Davos Agenda

7 sustainable finance challenges to fix global inequality

sustainable financechallenges

Developing countries face certain sustainable finance challenges to meet the SDGs. Image: Reuters/Willy Kurniawan

Olivier Cattaneo
Head of Unit, Policy Analysis and Strategy, Development Co-operation Directorate (DCD), Organisation for Economic Co-operation and Development (OECD)
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Davos Agenda

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  • The sustainable financing boom can have unintended consequences in developing countries.
  • High-income countries overwhelmingly dominate sustainable funds.
  • Barriers to sustainable investment in developing countries include debt constraints, reliance on hydrocarbons and lack of ESG reporting standards.

Despite the recent surge in global demand and supply of sustainable finance, the financing gap for the Sustainable Development Goals (SDGs) has actually widened, primarily in countries already furthest behind on the 2030 Agenda. Is it just a consequence of the COVID-19 crisis? Or has the system failed to channel sustainable finance to where it is most needed?

Sustainable finance and inequalities between countries
Sustainable finance and inequalities between countries Image: OECD

The mainstreaming of sustainability in finance and investment is an opportunity to seize and a trend to encourage. However, early evidence suggests that inequalities remain, and unintended consequences, unless acted upon, could actually slow down our collective progress towards the SDGs.

Sustainable finance challenges for meeting SDGs

Here are seven risks or challenges that require our urgent attention, and suggestions on how to mitigate them.

1. So far, the drive for sustainability has magnified global inequalities in access to finance.

While high-income countries (HICs) already held 80% of global assets under management, they now concentrate 97% of newly established sustainable investment funds. Sub-Saharan Africa represents 1.5% of total green bonds by number, and only 0.3% by value. The good news? Scaling up the use of innovative financial tools linked to sustainability could make some developing countries more attractive for investors (e.g. sustainability bonds, debt swaps) and benefit from funding pledges (e.g. COP15’s $100 billion dollar pledge for climate).

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2. High demand for sustainable recovery financing and upward pressure on interest rates linked to stimulus packages in HICs could affect other countries’ capacity to attract capital.

Low-income countries (LICs) with limited fiscal space and tight debt sustainability constraints could spend only 2.5% of their GDP on stimulus packages during the COVID-19 crisis, compared to 16% in HICs. Meanwhile, 56% of African countries with sovereign ratings were downgraded in 2020, compared to a global average of 31.8%. So LICs have far less room for manoeuvre trying to finance their sustainable recovery. A truly global stimulus package was needed to stem both COVID-19 and its economic consequences, but only 1% of HICs’ stimulus packages has been directed to non-domestic issues. This calls for more coherence in policies, avoiding "beggar-thy-neighbour" policies and embracing the full interconnection of SDGs and economies to tackle the root causes of global crises with adequate development finance.

3. Divestment from non-sustainable projects, or projects not labelled as sustainable, could have major implications for resources allocations and the geopolitical equilibrium.

There is a heated debate between partisans of “exclusionary investing”(i.e. avoiding certain sectors or activities with unknown or poor sustainability scores when constructing a portfolio) and partisans of “buying brown and helping it become green”. Mineral energy materials (23%) together with hydrocarbons (49%) made up close to three-quarters of sub-Saharan Africa exports and a quarter of government revenues between 1995-2018. Divestment from some sectors on which countries are still heavily reliant for job or wealth creation should be paired with adjustment (e.g. of skills) and diversification assistance (e.g. make greater efforts to create a pipeline of sustainable, bankable and scalable projects, and identify new production and export opportunities to harness the benefits of the energy transition).

4. Persistent barriers to investment and capacity constraints prevent developing countries from harnessing the benefits of the drive for sustainability.

These include the insufficient depth of financial markets or the lack of capacity to demonstrate compliance with sustainability standards (e.g. lack of data or reporting mechanisms). The size of stock markets represents more than 110% of GDP in HICs, compared to 60% in upper middle-income countries (UMICs) excluding China, and below 40% in lower middle-income countries (LMICs). This calls for additional capacity building in the area of finance and investment climate, and support to sustainability reporting and monitoring.

5. The absence of Environmental, Social and Governance (ESG) information in most developing countries could hide potential opportunities, and add to the income bias in investment decisions.

About 90% of a country’s sovereign ESG score is explained by its level of development, and failure to account for this bias in investment decisions could potentially divert flows to HICs at the expense of poorer countries. The drive for sustainability could give a new impetus to the long-overdue reform of credit and risk ratings, as well as the fight against SDG-washing in HICs, that unduly distracts investors from emerging markets. The use of innovative financial and de-risking instruments, such as results-based rewarding mechanisms or blended finance, should be further explored.

6. In spite (or as a result) of the drive for sustainability, the mismatch between needs and offer in sustainable financing could worsen.

Political or commercial priorities could clash with the universality of SDGs. In the area of development cooperation, the drive for sustainability has largely benefitted energy and transport infrastructure projects in the form of loans in MICs, while grants in LICs and funding to some essential sectors declined. Even within priority areas, like environment, 70% of climate funds and 93% of private finance mobilised are spent on mitigation projects in MICs – not enough goes to adaptation, and only 8% and 2% of the funds go, respectively, to least-developed countries (LDCs) and small island developing states (SIDS) that are heavily impacted by climate change. SDG-aligned budgets, development and financing strategies, such as integrated national financing frameworks (INFFs), could help better match sustainable financing needs and what is offered.

7. The proliferation of sustainability standards could create additional barriers to finance and investment in developing countries, adding significant compliance costs.

With more than 200 sustainability initiatives or coalitions of actors, the proliferation of sustainability standards not only creates confusion on markets; it also places a heavy burden on countries trying to attract sustainable investors of different origins, e.g. by forcing them to comply with different taxonomies. In the absence of harmonized definitions and standards, the interoperability of systems taking into consideration local contexts is a bare necessity. The participation of developing countries to the elaboration of international standards is also necessary to ensure they are fit for all, without diluting their ambition.

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Financing Sustainable Development

Aligning finance and investment on the SDGs will truly work for people and planet only if we strive to enhance both their sustainable impact and equal access by countries and sectors that trail the sustainability drive. A “just” transition calls for a renewed public-private partnership for sustainable finance with (i) a commitment of public and private sustainable investors to systematically include frontier investment outside HICs and large UMICs in their portfolios – with qualitative and quantitative targets, and (ii) a commitment of governments to promote and facilitate such investment, including through development cooperation and integrated national SDG financing strategies.

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Davos AgendaSustainable DevelopmentEconomic Progress
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