The Sustainable Development Goals (SDGs) for 2030 and global commitments towards achieving a ‘net zero’ economy are reshaping financial strategies around the world, pushing the financial focus beyond short-term gains to include environmental, social, and governance (ESG) factors for sustainable development. This shift is evident, for example, in Oman Vision 2040 and Saudi Arabia’s Vision 2030, which both prioritize economic diversification and social development.
Saudi Arabia’s plan aims to create a vibrant society and economy with initiatives in various sectors, while Oman focuses on reducing oil dependency and socio-economic challenges. Similarly, there is Germany’s sustainability strategy, the World Bank Group’s focus on poverty reduction and health, and the European Commission’s policy program embedding the SDGs, all which reflect a broader commitment to sustainability. These policies collectively highlight a global acknowledgment of the need to address crucial issues such as poverty, inequality, and climate change – and emphasize the pivotal role of SDGs in guiding government strategies for a sustainable future.
Yet it is Sovereign Wealth Funds (SWFs) and other state capital sources that have a unique opportunity to transform their investment strategies by focusing on co-operatives, employee-owned businesses, and social enterprises. These entities are inherently aligned with the SDGs and the goals of achieving a net-zero economy, often emphasizing social and environmental sustainability as core elements of their mission. The traditional focus of SWFs on short-term financial returns is evolving to incorporate these broader ESG dimensions, which points to how sustainable development is becoming integral to long-term profitability and risk management.
Mutual and social enterprises do have a role to play in sustainable finance, serving as lucrative and stable long-term, generational investments. Mutual organizations are member-owned rather than shareholder-owned – for example credit unions and cooperative banks – and often embody the principles of social sustainability. Their local roots and commitment to environmental sustainability make them ideal investment targets for SWFs and other sources of state capital looking to align with the SDGs. Social enterprises, similarly, are designed to promote social and environmental sustainability while also ensuring financial viability. There are many well-known examples of these today, including Patagonia and TOMS.
The perception that investing in these mutual and social enterprises may not yield immediate financial returns is changing. In fact, the 2023 People Powered Growth Report published by the Employee Ownership Association reveals significant positive effects of employee engagement and ownership. Employee and worker-owned businesses have consistently contributed to the UK economy, and can prove their ESG advantages, as they are on the way to more acknowledgment from politicians, policymakers, and capital providers for their contribution to ESG and SDGs.
So, with this in mind, what are the opportunities and setbacks for SWFs and state capital? Jonathan Michie and I are currently working on a research project at Kellogg’s Centre for Mutual & Co-owned Business on this topic and our research thus far highlights two primary challenges. First, there’s a general lack of awareness and understanding within SWFs and similar institutions about the potential of investing in mutuals and social enterprises. This necessitates a global effort in education and information dissemination. Secondly, the scale of investments required by mutual organizations is often smaller than the typical transactions handled by SWFs, suggesting a need for new intermediaries to manage these investments effectively.
Emphasizing the importance of businesses investing in communities should be a priority
It’s advocated that a paradigm shift is necessary in global investment strategies, particularly for SWFs, to embrace a long-term, patient capital approach that inherently values social and environmental sustainability. This shift requires progress in regulatory harmonization, self-assessment guidelines, and enhanced transparency in investment strategies. Interviews with stakeholders such as CEOs of SWFs, pension funds, investment funds, regulators, ESG professionals, academics, politicians, and legislators have underscored this need.
According to Kohlberg Kravis Roberts & Co (KKR) private equity firm, companies can significantly boost engagement by fostering widespread ownership among employees and empowering them with a say in the business – and this approach is seen as a potent mechanism for generating value. KKR has also noted that the primary reason for businesses to align their portfolios with environmental and social goals is to ensure sustainable development and ethical practices.
The financed emissions approach used in the global financial sector to measure climate impact begins when a financial institution invests in a company that produces emissions, and then accounts for a fraction of that company’s emissions in its own carbon footprint. This approach has been crucial in helping institutions understand their current impact but also poses challenges in terms of complexity and the need for a more nuanced understanding of different sectors and geographies. To address these challenges, portfolio-alignment tools have been developed, utilizing forward-looking climate scenarios to estimate the global carbon budget by sector and geography. This not only aids in plotting a course toward climate goals but also allows financial institutions to differentiate between companies based on their decarbonization progress.
As the ‘S’ aspect of ESG is becoming more prominent, emphasizing the importance of businesses investing in communities should be a priority. A robust ESG strategy will include aligning the company’s strategy with its sustainability efforts, ensuring compliance with relevant regulations, and moving from reactive to proactive approaches in sustainability practices.
Quantifying the return on sustainability investments, maintaining transparency, engaging the board and the broader organization, and collaborating efficiently for sustainable practices are key steps in this direction. Not focusing on the societal component of ESG will lead to broader problems, as ignoring the ‘S’ in ‘ESG’ can result in compliance risks, reduced investor interest, and potential divestments from companies with poor sustainability performance, as well as lead to a misalignment between a company’s strategic goals and its sustainability efforts, weakening the commitment to ESG overall.
Prioritizing the ‘S’ in ESG also leads to healthier communities. It provides a more equitable, just, and sustainable environment. When businesses engage with communities, it means more thought is put into fair labor practices, local opportunities, education – and investing in local development can foster a more resilient and inclusive society. This approach also aligns with the UNSDGs, offering a framework for businesses to evaluate and communicate their portfolio’s net societal impact and address any gaps.
The just transition to a sustainable and equitable future requires not just financial investments but also a commitment to social and environmental stewardship. Creating opportunities to align investment strategies of SWFs and other state capital with SDGs and the net-zero transition is not only a moral imperative but also a long-term strategic financial decision. As global commitments to combat climate change and to promote sustainable development intensify, the role of state capital in investing in social projects and sustainable businesses becomes increasingly critical. Investment in co-operatives, employee-owned businesses, and social enterprises may be the answer investors and communities are looking for.
© IE Insights.
