World Investment Report 2021


Chapter 5 – Capital Markets and Sustainable Finance

Despite extreme market volatility last year, the sustainable investment market has been expanding steadily, as demonstrated by the number of new sustainability-themed products, the amount of new capital flows and the number of new initiatives developed by exchanges, security market regulators, assets owners and managers, and other market actors.

The pursuit of sustainability has led to a rapid growth in sustainability-themed financial products. The global efforts to fight the pandemic and climate change are accelerating this momentum. UNCTAD estimates that the value of sustainability-themed investment products in global capital markets amounted to $3.2 trillion in 2020, up more than 80 per cent from 2019. These products include sustainable funds (over $1.7 trillion), green bonds (over $1 trillion), social bonds ($212 billion) and mixed-sustainability bonds ($218 billion). Most are domiciled in developed countries and targeted at assets in developed markets. This continued growth reaffirms the potential for capital markets to contribute to filing the financing gap for the SDGs.

Sustainability-themed capital market products

Over the past five years, the fund industry has been rapidly embracing sustainability through the multiplication of funds and indexes dedicated to sustainability themes. Sustainable funds include mutual funds and exchange-traded funds (ETFs) that describe themselves in their prospectus or other filings as selecting assets that integrate sustainability, impact or environment, social and governance (ESG) factors. Their number and assets under management (AUM) surged in 2020.

The total number of sustainability-themed funds had reached 3,987 by June 2020, up 30 per cent from 2019, with about half of all sustainable funds launched in the last five years. The AUM of sustainable funds quadrupled over the last five years; last year alone they nearly doubled, from roughly $900 billion in 2019 to over $1.7 trillion (figure 11). The growth held for both sustainable mutual funds and ESG ETFs. Nevertheless, together such funds represent only 3.3 per cent of all open-ended fund assets worldwide. That shows both the great potential and the long way to go.

Figure 11.

The vast majority of sustainability-themed funds is domiciled in Europe (73 per cent), followed by North America (18 per cent), with other regions, including developing countries, representing less than 10 per cent of funds. This reflects the maturity of the market and the relatively advanced regulatory environment for sustainable investment in Europe.

UNCTAD’s analysis of 800 sustainable equity funds for which relevant data are available shows that about 27 per cent of their total assets ($145 billion of a total AUM of $540 billion) are deployed in eight key SDG sectors: transport infrastructure, telecommunication infrastructure, water and sanitation, food and agriculture, renewable energy, health, education and ecosystem diversity. The health sector, which covers medical services, pharmaceuticals and medical devices, is the most common and single largest SDG sector for these funds, followed by renewable energy, food and agriculture, and water and sanitation. The analysis also suggests that these funds do not systematically suffer a financial disadvantage because of their investment strategy. Over a period of three years, 48 per cent of sustainable funds outperformed their respective benchmarks, while 52 per cent underperformed them.

Developing and transition economies so far remain largely absent from the sustainable fund market. They host about 5 per cent of the world’s sustainable funds by number and less than 3 per cent by assets, even though stock markets in developing and transition economies account for roughly 23 per cent of global market capitalization. This suggests that developing economies have the potential to significantly grow their sustainable fund markets. There are persistent concerns about greenwashing and the real impact of sustainability-themed investment products. The fund market needs to enhance credibility by improving transparency. Funds should report not only on ESG issues but also on climate impact and SDG alignment. Importantly, to maximize impact on sustainable development, more funds should invest in developing and transition economies. Nonetheless, the rapid growth of the sustainable investment market confirms its potential to contribute to filling the SDG financing gap.

The sustainable bonds market (green, social and mixed) grew in every quarter of 2020, from less than $70 billion in Q1 to close to $180 billion in Q4, pushed by the issuance of social and mixed-sustainability bonds as national and supranational organizations and corporations financed relief efforts during the pandemic (figure 12). The largest increase was seen in the social bond market, with a tenfold rise to $164 billion in 2020 — or one third of the total sustainable bond market, up from just 5 per cent in 2019. Mixed-sustainability bonds were valued at $128 billion, surpassing their 2019 total by a factor of three. Social and mixed-sustainability bonds are thus rapidly catching up with the green bond segment and becoming increasingly popular tools for financing SDG-related activities. Cumulatively, the total amount of outstanding sustainable bonds is estimated at $1.5 trillion.

