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Accelerating Participation In Sustainable Finance

A profound transformation is sweeping through the world of investments as investors, once solely focused on financial returns, are now seeking something more, exploring opportunities that promise competitive financial returns and carry the banner of sustainability. Industry leaders are fast recognising that a balanced approach to wealth accumulation, one that considers not just profits but also the well-being of our planet and society — going beyond the dollars and cents to the broader repercussions of our actions — is the way forward. This realization is wildfire igniting the growth of sustainable finance, a field that integrates Environmental, Social, and Governance (ESG) criteria into the heart of investment decision-making. Sustainable finance scrutinizes investment impact on the environment, society, and the ethical governance of the entities invested in. This holistic approach is leading to a significant realignment of business models as capital holders strive to meet evolving customer expectations, adapt to shifting economic landscapes, and adhere to the ever-evolving sustainability standards.

This wave is about channeling financial resources into projects that promote environmental well-being and directly support the transition to a zero-carbon economy. The entire financial industry has a critical role to play! It requires financial operators to play offense and respond to sustainability market demands and be ahead of the green supply curve, operating within the global standards and frameworks of the United Nations Principles for Responsible Investment (PRI), United Nations Sustainable Development Goals (SDGs), United Nations Global Compact (UNGC), United Nations Environment Programme Finance Initiative (UNEPFI) Principles for Responsible Banking, Equator Principles, UNEPFI Principles for Sustainable Insurance, and Green Bond Principles, among others.

ESG integration is the flagship strategy, reflecting a holistic viewpoint of investors that are not just dipping their toes in the water; they are refining their strategy, moving beyond basic screening to embrace more advanced approaches like thematic and impact investing. Most investors prefer active ESG integration. They are looking for companies and securities that actively incorporate ESG principles and are willing to engage with investee companies to ensure the positive impacts are real. A survey report in December 2020 by NAVEX Global revealed some fascinating insights. It disclosed that 88% of publicly traded companies had already embraced ESG initiatives; roughly two-thirds of privately owned companies were treading a similar path.

Furthermore, in October 2023, Capital Group reported that 90% of investment professionals are weaving ESG considerations into their investment approaches. This is not a passing fad; the proportion of investors consider ESG as core of their investment philosophy is at 33% in Europe, Middle East and Africa (EMEA), 25% in Asia-Pacific, and 9% in North America. And, indeed, the numbers are compelling. In Q3 of 2023, global ESG fund assets had ballooned to approximately $2.7 trillion. The winds of change are blowing, but not every region is experiencing them equally. Europe was at the forefront of this movement, with ESG fund assets commanding an impressive 84% share, followed by the United States with an 11% share.

Nigeria’s sustainable finance market is relatively small, but there are significant potential opportunities for tapping into the global sustainability-themed market. While the benefits are widespread, the costs of not taking action could be as high as $450 billion by 2050, according to the Africa Development Bank report. Some growth has been recorded on the back of the government and corporate sector’s efforts. As of 2022, five corporate green bonds valued at ₦32.83 billion and two sovereign green bonds valued at ₦25.69 billion were listed on Nigeria’s exchanges. Total investment in sustainability-focused mutual funds amounted to ₦2.4 billion. Based on the African Development Bank’s estimate, for 2020-2030, Nigeria requires $247.3 billion for its climate finance needs, averaging $22.5 billion annually.

With Nigeria’s Climate Change Act and the National Council on Climate Change (NCCC) launched, some vital legal frameworks and structures for building nation-wide sustainable practices are in place, but like many other slow-to-decarbonise economies, there are potential challenges to attracting global sustainability-themed funds. One of the significant hurdles is the heavy reliance on fossil fuels for foreign exchange earnings. A staggering 80% of the government’s revenues come from oil exports. With financial institutions, an additional challenge emerges from the “disproportionate importance on the “Governance” aspect in investors’ decision-making processes, over the “Environmental” and “Social” dimensions of ESG investing.” Hence, “in spite of progress in governance, advancement in the environmental aspect is on the back burner.” A scarcity of expertise in sustainable finance practices presents another hurdle for banks and financial institutions in meeting vital requirements in ESG impact investing and reporting.

Limited access to finance in Nigeria constitutes a different set of challenges. While opportunities for sustainable investments exist, such ventures often require substantial financial commitments over medium to long terms. The prevailing short-term financing options in the financing system underscores the need for alternative medium- to long-term funding options, especially for sustainable infrastructure development projects.

The prospects of embracing sustainable finance offer compelling advantages for Nigeria. Improved risk management and long-term good financial performance are potential benefits. It also provides a wide range of non-financial benefits. Embracing sustainable finance paves the way for more innovative financial products, such as green bonds and sustainability-linked loans, particularly for financing critical national development projects. Sustainable reporting enhances transparency and accountability, building the reputation of financial institutions as responsible entities. Global investors and lenders increasingly support organizations committed to sustainability.

Aligning with the Sustainable Development Goals (SDGs) allows Nigerian financial services players to demonstrate commitment to a sustainable future, impacting economic development and environmental and social well-being locally and globally. Nigeria stands at the crossroads of sustainable finance. This path must now align with global trends to prepare for a future that is economically, socially, and environmentally sustainable. To pave the transition pathways for the country and accelerate progress, below is how stakeholders can drive participation.

