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Edited by Sabri Boubaker, Douglas Cumming and Duc K. Nguyen

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Eleonora Broccardo and Maria Mazzuca

This chapter analyses how financial innovations and financial engineering can contribute to sustainability. The topic is discussed using the lens (and the examples) of finance. While different solutions can be used, we focus on green bonds (GBs) and social impact bonds (SIBs). The unique feature of GBs is the issuer’s statement to raise capital to fund investments with a specific environmental impact, whereas SIBs are innovative financial instruments which require the use of sophisticated techniques to fund social investments by reallocating risks and responsibilities among interested (private and public) parties. Our analysis rationale is that the increase of the understanding of the market (GBs) and of the instruments’ functioning (SIBs), also from a financial perspective – the one used in the chapter – can improve their use. We create a conceptual framework within which it is possible to analyse the financial instruments available for financing sustainability. Successively we analyse GBs, presenting both the main standards and the sources of guidelines for these instruments and market stakeholders; next, we focus on the so-called labelled green bond market. We analyse the social impact bonds clarifying their dynamics, structure and participants, after which we discuss the case study of Newpin SBB. GBs and the SIBs enable the achievement of different economic goals, which are separately discussed. They also pose risks and challenges, which we analyse by using a common framework.

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Christin Nitsche and Michael Schröder

In recent years, the socially responsible investing (SRI) industry has become an important segment of international capital markets by incorporating ESG (environmental, social and governance) factors into investment selection processes. This study analyses whether SRI mutual funds are conventional funds in disguise or invest in line with their ESG objectives. In contrast to other studies, the analysis exclusively focuses on the non-financial performance of SRI vis-à-vis conventional funds and applies ESG corporate ratings of three rating agencies (Oekom, Sustainalytics and ASSET4) for a European and a global fund universe. The SRI and non-SRI funds are analyzed with respect to differences in their Top fund holdings, the average ESG values and the distribution of ESG performance, as well as the significance of rating differences by utilizing cross-sectional regressions. At a first glance, the top holdings of both fund types seem to be very similar, but SRI funds have on average higher ESG rankings. The cross-sectional regressions show that the ESG rating differences between SRI funds and conventional funds are significantly positive, i.e. SRI funds exhibit significantly higher ESG ratings than conventional funds.

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K. Thomas Liaw

The chapter reviews the development of the green bond market and discusses the investment implications. The supranational organizations were the first issuers of green bonds. The introduction of Green Bond Principles and strong policy support in developing countries contributed to an increase in the issuance of green bonds. Corporations, banks and municipalities have become active issuers. Demand has increased as well, as investors with environmental focus raised allocation in this asset category. The common motive to invest in green bonds is to support the climate. The chapter discusses an additional financial incentive. Adding green bonds to a portfolio produces benefits from diversification if correlations are not perfectly positive. Furthermore, the chapter examines the performance and correlations of the four green bond indices. The best performance was in the first quarter of 2016 and losses were seen in 2013 and 2015. The results also showed that, within the green bond market, it is not efficient to invest in both S & P and BoA Merrill Lynch index-based funds, as those two indices are highly correlated and the diversification benefits are limited.

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Karen Delchet-Cochet and Linh Chi Vo

SME (small and medium enterprise) engagement in corporate social responsibility (CSR) has recently emerged in mainstream academic research. Researchers are now beginning to recognize that CSR in SMEs may not be assessed on the basis of our understanding of CSR in large organizations. The unique characteristics of SMEs render it far from applicable for them to employ CSR theories and practices of large corporations. One important gap in this literature involves the lack of CSR implementation tools that are tailored to SMEs. The purpose of this chapter is to contribute to the literature by proposing a framework for effective CSR implementation in the specific environment and conditions of SMEs. Our recommendations are drawn from two projects for developing CSR implementation procedure for SMEs in France: the Global Performance procedure and the SD21000 implementation guideline.

