Financing Transitions: How Can Financial Institutions help pave the Way to a Greener Economy?

"Sustainable investing is now indispensable, especially in Europe," says Ron Gruijters, manager of sustainable finance at DUFAS. As a trade association for Dutch asset managers, DUFAS observes how this theme is transforming the financial world. "The Netherlands is one of the frontrunners: our large pension funds, for example, recognised the importance of sustainable investing more than ten years ago. What started as a niche has developed in Europe into a comprehensive package of regulations that encourages financial institutions and governments to invest in greener and more sustainable ways."

Investing as a Catalyst for Transitions

Sustainable investing is anything but simple, emphasises Gruijters. "It encompasses major themes such as climate change, waste management, human rights, and social responsibility. We increasingly see it as a catalyst for the major transitions we face, such as energy and food transitions," he explains. In the Netherlands alone, the energy transition requires investments of billions, not only in solar and wind energy but also in infrastructure such as heating networks and transport. "The public sector can never bear this burden alone," says Gruijters. "Private parties and institutional investors are indispensable. Therefore, it is crucial that our sector and the government collaborate to make this feasible."

Organisations such as Robeco, PGGM, and APG collaborate within the DUFAS framework on issues related to sustainable investing. “It is important not to paint the financial sector with the same brush,” Gruijters emphasises. “For example, pension funds often invest without a profit motive, while asset managers depend on their clients' mandates and commercially viable investment products.” DUFAS collaborates with InvestNL, an impact investor that brings together public and private funds to finance sustainable transitions. However, as Gruijters adds, the biggest challenge remains: how do you define what a sustainable investment is? How do you balance climate and nature against social issues such as human rights? Some of these questions are addressed by European legislation, but it is still a work in progress. “That's why we are trying to solve this complex puzzle together with knowledge institutions like WUR." The complexity of this puzzle is further highlighted by a world full of geopolitical tensions, which suddenly calls for investments in sectors such as defense and the arms industry.

A Common Language for Sustainability

Rabobank plays a vital role in financing sustainable transitions in the agriculture and energy sectors, yet the challenges are significant. “With others, have developed instruments to measure sustainability performance, such as the Biodiversity Monitor for dairy farmers and the Open Soil Index,” says Harry Smit, senior analyst at RaboResearch Food & Agribusiness. “Rabobank has also set aside a budget of 4 billion euros to support Dutch farmers in transitioning to more sustainable farming systems.” However, this budget comes with conditions: farmers must take steps towards emission reduction and biodiversity preservation, for instance.

A major hurdle is the chaos of sustainability indicators. “We have our own system, dairy factories use different tools, and the government is once again implementing different regulations,” Smit explains. “This proliferation makes it complicated for farmers.” Rabobank is therefore striving for a shared “sustainability language,” the True Value Language, that all parties in the chain apply. Together with chain partners, governments, and research institutions like WUR, the bank is working on uniform benchmarks and reliable systems. “Scientists can help make the data behind these systems more transparent and reliable,” Smit emphasises.

Although talks with chain partners are in full swing, there is still a long way to go, Smit says. Developing an independent public instrument to prevent conflicts of interest is crucial. The international context, starting with Europe, requires attention because the Netherlands exports many of its products to the European Union. "Ultimately, we need a global language, for instance, regarding deforestation and the use of pesticides."

Increasing green finance is not enough

“The focus on sustainable investments represents promising progress, but it is not a total solution to transform our agricultural and food systems,” says Katie Kedward, senior research fellow in sustainable finance at the Institute for Innovation and Public Purpose, at University College London. Her institute studies sustainability from a macroeconomic perspective. “Increasing green finance will be insufficient as long as investors continue to fund activities that are destructive to nature.” Kedward believes it is important to focus not only on standards for the concept of “sustainability” and how best to measure it. Crucially, she argues, we also need to reduce flows of finance to nature-harmful activities, such as deforestation-linked commodity production.

While financial institutions hold a key to change, it is unlikely that they will take the lead themselves and they need an encouraging policy environment. "Financial institutions are generally profit-driven entities. Halting cheap, destructive activities whilst simultaneously investing in sustainable alternatives is often not profitable enough to attract large private investors,” says Kedward. Sometimes, investors or institutions also make the conscious decision to continue exerting influence as shareholders on certain companies or portfolios. “Strategic use of policy tools can help shift the risk-reward balance to speed up change.” She points to initiatives such as the EU Taxonomy and the Corporate Sustainability Reporting Directive (CSRD) as initial steps but stresses the need for further action. Public bodies, including public banks and financial supervisors and regulators, can play a crucial role in guiding the private financial sector, she says: "They can broadly signal risks and use their policy tools to guide financing. Such precautionary risk management is within their mandates because investments in activities that cause nature loss pose long-term risks to the financial stability of the entire system."

The Enormous Impact of Biodiversity Risks

What are the risks Kedward refers to? At Wageningen University & Research, environmental scientists and socio-economic researchers combine expertise in ecosystems, food systems, and economics to make these invisible threats tangible. “Nature pays a high price for our economic growth,” explains biologist Arnold van Vliet. Although the focus is often on climate change, biodiversity loss is equally disruptive, he argues. “Nature provides crucial ecosystem services, such as crop pollination, natural water storage, and climate stabilisation. Without these services, our society as we know it would simply cease to function.”

