Sustainable Finance is an emerging field. Hopefully we help in the efforts to build an area in which financial markets can work in tandem with companies to improve environmental performance. Below there are three articles with an unifying theme – the idea that market solutions may bring forth change in financial system regarding sustainability. The first was published in the Harvard Business Review and proposes a methodology to quantify the costs and benefits associated with sustainability issues in the beef industry. The second was published in the Journal of Business Ethics. I and my co-authors develop a ratings system based on sustainability criteria. Banks can use it to improve their loans and their credit-risk models. The third article shows how to change valuation models to incorporate sustainability criteria. If this concept is spread out market forces will lead to firms searching for sustainability opportunities to maximize shareholder value, creating a positive feedback that could improve the allocation of capital towards companies that are better managed regarding their sustainability indicators.
The application of the methodology to the beef industry in Brazil found that embedded sustainability does improve financial performance through mediating factors such as innovation, operational efficiency, risk reduction, employee recruitment, engagement and retention, customer and supplier loyalty, competitive advantage, reduced cost of capital, and improved marketing and sales.
Within the banking community, the argument about sustainability and profitability tends to be inversely
related. Our research suggests this does not need to be strictly the case. We present a credit score system based on sustainability issues, which is used as criteria to improve financial institutions’ lending policies. The Sustainability Credit Score System (SCSS) is based on the analytic hierarchy process methodology. Its first implementation is on the agricultural industry in Brazil. Three different firm development paths are identified: business as usual, sustainable business, and future sustainable business. The following six dimensions are present in the SCSS: economic growth, environmental protection, social progress, socio-economic development, eco-efficiency, and socio-environmental development. The results suggest that sustainability is not inversely related to profit either from a short- or long-term perspective. The SCSS is related to the Equator Principles, but its application is not driven to project financing. It also deals with short- and long-term risks and opportunities, instead of short-term sustainability impacts.
We present the Sustainability Delta model as an improvement over existing Environmental, Social and Governance (ESG) methodologies used in firm valuation. Starting from the question how banks should integrate sustainability criteria into their valuation methods, we find that ESG methodologies currently do not consider the potential to generate higher future revenues due to sustainable innovations and also lack the consideration of different scenarios such as higher standards in legislation or consumer demand. To address these shortcomings the Sustainability Delta model is developed. Simulation results on the sugar manufacturing industry in Brazil demonstrate by using the Sustainability Delta we estimate an improved firm value of 1.24%. The Sustainability Delta would allow for a more accurate valuation of firms as well as for the more effective allocation of capital for investors, which should bring market pressure to improve sustainability practices and thus contribute to sustainable development.