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Kathrin Berensmann, Florence Dafe and Nannette Lindenberg

This chapter addresses the potential and challenges of green bonds to finance ecologically sustainable investments. Governments, investors and the media have hailed green bonds as a key instrument of climate finance because of their prospects for tapping the trillions of dollars held in global bonds markets and by institutional investors. Does the explosive issuance of green bonds mean that bonds markets are ‘greening’? This chapter details the growth of the green bonds market, the appeal of green bonds to investors and challenges to the market’s development. One major conclusion is that a weak governance framework limits how much green bonds can contribute to sustainable development. In order to ensure that the green bonds market matures with integrity, weaknesses in governance structures must be addressed. The chapter concludes by providing policy recommendations for developing the green bonds market.

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Harjap Bassan, Kartick Gupta and Ron P. McIver

In this chapter we examine inter-industry and intra-industry (country-level) differences to firm-level returns from engaging in environmentally sustainable practices. Differences in environmental impact and public attention suggest market rewards for undertaking environmentally sustainable practices may differ by industry. An uneven global distribution of activity by industry, and country concentration of industry sectors, imply country-level differences may influence rewards from and incentives to engage in these practices. Using a fixed-effects panel data regression model, we analyze firm-level environmental performance indices constructed from environmental indicators in Thomson Reuters’ Asset4 CSR dataset. Data cover 45 countries from 2002 to 2013. We find statistically significant negative relationships between firm-level environmental performance and stock returns in the consumer services, financials, oil and gas, and utilities sectors. At the country level we identify a statistically significant negative relationship between high levels of institutional quality – i.e. government effectiveness, regulatory quality, rule of law, corruption control, and accountability – and stock returns in the consumer goods and oil and gas sectors. For the highly regulated financial and utilities sectors, we find a statistically significant negative relationship between low levels of institutional quality for a sub-set of institutional quality factors and stock returns. For other sectors effects are limited or statistically insignificant.

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Mohamed Ariff and Alireza Zarei

Researchers focusing on how currency values change and are managed have yet to show how relative measures could help track instability and also help rank countries by relative measures rather than measures based on each currency. The aim of this chapter is to provide ideas towards this end to measure currency instability and then to rank currency risk. We also test how these measures stand up. Exchange rate volatility has been at the center of several financial crises normally leading to economic declines, which usually also precipitate financial instability. Much has been written about how countries manage their exchange rates in order to promote economic growth, especially sustainable trade, by designing proper exchange rate regimes. Exchange rate stability has been a pillar within economic policy circles ever since the 1946 Bretton Woods arrangement, which replaced the US$ and gold standard with free-floating or other currency management regimes, came unstuck in 1973. How good currency stability is achieved by a given country could be measured using four concepts: relative volatility; interquartile range; degree of cointegration; and speed of adjustment to the benchmark currencies of peers. We explore these ideas in relation to the experiences of 14 countries over some 26 years.

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Frédéric de Mariz and José Roberto Ferreira Savoia

The UN’s Sustainable Development Goals, signed in 2015, call for a closer collaboration between the public and private sectors to solve social and environmental issues. We analyze the emergence of Social Impact Bonds (SIBs) – innovative financial instruments that join private risk-taking with public funding in a pay-for-outcome structure. SIBs were launched in 2010 in the UK and bridge the gap between private capital markets and public agencies to deliver a social outcome. After taking stock of the existing literature and lessons learned from more than sixty existing SIBs. Our contribution consists in an in-depth analysis of the financial structuring of SIBs, a theme not well covered in the literature. We found that financial structuring involves four key steps: legal structure, definition of the desired risk-return-impact, placement of the SIB and governance. We also make four recommendations to grow the sector, consisting in the creation of SIB Funds, the wide dissemination of knowledge, a standardization in processes and the definition of favorable regulations.

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Michael Dempsey

Economists from Keynes (1936) to Minsky (1986) have recognized the fragility of markets and the impact of such fragility on the broader economy. In some contrast, academic finance has chosen to build a theoretical framework on an understanding of markets as efficient and in equilibrium. Such understanding has led to a theoretical framework that greatly overestimates the market’s capacity for efficiency and self-correction.