A Measured Approach

Sir Ronald Cohen, veteran venture capitalist and impact investing guru, explains why he believes we’re on the verge of an impact revolution.

According to Oscar Wilde, a cynic is a man who “knows the price of everything but the value of nothing”. Sir Ronald Cohen is a man who wants to know the price of everything a company does to impact society and the environment, because this will mean those impacts are valued by all, including investors, but also governments.

You don’t need the wit of the Wilde to know Cohen is no cynic. He is an optimist, but one who is grounded by more than 50 years of investing experience.

Formerly a venture capitalist, co-founding Apax Partners among others, Cohen has spent more than a decade putting a monetary value on impact, including as Chair of the Global Steering Group for Impact Investment (which has its annual conference next month) and the International Foundation for Valuing Impacts (IFVI).

Momentum is building. Last month, the IFVI issued its draft methodology for impact accounting, building on the work of Harvard Business School’s Impact-Weighted Accounts Initiative, which Cohen also chaired.

Before the end of the year, it will publish a price for carbon emissions, which Cohen hopes will put an end to one of the many hot and increasingly political debates surrounding the net zero transition.

There are lots of prices for the cost of polluting the atmosphere by emitting more CO2. On some markets, carbon offsets might trade at US$30 per tonne, companies use a range of internal prices (typically around US$100), while Harvard’s IWAI used US$300, based on a science-led approach. The latter figure, when applied to many global firms, effectively renders them highly unprofitable.

Cohen expects IFVI to announce a price recommendation for carbon and the case for it. Putting a price on carbon will be “transformative”, he says. But Cohen has plans way beyond carbon, arguing that making impact’s cost both concrete and comparable will unleash an era of radical transparency, with implications for public and private capital flows.

“Tipping point” for ESG and impact

Cohen predicts a “tipping point” in the next year or two, which will effectively result in a merger of sorts of ESG and impact investing.

Concerns over greenwashing have accelerated efforts by regulators and standard setters to develop and introduce more robust forms of disclosure and measurement to the burgeoning ESG investing market, he suggests. While such efforts have a long way to go, the overall effect is to facilitate the introduction of impact into the financial analysis and evaluation of companies.

“When ESG [investing] has reliable measurement, we will begin to see investment decisions made in a different way,” he says.

Cohen cites academic research showing that the rising tide of ESG-led investment flows has already shifted the valuation of companies in favour of those that have better environmental performance.

“Within the same sector, differences in valuation are accounted for by differing environmental impact of competitors. And that’s been done with very crude methods of reporting,” he observes.

“Once you begin to get a more granular comparison of the impacts of different companies, you can compare impacts in the same way you can compare profits, ultimately in monetary terms.”

The disclosure requirements being introduced in major jurisdictions – such as Europe’s Corporate Sustainable Reporting Directive, or the climate and general sustainability reporting standards of the International Sustainability Standards Board (ISSB) – are a welcome but insufficient first step, according to Cohen.

“They won’t bring impacts into financial analysis, because they’re disparate metrics with no single unit of measurement,” he explains.

Cohen characterises the work of the IFVI, effectively standardising the valuation of impacts, as complementary to global standards setters and regulators in major markets. The regulators are doing critical work in standardising quantity metrics, such as the carbon emissions firms must report, says Cohen. These provide the “bedrock” for the monetary valuation of impact.

Meanwhile the IFVI’s proposed framework for impact accounting will enable a significant and much-needed leap forward, he asserts. “We are shifting ESG from its current position of measuring nothing very reliably to measuring all impacts reliably and in monetary terms.”

The regulators will take note, but they will not be the first adopters, Cohen predicts. “Data providers are very interested in providing investors with the most user-friendly data they can, and obviously monetary data is a lot more powerful,” he says.

Research conducted for the IWAI shows the potential. Of the 3,000 companies of its environmental dataset, 450 of those companies delivered more damage than profit. The IWAI also looked at the social impacts of firms, defining the economic costs of diversity as the lost salaries to specific communities.

“In the next couple of years, we’re going to be dealing with measurement around corporate impact in a completely different way,” predicts Cohen.

German apparel brand Puma and French food and beverage maker Danone have already been piloting monetising their impacts. The IVFI’s framework is also being road-tested through its partnership with the Value Balance Alliance (VBA), which includes multinational companies such as Anglo-American, BASF, Bayer, BNP Paribas, DHL Group, L’Oreal, and Volkswagen among its members.

Once data providers begin to offer the benefits of impact transparency and comparison to investors, regulators may seek so make the information and processes more standardised and verified. “Once they see the figures circulate, they will find it natural to look at the work of the IFVI, adopting it and improving it,” says Cohen.

“In the same way that the ISSB integrated the Sustainability Accounting Standards Board, you could well see IFVI being integrated in the next two or three years.”

Impact implications

The lack of a comprehensive framework for measuring impact is not the only reason why most investors do not factor it into their decisions. Guidelines and regulations the world over have long told them that their fiduciary duty requires prioritising risk and return. This is changing in some jurisdictions, but not all.

Nevertheless, Cohen expects a “paradigm shift” which will see investors make decisions based on impact and returns, by taking advantage of greater transparency, including that provided by the ability to put a monetary value on impact.

“Once you have granular, verified data on impact, you give consumers, investors, employees and governments the basis on which to improve impact performance,” he says.

