The incentives facing institutional investors are aligned with key players in the financial system, including brokers and investment banks, rating agencies, regulators and stock exchanges. To unlock their contribution to sustainable development, long-term and sustainability considerations need to be more effectively mainstreamed in the financial system. This will require adjustments to the regulatory framework and the decision-making process of key players like rating agencies and standard setters.
Commercial banks are the sources of two-thirds of all financing globally. Although they may not be ideally suited for long-term lending due to their short-term liabilities, they have traditionally been major financiers of infrastructure projects in developing countries. Commercial banks are also important sources of finance for small and medium enterprises. However, commercial bank lending is constrained by their continuing deleveraging and the large transaction costs involved in lending to smaller enterprises.
Challenges also emanate from the industry-wide practices of key players like rating agencies, who tend to be procyclical and short-term in their outlook. Extending the horizon of credit rating agencies beyond their current 3-5-year window could help unblock the supply of long-term finance for sustainable development. Credit rating agencies could also be encouraged to publish scenario analyses based on transition pathways with an extended time horizon, which could inform complementary products that would be valuable to long-term investors. Other work could include ensuring greater harmonization of methodologies, especially around the incorporation of material ESG/SDG considerations, and assessing gaps between the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and credit rating agency assessments in this area.