How financial authorities can build a sustainable financial system: Guidance from the PRI

The PRI has identified 10 policy tools for financial authorities to support them in building a sustainable financial system. This Sustainable Investment Policy Toolkit explores this topic in two parts which are published separately.

Financial authorities are crucial in building a stable, sustainable financial system that rewards long-term responsible investment, to the benefit of investors’ clients and beneficiaries and the environment and society as a whole. 

Part 1 of the report provided by the PRI explores:

• The challenges faced by investors in scaling up responsible investment that aligns with their commitments to address system-level sustainability-related risks and support a just economic transition
• financial authorities’ sustainability-related policy ambitions observed across the G20 countries
• The policy measures that financial authorities can implement to create a stable environment for responsible investors that allow them to fulfill their mandates and respond to emerging challenges and opportunities

Part two (published separately) provides deep dives into specific policy measures identified in part one. Together, the two parts of the Sustainable Investment Policy Toolkit may also guide and support investors in their own engagement with policy makers on broader sustainable finance and economic policy reforms.

‍

Challenges for investors in pursuing responsible investment

The PRI highlights 6 major challenges in pursuing responsible investment practices:

1. Lack of incentives resulting from issues such as externalities, entrenched short-termism and collective action problems. 
2. Incomplete capital markets, reflected in the shortage of investable project pipelines, mispricing of sustainability-related risks and restrained supply of capital, particularly for projects that involve high levels of risk, require significant upfront investment or have long time horizons before generating returns.
3. Policy inconsistency and uncertainty further constraining the long-term allocation of capital to support a just economic transition.
4. Lack of transparency and credibility as a result of inadequate availability of standardised and comparable data and metrics, and a lack of verification mechanisms to monitor and understand sustainability-related risks, impacts and claims. 
5. Principal and agent challenges, possibly leading to misaligned incentives across the investment chain and increased transaction costs. 
6. Lack of awareness, capacity and sustainability expertise which limits investors’ ability to fully address material sustainability-related risks and opportunities in pursuit of long-term risk-adjusted returns.

‍

The PRI further addresses the different levels of sustainability ambition of financial authorities that have been observed across G20 jurisdictions:

Level 1 - Managing exposure to sustainability-related risks

Here, financial authorities aim to enhance resilience by ensuring that investors are equipped to respond to sustainability-related risks. In doing so, policy frameworks are designed to promote practices such as stress testing, scenario analysis, risk management and disclosure practices. This enables investors to identify, monitor and address the impacts of sustainability-related risks on investments and financial stability. 

Table 1 displayed some examples of frequently adopted financial policies to manage exposure to sustainability-related risks

Level 2 - Addressing the drivers of sustainability-related risks

At this level, financial authorities aim to guide and support investors to consider how their investments impact investee entities. This will subsequently shape the impact of investee entities on the broader environmental and social conditions that may drive or mitigate system-level sustainability-related risks. 

Here, financial authorities may focus on frameworks that encourage investors to identify, assess, and manage investment impacts that could influence, reduce, or support adaptation to system-level sustainability risks.

‍

Level 3 - Supporting governments in driving the economy-wide transition

Here, financial authorities collaborate with government efforts, delivering an economy-wide transition to fulfil their mandate to enhance the financial stability and other objectives. This enables an alignment of responsibilities, ambitions, and actions across the financial sector and the broader economy to create capital flow in line with transition goals. 

‍

The PRI concludes by suggesting 10 policy tools for a sustainable financial system

1. Investor sustainability responsibilities:
2. Corporate sustainability responsibilities
3. Investor sustainability disclosure requirements
4. Corporate sustainability disclosure and accounting standards
5. Regulatory frameworks for effective stewardship
6. Transition plans
7. Human rights and environmental due diligence requirements
8. An enabling policy environment for sustainable financial instruments
9. Service provider sustainability regulations
10. Sustainability standards and classification instruments

These suggestions were based on an analysis of existing policies and regulations across the G20 - these policy tools could combat the challenges faced by investors and support a sustainable financial system.