“In the case of government, it may mean giving tax credits to companies delivering positive effects or it may mean taxing companies that are contributing the negative effects, as is increasingly being done through carbon taxes.”

Investors, says Cohen, will soon be in a strong position to assess accurately the financial implications for a company of improving its impact performance, for example in terms of investment in new operations to reduce carbon emissions, or changes to labour practices.

“The companies that can best optimise both profit and impact will grow the fastest and will be worth the most. Those that don’t embrace impact will be like those that didn’t embrace the tech revolution. They will find new companies like Tesla come along and disrupt their existing business model, through technology and impact.”

While the impact revolution will require changes from governments, many of which are wavering in their commitment to the policies needed to minimise negative environmental impacts, Cohen insists there is broad global consensus at the political level on the need for and the benefits of impact measurement as part of a multilateral sustainable development agenda.

This started with the establishment of the G8 Social Impact Investment Forum in June 2013 and has continued right up to the recent Group of 20 Leaders Summit in New Delhi, which committed to actions supporting the G20 High-Level Principles on Lifestyles for Sustainable Development.

One outcome of this, says Cohen, is that governments will be able to measure the impacts and effectiveness of their own policies and activities with greater accuracy, shifting to an approach that ensures “every dollar is well-spent, with innovation and evidence driving social and system improvements”.

Outcomes-based government spending

Cohen has long been concerned about social inequality and is known by many as the ‘godfather of social impact investing’.

His recent book, ‘Impact – Reshaping Capitalism to Drive Real Change’, opens with him recalling a speech he gave two decades previously, predicting a ‘curtain of fire’ separating rich and poor “if we did not tackle the needs of those left behind more effectively”.

“It was inevitable that technology would pose a real challenge in terms of economic gaps. And if we didn’t worry about society, it was inevitable that you will see the fabric of society seriously rent by social tensions,” Cohen tells ESG Investor.

“This is a creating a feeling in the part of the population that is less educated and has benefited much less economically from the tech revolution – or the support given to the financial system – that elites are dominating the political system.”

As result, we face a “strange phenomenon”, says Cohen, in which the forces of democracy and capitalism – both based on individual freedom – are “clashing over the distribution of the game”.

But he believes that governments have an opportunity to resolve social tensions while addressing concerns at different ends of the political spectrum, partly by leveraging the transparency that impact measurement offers.

“At a time when government budgets are constrained, impact investing may gather momentum as a way of making money go a lot further in delivering social improvement.”

The burgeoning markets for sustainability-linked bonds (SLBs) and loans, already worth over US$1 trillion by some estimates, shows the way ahead, according to Cohen. Sustainability-linked debt instruments differ from green and social bonds in that their proceeds can be used to fund a range of sustainability-related activities, subject to targets, rather than being restricted to specific projects.

“Sustainability-linked bonds and loans draw the attention of governments to the power of outcomes-based approaches in guiding capital to achieve certain impacts,” says Cohen.

Allied with greater transparency through impact accounting and related developments, the growth of SLBs in particular could herald the beginning of outcomes-based government spending, Cohen suggests. “When you have a trillion that is outcomes-based in the financial markets, the signal it gives government is: there’s big money here, attracting big investment through spending more effectively.”

The Sustainability-linked Sovereign Debt Hub was launched last September by the World Bank, the European Bank for Reconstruction and Development and the Asian Infrastructure Investment Bank, with support from the International Capital Market Association and the Climate Bonds Initiative. To date, Chile and Uruguay are the only sovereigns to have launched SLBs.

Cohen acknowledges the institutional readiness of governments has slowed take-up to date, in contrast to investors who have long recognised that the ‘trend is your friend’.

To address perhaps the most significant finance gap facing governments – the one blocking progress on the UN Sustainable Development Goals (SDGs) – public sector finance is insufficient, he admits, no matter how well targeted.

“The gap can’t be filled by governments and philanthropists alone. It has to be filled by the capital markets,” says Cohen.

This week’s UN SDG Summit recognised as much, with its political declaration underlining the need for reforms that draw in private capital more effectively.

“If investors and companies can measure their impacts, either encouraged or directed by regulation, you will begin to see firms worth more than US$100 trillion going in the direction of achieving specific impacts. You will be able to make links from impact statement to specific SDGs. A firm in the carbon capture business would have a line directly to an emissions-related SDG.”

Era of transparency

The coming era of transparency will lead to momentous changes, Cohen argues, in both the public and private sectors. In the first instance, ESG investing is set a step-change.

“The importance of ESG is that this is the first time the financial markets have tackled the issue of optimising risk, return and impact,” he says.

“It hasn’t been done perfectly. Impact investment is the next step along, because by definition it involves measuring rigorously the impact that you create. The next phase is going to transform ESG into impact investment through this new, improved transparency.”

Whether the headwinds faced by ESG investing to date will be dissipated by this change or strengthened remains to be seen. Cohen draws parallels with the legislation brought in under US President Franklin Roosevelt after the Wall Street Crash, which faced stiff opposition at the time but still today form the basis of investing and accounting in the US.

“The forces of unreadiness and bureaucracy always create huge inertia. Opposite that, you have the force of consumers and investors. Ask yourself: who’s going to win at the end of the day? I think the answer is clear.”

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