To make the severity of biodiversity loss more concrete, economist Haki Pamuk and his colleagues map its economic impact. “For example, the scenario work we use shows intensive land use in certain regions of the world is expected to cause a decline in crop yields due to biodiversity loss. Preliminary results show when extreme weather events are taken into account, this decline can reach over 30% by 2050 in some regions of Africa,” Pamuk explains. By linking this data to the macroeconomic MAGNET model, a globally used tool to simulate economic interactions, the magnitude of the consequences becomes clear. “The results are striking” Pamuk notes. “Decline in soil quality due to biodiversity can trigger a domino effect: farmers face lower yields, supply chains are disrupted, consumers pay higher prices, and governments may face increasing pressure.”

These risks are also gaining attention in the financial sector. In a public-private partnership, Pamuk, Van Vliet, and their colleagues collaborate with banks, insurers, and other financial institutions to identify harmful practices and propose alternatives. “We help them identify investment opportunities that improve soil quality, pollination, and biodiversity,” Pamuk explains. Together with Wageningen's Earth Systems and Global Change Group, they analyse which investments in alternatives should be prioritised. Examples include measures to support natural and computer based pest control systems, or promote agroforestry, crop rotation, cover cropping, no-tillage to enhance soil biodiversity and health. “Through targeted investments, we can not only stimulate recovery but also develop sustainable economic models that limit damage and accelerate transitions,” Pamuk emphasises.

Aligning Public and Private Roles in Transitions

However, the challenge extends beyond financing. “We need a systematic approach that discourages harmful practices and makes sustainable choices more attractive,” adds Van Vliet. This requires close collaboration between research institutions, governments, and the private sector. “We also need to clearly communicate the benefits to society,” Van Vliet stresses, “Not more expensive groceries, but investments in a healthy living environment and products that are affordable and available in the long term, and that lead to much lower societal and economic costs than is currently the case due to biodiversity loss."

To accelerate sustainable transitions, the roles of the public and private sectors must be better aligned. The Public-Private Partnership (PPP) on biodiversity risks offers valuable insights but is not yet a catalyst for large-scale changes. According to Haki Pamuk, this is largely due to how we measure economic progress. “We use Gross Domestic Product (GDP) as the main indicator, but that’s like a baker only looking at how much bread he sells, without accounting for its nutritional value,” Pamuk explains. “GDP says little about the ecological and social price we pay for our economic activities - if it says anything at all.” Pamuk underscores the need for a fundamental shift in our economic system. “We must create incentives that discourage harmful investments and promote sustainable alternatives. Only then can we achieve real transitions.”

Katie Kedward agrees. “It’s not either politics or the financial sector that offers the solution. Both must work together to create rules that make sustainable choices the standard,” she argues. Kedward points out that large quantities of finance still largely flows to harmful sectors like oil and gas. “This will only change if governments set clear frameworks and stimulate funding for sustainable alternatives.” She emphasises another key point: while green financial instruments can encourage businesses to become more sustainable, such investments don’t necessarily finance actual ecosystem restoration. “Even if they manage to be profit-making, on-the-ground conservation activities usually do not generate a return on investment that appeals to investors”, she explains.

To bridge this gap, Kedward sees an inevitable role for public finance to fund those types of conservation activities that will always be underprovided for by the private sector. Blended finance – the use of public money to mobilise private investment – may also be effective, but she warns: “Caution is needed to ensure blended finance represents a genuinely cost-effective solution to funding nature conservation. In particular, governments shouldn’t just ‘de-risk’ private investments but also share in the rewards”.

Ron Gruijters from DUFAS adds to Kedward's viewpoint, emphasising the importance for asset managers to have mandates from their clients to invest in transitions. "Another option is the development of commercially viable investment products," he says. "This requires reliable government policy but also, for example, scalability of financing." Together with InvestNL, DUFAS is mapping out these kinds of financing bottlenecks and suitable solutions for investment products.

A New Mindset for Transitions

Achieving a better balance between the public and private sectors is thus no simple task. Pamuk stresses that close collaboration with research institutions is essential to realise measurable and achievable transitions. “Developing shared standards and reliable benchmarks is a step in the right direction. But to truly succeed, we need to shift our focus from short-term financial gains to long-term sustainable value,” he concludes.

To accelerate sustainable transitions, governments and financial institutions rely heavily on the reliable data scientists provide, confirm Gruijters and Smit from their daily practice. However, developing this data requires a fundamental shift in thinking, say Van Vliet and Pamuk. “It starts with transparency: making clear the impact of non-sustainable investments on nature, the environment, and people,” Van Vliet explains. Transparency not only offers a chance to benchmark but also to showcase improvements. “This requires a smart combination of quantitative and qualitative data on CO2 reduction, effects on nature, ecosystem services, and human health, and economic consequences of those effects. That is our challenge as scientists,” Pamuk adds.

Pamuk and Van Vliet call for intensive collaborations between public and private parties and research institutions and involving wider society. “The more case studies we analyse, the better we can develop systems that truly contribute to transitions,” emphasises Pamuk. But this also requires action and investment. “And first and foremost, the mindset that we are working towards a transformation and saying goodbye to our old economic systems.”