources of risk. Second, it underlines the role of financial firms in sustainability transitions. Environmental risks must be priced correctly, so that sufficient capital is allocated. The progress of financial firms in incorporating environmental risk management into mainstream financial risk frameworks is summarised as are the challenges and solutions.

Recent research across European countries indicates that a large majority of individual investors – between 60% and 75%, depending on how the questions are framed – want to invest sustainably. Consumers say that they are willing to give up return for environmental outcomes: a recent survey of German and French retail investors suggests that 64% would accept a sacrifice of -5% on their pension benefits. In this context, the €97 trillion question is obviously why most of them still invest in non-sustainable investment products. This chapter is an attempt to answer that question, with a focus on upcoming EU regulations such as the Ecolabel for financial products. Covering the results from our upcoming research reports, we cover issues including consumers’ sustainability objectives, mis-selling of financial products, lack of voting rights on sustainability issues, environmental impact claims and deceptive green marketing. We describe the main issues with the European policy response, and how they may end up amplifying existing problems – by creating confusion in relation to how green financial products are understood and how to deal with the expectations of impact-focused consumers.

The industry of Sustainable and Responsible Investments funds started booming after the financial crisis. The loss of faith in conventional finance made people look for 'other' values for their savings. A need for enhanced transparency popped up and suddenly most players in the financial system offered such products. Or did they? It became difficult not to get lost in an alphabet soup of 'sustainability' related acronyms, and it became more difficult not to get confused and make a valid choice. After different players and even government actors started launching such labels, comparability issues cropped up, adding a further layer of complexity for retail investors. French, Luxembourgish, German, Austrian labels came to the fore with no European framework to facilitate the comparison, except for a methodology based on transparency standards developed by the European Forum for Responsible Investment - Eurosif. The lack of generally accepted definitions for these sustainable funds did not help resolve the fragmentation of standards which abounded in the industry. European Institutions stepped in to facilitate sustainable finance and put some solutions on the table.