1. Develop and implement a national sustainable finance plan:
In line with its commitment to global carbon reductions, the federal government has enacted the Climate Change Act and set up the National Council on Climate Change (NCCC). Now is the time to ensure that the Council’s mandates align with the Nation’s priorities and provide a strategic national road map and action plan. NCCC should promote a nationally coordinated green finance action plan to nurture a vibrant, sustainability finance ecosystem. While the plan should align with global standards and best practices, it is critical to support the implementation and monitoring of the plan with hard and soft infrastructure and suitable institutional environments – preferential regulatory treatment and incentives, inclusive – to drive faster progress.

2. Adopt a global regulatory perspective:
Regulators play a crucial role in shaping national sustainable finance landscapes by crafting policies and implementing prudent regulations within globally accepted best practices. Securities and Exchange Commission (SEC)’s Green Bond Rules is one initiative in this direction. Regulators can explore international best practices to understand intent and match regulations with innovation. Adapting global best practices tailored to Nigeria’s peculiar context can pave the way for robust and effective regulatory frameworks. For instance, by permitting flexibility in regulations to accommodate innovative products, experimenting with new financing models peculiar to the Nigerian context, and finding the best compliance and enforcement mechanisms, significant progress can be recorded. In addition, regulators can coordinate with stakeholders and actors to raise awareness, build capacity, and provide support for infrastructure development. Finally, regulators can ensure that financial institutions effectively manage ESG risks by monitoring and enforcing ESG risk management and reporting practices.

3. Investing in Sustainability:
Private investors wield significant influence in driving the sustainability agenda and are making conscious efforts to disinvest from unsustainable projects. By making conscious investment choices, private investors in Nigeria can promote responsible and sustainable practices. Such practices can include early investments in small-scale innovative projects and investments in sustainable value chains to reduce Scope 3 emissions, which are outside the organization’s control but linked to other ecosystem players, suppliers, distributors, etc. According to McKinsey’s estimates, about 50% of the 75% emissions across the value chain results from suppliers’ dealings in goods and services.

4. Accelerate the rise of green products:
According to the United Nations, over 80% of the investment industry and more than 300 banks, representing 50% of the global banking assets, have committed to the Principles for Responsible Investment (PRI) and Principles for Responsible Banking (PRB), resulting in $2.5 trillion global sustainable fund market. Nigerian banks, asset managers, pension fund administrators, and insurers should not take the back seat. They should consider introducing green products to tap into the growing segments of responsible banking and investment. There is potential for an early mover advantage in this promising field. Products can be crafted to fund initiatives with positive environmental impacts (like renewable energy and afforestation) or social impacts (like affordable housing or healthcare initiatives). Issuers and other organisations can benefit from sustainability-linked bonds and loans tied to the company’s sustainability performance. In this case, the interest rate is adjusted based on predefined sustainability targets. The bourses in the capital markets can support the growing demand for sustainability-linked investments by facilitating the listing of an expanded selection of ESG exchange-traded funds (ETFs). Also, the exchanges and other professional bodies in the industry should continuously provide practical tools to help the incumbents and potential issuers easily integrate sustainable considerations in their business.

5. Integrate sustainability for profit:
Nigerian businesses should integrate sustainable finance principles into their core business models. Early adopters have the opportunity to acquire a significant share of the market. Carbon emission reduction strategies could lead to cost reduction. Companies can achieve the twin objectives of carbon emission reduction and low operating costs through energy efficiency, efficient product design, embedded carbon reduction in procurement, product design, and emission reduction in variable cost footprints. For now, “climate technologies are not commercially viable, but this will change in no distant future.” “Businesses should be ready to transmit to benefit from green resource opportunities rather than be passive and bear a considerable loss from stranded assets.” To meet the demands of this new era, capital holders and potential investee companies must embrace sustainability in every facet of their business model. This implies a profound consideration of its influence on organizational procurement systems, planning and budgeting, recruitment style and culture.

6. Raise the bar of awareness and training:
Alongside many other not-too-big steps, raising awareness for sustainable finance among the financial sector ecosystem players is crucial. Awareness should pinpoint green finance trajectory and massive potential and how this field would soon become a leader in the investment world. In addition, it is necessary to elevate expertise in sustainable finance subject matters and their integration into mainstream financial sector practices. This calls for tailored training and development programs for top- and middle-level management positions. Industry leaders like the Nigerian Exchange Limited (NGX) and FMDQ are already progressing along this path. NGX collaborates with the Global Reporting Initiative (GRI) to conduct a capacity-building session on sustainability reporting and ESG disclosures for listed corporates. FMDQ, in partnership with the Financial Sector Deepening (FSD) Africa and Climate Bonds Initiative (CBI), through the Nigerian Green Bond Market Development Programme, provided capacity-building sessions and focused training to a wide range of ecosystem players, including regulators, investors, intermediaries, solicitors, rating agency, verifiers and state executive councils. The industry requires more of these initiatives for general and tailored capacity-building and skill development programmes in low-carbon financing.

With the renewed commitment of the world’s leaders and heads of state at COP 28, climate action will certainly accelerate across continents and regions. Fortunately, fixing climate finance is one of the four pillars set by the COP 28 Presidency, and the vital role of non-Party stakeholders, including businesses, cities, subnational regional regions, and investors, was reemphasized. Africa will play an essential role in energy transition and Nigeria must be at the forefront of this move. Beyond the recommendations already offered in this Policy Insight, demonstrating strategic leadership by the government and private sector’s business leaders would provide the role modeling required to spur larger participation. Now is the time for businesses to start locking in the benefits of sustainable finance. By incorporating sustainability mandates very early, companies in Nigeria can play offense, not waiting for regulatory requirements to catch up with them.