The majority of global financial flows are not purposed to serve the wellbeing of people or the planet, and many funds are sitting in negative returning government bonds.
The OECD recently convened the third edition of the Private Finance for Sustainable Development (Conference with over 600 actors discussing ways to better align financial flows with the 2030 Agenda in developing countries.
They focused on shifting the culture of profit-making and repurposing financial innovation to help actions catch up to ambitions.
Ten years from now, we will be held accountable for our promises on delivering the 2030 Agenda. We have before us a massive gap between the targets set in the 2030 Agenda and the global action required to achieve those targets. UNCTAD has estimated that developing countries face an USD 2.5 trillion annual investment gap to reach the Sustainable Development Goals (SDGs).
According to the IMF, low-income developing countries will need, on average, additional spending of 15 percentage points of GDP on education, health, roads, electricity, water and sanitation in 2030 (IMF, 2019). Despite significant progress on many fronts, it is clear that a massive gap between ambition and action remains.
In the midst of this large gap, we know that international capital markets have never seen as many trillions of USD invested as we see today. Yet, the majority of these financial flows are not purposed to serve the wellbeing of people or the planet, and many funds are sitting in negative returning government bonds.
On 29 January 2020, the OECD brought together over 600 public and private actors committed to promoting a better alignment of global financial flows with the 2030 Agenda in developing countries. From participants’ shared sense of disappointment that we are off-track to deliver the ambitious ‘strategy for mankind’ came a distinct and shared sense of urgency to make the coming decade one of action.
This article summarizes key ideas and takeaways from the 3rd edition of the OECD Private Finance for Sustainable Development (PF4SD) Conference’s discussions.
Shifting the Culture of Profit-making
After five years of slow and uneven progress towards financing the SDGs, we have a clear need for more resolute action from governments and private actors alike. We are ten years away from our deadline to deliver on the SDGs, including the complete eradication of extreme poverty. This means lifting just under 10% of the world’s population – around 700 million women and men – out of extreme poverty over the next decade. In the meantime, the climate crisis is threatening to overshadow all development challenges and to overturn hard-won gains. According to the World Bank, the worsening impacts of climate change could force over 140 million new migrants to leave their homes by 2050. Furthermore, the planet’s main life support system – the ocean – is under unprecedented pressures, with critical direct implications for 40% of the world’s population living within 100 kilometers of the coast. It is no longer enough to react to crises when they arise.
Governments hold the primary responsibility for delivering on the 2030 Agenda. Public policy and regulation need to be re-purposed towards fostering public and private investments that are truly aligned with the SDGs. We cannot expect capital allocation towards sustainable development if we do not incentivize long-term, patient, and green investments. It is not just about mobilizing new investments, but also about channeling old ones.
Scaling up private finance for sustainable development requires data to bridge understanding, measurement and disclosure of environmental, social and governance (ESG) risks. Data, however, can be problematic and expensive to obtain. The recently launched Future of Sustainable Data Alliance, of which the Institute of International Finance is a Founding Member, will ease access to ESG data so that investors can accelerate mobilization of capital into sustainable finance. Harmonizing reporting standards is the next step, bearing in mind the various users of ESG reporting – including policy makers, investors, civil society – and their needs.
The sense of urgency must also be stepped up in terms of raising local currency financing using risk mitigation instruments. For the first time, in January 2020 the London Stock Exchange welcomed a Kenyan shilling green corporate bond on the International Securities Market, guaranteed by GuarantCo, to finance clean, safe and affordable student accommodation in Nairobi. But much more can be done in this field in order to accelerate the development of local financial markets.
Further scaling of these solutions requires an open dialogue and trust building between public and private actors who have not traditionally worked together. The Kampala Principles on Effective Private Sector Engagement in Development Co-operation aim specifically to guide collective work on making private sector partnerships for development co-operation more effective while ensuring inclusivity at country level.
A key message from those present at PF4SD was that we must get out ahead with strategic investments in sustainable development. This means thinking outside the box, although participants recognized that this is easier said than done. It will mean shifting the culture of profit-making: giving “returns on investment” a new meaning and creating the incentives to match. Quite simply, it will mean understanding and shaping how the next generation is defining the “value” of people and planet.
Repurposing Financial Innovation
Shifting just 1% of total global financial assets – estimated at USD 382 trillion – could bridge the existing USD 2.5 trillion annual investment gap for delivering the Goals.
Financial innovation is an essential part of the equation leading to mainstreaming and scaling sustainable finance, for instance by easing financial inclusion and financial literacy. When looking at the corporate space, blockchain-based technologies and smart contracts are promising solutions that, with the right policy frameworks, can facilitate access to financing for SMEs and their integration in global value chains.
Yet, a lot of the financial innovation we are seeing today is aiming at rent seeking and profit maximization. Financial markets have not been effective in providing coordination and information, as we still do not see capital flowing to countries with capital shortages and productivity catch-up potential. We need to refocus financial innovation on finding solutions that will help investors to find large-scale sustainable development opportunities in the short term and, more importantly, in the long term.
