How sustainable finance creates impact: transmission mechanisms to the real economy

Abstract

When and how does sustainable finance tangibly contribute to creating a better world? In this paper, we outline mechanisms through which impact on sustainability outcomes is transmitted from financial systems to the real economy. We argue that, to have a positive impact on sustainability outcomes, financial institutions must make a clear contribution to: (1) reducing (increasing) the cost of capital for firms’ (un)sustainable activities; (2) increasing (reducing) their access to liquidity; and (3) encouraging or enabling sustainable corporate practices. We assess the potential for impact in each category across several asset classes. We analyse how financial institutions can integrate the development of “impact budgets” into strategic asset allocation. Finally, we consider ways in which future research could consider the implications for impact-oriented portfolio construction in more detail and develop empirical methods for further testing and quantifying the impact of the different transmission mechanisms we discuss.