Despite an average annual growth rate of 67 per cent and significant size in absolute terms, the sustainable bond market is still very much in its early growth stage, representing only about 1.3 per cent of the total global bond market of approximately $119 trillion. This suggests enormous growth potential for this segment going forward. In the next five years, the sustainable bond market can expect to see further acceleration of growth as investors and issuers become more confident with this investment vehicle. By 2025, the sustainable bond market could reach 5 per cent of the total global market, which would bring over $6 trillion of new resources to SDG sectors.

Figure 12.

Institutional investors and financial service providers Institutional investors are in a strong position to effect change towards sustainability. They can do so primarily through two routes: (i) asset allocation – where they choose to invest the capital at their disposal, which can have a determinative impact on companies and markets; and (ii) active ownership – how they influence the policies of the companies they invest in through corporate governance mechanisms.

In particular, four groups of upstream institutional investors have an important role to play in driving sustainable investment and have a strong institutional interest in doing so: the first two, pension funds and sovereign wealth funds (SWFs) managed reported global assets of $52 trillion and $9.2 trillion, respectively, in 2021. The second two, insurance companies and banks, manage assets but primarily provide financial services for their clients in the form of risk management products and loans. The investable assets of insurance companies reached $32.9 trillion in 2018, and those of banks reached $155 trillion in 2019.

The potential influence on corporate sustainability of pension funds and sovereign wealth funds (SWFs) is enormous. More than 40 per cent of their assets (over $60 trillion in total) are invested in publicly listed equities, making them “universal owners” with large shareholdings in companies across a wide range of sectors and markets. Given their long-term obligations, pension funds are in a better position to assess long-term risks to their portfolios, and the intergenerational nature of their business model tends to make them more responsive to ESG- and SDG-related issues. Consequently, there has been a realization on the part of these large institutional investors that ESG factors constitute material risks.

However, public pension funds could do more to promote sustainability. According to an UNCTAD report, among the world’s 50 largest public pension funds and 30 largest SWFs, only 16 public pension funds and 4 SWFs published a sustainable or responsible investment report in 2019. More fundamentally, public pension fund portfolios largely bypass developing-country markets, limiting their contribution to sustainable development.

Meanwhile, SWFs should uphold responsible investment principles and standards, such as the Principles for Responsible Investment in Agriculture, which protect the rights of minority shareholders and local stakeholders. Homecountry governments need to review the mandate of funds to allow them necessary space for investment abroad in productive assets and activities.

Developing host countries need to consider reducing entry barriers for institutional investors while safeguarding public interests. They can use risk-sharing tools, such as public-private partnership, investment insurance and blended financing, to help improve the risk-return profile of SDG investment projects and make bankable projects readily available for institutional investors, while taking measures to maximize development benefits. Insurance companies can contribute to sustainable development in their role as risk solution providers, as well as their role as investors (with AUM of more than $30 trillion in 2018). Climate change is a systemic risk for the world. Total economic losses from disasters globally were an estimated $202 billion in 2020, up from $150 billion in 2019, with about $190 billion resulting from natural catastrophes.

The banking sector can foster sustainable development through enhanced corporate lending. The volume of sustainable financial products has grown in recent years, driven by increased demand and by campaigns to promote financial sector sustainability. The sustainable loan market was valued at about $200 billion in 2020, consisting mainly of green loans (which are used to finance green assets and projects) and sustainability-linked loans (which are tied to the borrower’s ESG rating and not the use of proceeds). The frameworks underpinning these instruments are the Green Loan Principles established in 2018 and the Sustainability Linked Loan Principles established in 2019 by the Loan Market Association, a banking industry group.

European markets played a leading role in the upward trend of the sustainable loan market, consistently representing about half or more of the market over the past five years. Most loans raised under the Green Loan Principles are raised to invest in renewable energy, while the sustainability-linked loans are going to a more diversified set of industries.

Stock exchanges and derivatives exchanges

Stock exchanges and derivatives exchanges affect sustainability in their markets through their influence on corporate ESG behaviour and through the promotion of sustainable finance products. Derivatives exchanges can contribute through sustainability-aligned derivates products, ESG data products and enhanced transparency. Stock exchanges contribute through a wider set of mechanisms. The number of stock exchanges with written guidance for issuers on ESG disclosure rules (SDG 12.6) has grown rapidly, from 13 in 2015 to 56 in 2020. The number of exchanges that provide training on ESG topics to issuers and investors also continues to rise, with over half offering at least one training course.

Mandatory ESG reporting is on the rise, supported by both exchanges and security market regulators. The number of exchanges covered by mandatory ESG disclosure rules more than doubled in the past five years, to 25 today. The number of stock exchanges with dedicated sustainability bond segments (including green bond segments, SDG 13) increased by 14 between 2019 and 2020, for a total of 38.