The good news is that shareholders are reorienting management towards more sustainable business practices, to address ESG issues. ESG investing has grown significantly in recent years, rising to nearly USD 18 trillion in assets, with an additional USD 6 trillion in sustainable investing that captures some component of ESG. This investment represents a sizeable amount of the overall USD 30 trillion sustainable investment universe, clearly suggesting that ESG is much more than a fad. Impact investing is also capturing the growing attention of mainstream investors, whose market size is estimated at more than USD 500 billion and still growing. Travis Spence, Managing Director, J.P. Morgan Asset Management, highlighted a big step change recently in the dialogue around ESG moving rapidly from a “nice to have” to a “must have” in investment portfolios. ESG criteria are becoming the main drivers shaping portfolios.
Newly released OECD data on blended finance shows that private finance mobilized by development finance reached USD 205 billion between 2012 and 2018. However, less than 6% went to least developed countries, and less than 6% to social services like education and health, with the majority going to economic infrastructure. These funding flows are clearly misaligned with the objective of leaving no one behind.
The PF4SD Conference deep-dived into the alignment of private finance with specific SDGs:
- Gender equality (SDG 5): Gender equality is a pre-requisite for sustainable development for all, and the number of actors showing interest in gender-lens investing is rapidly increasing. Development finance institutions have accepted the “2X Challenge: Financing for Women” and to date mobilized USD 2.5 million out of the USD 3 billion goal. India has launched the world’s first domestically funded SDG Bond to support tribal women in becoming self-reliant. As a minimum requirement and first step, investors need to ensure that their activities do not undermine gender equality and women’s empowerment.
- Climate action (SDG 13): The majority of private finance mobilized for development continues to be channeled into economic infrastructure. Sustainable infrastructure will be the foundation to realize the transformation to low emissions and climate resilient development pathways. The economics to this is catching up, with improved estimates for the co-benefits of climate action such as reduced pollution and improved land use. With low global interest rates and the window closing on our ability to limit temperature rise under 1.5°C, the opportunity to close the investment gap required to achieve Low-Emission Climate-Resilient development is now. Technology is on our side for this, but all pools of finance and actors need to work together to make use of this opportunity –starting with governments themselves.
- Life below water (SDG 14): The global ocean economy is expected to grow at a faster pace than the rest of the economy between 2010 and 2030 (OECD, 2016) and as more capital enters ocean-based industries, it is critical that investments are geared toward improved sustainability, instead of increasing over-exploitation of resources. However, new research shows that the majority of investors are not aware of the impact of their investments on the marine environment or how a degrading ocean may subsequently affect their portfolios’ performance and value, building up unknown liabilities.
- Decent work and economic growth (SDG 8): The fact that 30 million African youth are expected to enter the labor market every year by 2030 makes SDG 8 one of the most pressing challenges. Beyond employment creation, SDG 8 also calls for reducing informal employment, narrowing the gender pay gap and improving working conditions. ILO’s Decent Work Agenda highlights the importance of promoting sustainable enterprises for innovation, growth, and more and better jobs. DFIs have a key role to play to enable high-impact investments that create quality jobs. Enhancing social dialogue is a key lever to achieve the Decent Work agenda and governments should invest in institutions underpinning multi-stakeholder engagement and social dialogue.
Aligning private finance with the SDGs requires an open dialogue and trust building between public and private actors not traditionally used to working together. The Kampala Principles on Effective Private Sector Engagement in Development Co-operation are also relevant in this space – they aim specifically to guide collective work on making private sector partnerships for development co-operation more effective while ensuring inclusivity at country level.
The Road Ahead: A New Course for 2030
After five years of slow and uneven progress towards financing the SDGs, we have a clear need for more resolute action from governments and private actors alike. Governments hold primary responsibility for delivering on the 2030 Agenda. Public policy and regulation needs to foster public and private investments that are truly aligned with the SDGs. We cannot expect capital allocation towards sustainable development if we do not incentivize long-term, patient, and green investments. It is not just about mobilizing new investments, but also about channeling existing finance.
The G7 Ministers of Development have called for a SDG-compatible finance framework to make trillions of private investment and savings work better for the Goals. At the PF4SD Conference, Cyrille Pierre, Deputy Director for Global Affairs, Culture, Education and International Development, Ministry for Europe and Foreign Affairs of France, noted France’s readiness to take leadership of this process, with the support of the G7, the G20, the UN and the OECD.
Scaling up private finance for sustainable development requires data to bridge understanding, measurement and disclosure of risks. The OECD is working to promote more consistent, standardized measurement of all types of flows for SDG financing, monitoring and reporting on the contribution of public actors through Official Development Assistance (ODA) and of all finance – including private finance mobilized by public interventions, triangular co-operation, etc, through the new tool Total Official Support for Sustainable Development (TOSSD).
It is clear that low-income countries and fragile contexts are still dramatically left behind. OECD data show that only 5.5% of private finance mobilized by official development finance interventions went to least developed countries and other low-income countries. Financial institutions – both public and private – need to rethink their models and incentives to take on the high risks that investment in difficult contexts entail. With 27% of the world’s population living in fragile contexts by 2030, we need to invest in stability. With 85% of the poorest people living in the top 20 climate-affected countries, we can’t afford to subsidize these countries’ economic and environmental instability with non-renewable energy activity. Furthermore, we need to solve the problem of aggregation of small deals in developing countries, to allow institutional investors to mobilize their trillions of USD under management.
Setting a new course is a big undertaking, but our actions must catch up if we are to achieve our 2030 ambitions.
This guest article was authored by the OECD Development Co-operation Directorate organising team.