The 6 market gaps the finance sector must address to help meet the SDGs

On 30 September 2015, the global community, represented by all 193 member states of the UN, adopted the Sustainable Development Goals (SDGs). Three months later, world leaders charted a new course in our battle against climate change with the Paris Agreement which – for the first time – brought all nations into a common cause to limit global temperature increases.

The need for more collective action to address the world’s most urgent challenges couldn’t be clearer. The world faces new and ever more complex challenges from climate change to mass migration and global epidemics which threaten economic growth, prosperity, peace and life as we know it.

No sector has a more important role to play than finance in determining whether or not we are successful in addressing these challenges. In the words of UN Secretary-General António Guterres: “Finance could be, should be and will be the decisive factor – the difference between winning and losing the war.”

Investment is the single and most urgent need related to all of the interconnected challenges of the SDGs. According to the UN, we face an annual gap of $2.5 trillion in financing the SDGs in developing countries alone. Similarly, the International Energy Agency estimates that the current rate of investment in combating climate change equates to about half of the $3.5 trillion a year needed for the next 30 years. In today’s fiscally constrained environment, without a quantum change in the levels and direction of private investment, we stand no hope of meeting these commitments.

The finance sector has not only a unique responsibility in achieving the SDGs but also a singular, strategic interest in ensuring they are met. Safeguarding a more stable and prosperous long-term future is critical to all of the world’s largest institutional investors or so-called “universal owners” with highly-diversified, long-term portfolios, which are inevitably exposed to global environmental, social and economic shocks and stresses.

It’s not all about protecting downside risk, however. The SDGs also mark a historic opportunity for the financial services industry. With raised awareness of the urgency of the global challenges among consumers and regulators as well as the recognition of the business case for sustainability by corporate leaders, the world is at the beginning of a seismic shift towards an “impact economy” where sustainability and social impact is fundamentally incorporated across investment, production and consumption decisions.

According to the Business & Sustainable Development Commission composed of more than 35 global CEOs, sustainable business models linked to the SDGs could bring economic opportunities worth up to $12 trillion by 2030. The winners of tomorrow in finance and business alike are those who seize this opportunity by developing and investing in products and services that meet this growing customer demand and address the needs of the impact economy.

And yet, progress towards mobilizing investment towards the SDGs has been slow and thin. Increased interest in Socially Responsible Investing (SRI) has not translated to significant growth in investment in on-the-ground projects and solutions that address the SDGs. In 2016, $1 in every $4 under professional management was reviewed on environmental, social and governance grounds, an increase of 25% from just two years earlier. However, less than 1% of global investments sought to achieve measurable societal outcomes. Moreover, according to a 2018 study by the Boston Consulting Group, the number of privately-investible, large-scale projects in developing countries with the potential to advance progress toward the SDGs has actually fallen since 2012 and been flat since 2015.

Clearly, business-as-usual is not an option if we are serious about addressing the SDG challenge. In the words of Mark Carney, Governor of the Bank of England, we will need to build a new financial system to address the SDG financing gap. The Rockefeller Foundation together with the Global Steering Group for Impact Investment (GSG) and with the support of C-Change and a number of expert practitioners has set out to surface the pain points and associated innovations that building this system will require.

Our conversations with more than 30 leading market actors – including investors, intermediaries, and advisors – suggest six market failures in today’s capital markets. These gaps are multiple and cut across the consecutive stages and range of actors in the value chain, from asset owners and asset managers to Development Finance Institutions (DFIs) and philanthropy.

In the next six months, we will hold a number of design sessions building on this analysis, including at the GSG Impact Summit in New Delhi where we will co-create solutions to these failures. In doing so, we will keep a relentless eye on building innovative solutions that meet the needs of the largest pools of investment capital and measurably contribute towards the SDGs.

Clearly, we are not starting from scratch. Many innovative financial instruments and mechanisms have already made a tremendous impact on the orientation and integration of societal factors into our financial system.

Take green bonds, for instance, which tie the proceeds of bond issues to environmentally-friendly investments such as wind and solar power, mass transit and upgrades in energy efficiency. The market started a decade ago with issuances from the European Investment Bank and World Bank and was worth just a few hundred million dollars annually. In 2017, the green bond market grew to more than $160 billion, marking the seventh consecutive year of record-breaking annual issuance. Today, green bonds represent one of the fastest-growing segments of the fixed income universe with an expected compound annual growth rate of 30% in 2018.

Other initiatives are integrating the SDGs in global financial markets guidance and policies. Yet, it is also clear that we need an economic model that serves our society and planet rather than the other way around, as well as bigger, bolder, and smarter finance solutions that are truly destined and able to build a better world.

With this blog post, we invite your reactions to our preliminary diagnosis of the gaps that stand in the way of more capital flowing towards the SDGs across the financial services value chain. We also want to hear what solutions you see to achieving a step-change in the number and scale of “fit-for-purpose” investment products that are SDG-aligned.

The world of finance has long demonstrated an ability to innovate in order to create new market sectors, improve the efficiency of markets and deliver growth and returns. Our task is to bring to bear the same resources, creativity and talent to adapt the current financial value chain so it can flourish in the impact economy and address the world’s most critical needs before it’s too late.

This blog is part of a series by TPI and C-Change on a new collaborative infrastructure for the SDGs.