The United Nations Sustainable Stock Exchanges database contains data on 106 stock exchanges worldwide, listing over 53,000 companies and representing a market capitalization of more than $88 trillion. The database specifically tracks various activities related to ESG factors, all of which have seen rapid growth over the last decade (figure 13).

This upward trend is expected to continue as investor interest in ESG-themed products is strong and growing, public policies to promote sustainable development are strengthened in several jurisdictions and more stock exchanges recognize the important role that they can play in promoting investment in sustainable development.

Figure 13.

Whereas the role of stock exchanges in sustainable development has been well explored over the past decade, the potential role of derivatives exchanges – where nearly 35 billion futures and options contracts were traded globally in 2019 – is less understood. In 2020, both the United States Commodity Futures Trading Commission – an industry regulatory body – and the Futures Industry Association – an international industry association – acknowledged the potential role of derivatives markets in addressing climate change and associated risks. In early 2021, the United Nations Sustainable Stock Exchanges and the World Federation of Exchanges provided an Action Menu for derivatives exchanges to contribute to sustainable development.

The future of sustainable finance

To continue growing and ensure concrete impact over the long term and to fully unleash its potential to finance sustainable development, the sustainable investment market needs to address “a triple challenge”: (i) the niche market risk, (ii) the geographical imbalance of investments and (iii) greenwashing concerns. Addressing these challenges requires three fundamental transitions in the sustainable investment market:
• Growing sustainable investment from “market niche” to “market norm”, by making sustainability integration universal rather than a strategy of a subset of the larger market.
• Transforming the sustainable investment market from a developed-country phenomenon to a global market, which benefits all countries, in particular developing economies.
• Strengthening the credibility of sustainability ratings and reporting with more robust and regulated standards and taxonomies.

This transformation, from the market of today to the market of the future, entails concerted efforts by all stakeholders, including fund and index providers, institutional investors, stock exchanges and regulators. More work can be done to encourage the integration of ESG factors into mainstream products and indexes. Rules and guidelines to establish industry standards and governance requirements with an aim to bring transparency, predictability and credibility to the market are moving beyond voluntary measures. Slowly, regulation is helping to shape the future contours of the sustainable investment market.

To help address the challenges, UNCTAD, together with partners, will launch a new initiative, the UN Global Sustainable Finance Observatory. This initiative is built on the vision of a future global financial ecosystem in which sustainable development (as defined by the SDGs) is fully embedded into the business model of financial markets and in investment culture.

The Observatory will promote and facilitate the transition of sustainable investment from market niche to market norm, leading up to 2030 and beyond. It will address the challenges of fragmentation in standards, proliferation in benchmarking, complexity in disclosure and self-declaration of sustainability. It will integrate the relevant instruments and outputs on its virtual platform to facilitate the assessment, transparency and integrity of sustainable finance products and services. The Observatory will work in tandem with the standards-setting processes of the financial industry and regulatory bodies to promote the full and effective integration of sustainable development (as defined by the SDGs) into all aspects of global financial ecosystem.

Specifically, the UN Global Sustainable Finance Observatory will
i. Promote the integration of the SDGs into the sustainability assessment ecosystem in a coherent and synergistic manner, including through the established UN Core Indicators for SDGs reporting by enterprises (UN ISAR).
ii. Build a global database of sustainable investment funds and other products to improve the open-source availability of sustainability data for key stakeholders and the public.
iii. Conduct sustainability assessments and rankings of “self-declared” sustainable products on the global capital market, and award best performers while also disclosing greenwashing cases.
iv. Establish a pool of various sustainability ratings on the capital market for
transparency as well as public scrutiny for better reporting methodologies in different industries.
v. Compile a global inventory of good regulatory and policy practices for sustainability integration into capital markets and facilitate peer learning.
vi. Provide a capacity-building platform to assist developing countries with policies, regulatory measures, product development, industry standards, reporting and other related issues to ensure their maximum benefit from sustainable finance.

The UN Global Sustainable Finance Observatory will be launched officially in October 2021 at UNCTAD’s World Investment Forum, which brings together the global investment-for-development community, including all capital market stakeholders along the global investment chain. The Observatory will seek the endorsement of the UN General Assembly as part of its efforts to accelerate progress on the achievement of the SDGs, and to meet commitments on climate change, and financing for development, especially in the context of the pandemic recovery response.