The opportunities to drive positive social and/or environmental outcomes seem endless, but is harmonisation welcome or even possible?
Investors are increasingly considering sustainability beyond the risk management lens, with the global impact investing market reaching an estimated US$1.64 trillion by the end of last year.
“Although ESG risk management is an essential aspect of all investment strategies, it represents the most basic level of engagement with environmental and social issues,” says Laura Boyle, Head of Stakeholder Engagement at UK-based impact manager Snowball.
Boyle suggests demand is outpacing supply in the sustainability-led investment market.
“Delivering the bare minimum is not enough to attract the growing number of investors who have realised that investment priorities are changing and are demanding a more sustainable and better-quality return,” she asserts.
ESG and sustainability-focused investors largely agree that impact investing is about delivering positive outcomes for people and planet and avoiding negative fallout across environmental and social themes.
“The impact lens can unlock very interesting investment opportunities that are not highly correlated with the broader market and provide long-term, secular investment returns to help combat potential short-term volatility,” Louise Kooy-Henckel, Director of Sustainability EMEA at US-headquartered asset manager Wellington Management, tells ESG Investor.
“This should help build more resilience and sustainability in investors’ long-term investment portfolios,” she adds.
Despite growing investor appetite, it is increasingly recognised by investors, intermediaries and regulators that the impact investing market is being held back by a lack of consensus on its definition, beyond the broadest of terms. When we’re still struggling to define and eliminate greenwashing, what hope is there of ringfencing impact-washing?
Without a universally recognised set of standards, there is a risk that the impact label on a fund could become as meaningless and open to scepticism as some of the funds bearing an ‘ESG’ or ‘green’ label, prior to the tougher stance recently adopted by regulators.
As regulators lean toward towards establishing a baseline for impact standards, transparency and accountability are vital to ensure institutional investors are on the same page as to what impact really means.
Developing an impact thesis
Investors are all too aware of the difficulties of ensuring and demonstrating that their strategies deliver net positive outcomes. The approaches they take to meet these challenges are many and diverse.
Paul Hailey, Head of Impact and ESG at responsAbility Investments, a Swiss impact asset manager specialising in private market investments, says the firm aims to drive positive impact in sustainable agriculture in emerging markets.
Typical targets for these investment strategies are “smallholder cooperatives, processors or traders” that have some kind of sustainable label, like Fair Trade or Rainforest Alliance.
responsAbility’s Sustainable Food in Asia strategy takes significant minority stakes in high-growth mid- and downstream sustainable companies across South and Southeast Asia that are contributing to improvements in food production and distribution. Its Sustainable Food in Latam strategy targets investments in sustainable producers and exporters of fruits and vegetables across Mexico, Colombia, Chile and Peru.
The challenge is getting “the balancing act” right between positive and negative impacts across all environmental and social themes, Hailey says. While an investment could generate a positive social outcome, such as lessening poverty in that area, it could subsequently result in a negative environmental outcome, such as an increase in coal usage as the area becomes more prosperous and industrialises, he says.
Independent social investment institution Big Society Capital (BSC) is focused on delivering social impacts to “the most vulnerable and disadvantaged in UK society”, according to CEO Stephen Muers.
Last year, BSC published a report outlining its contributions to UK-based social impact projects over the past decade, including London Early Years Foundation, a charity providing subsidised childcare to deprived communities, ensuring that parents are able to continue work and maintain an income.
Data collation is challenging when working with smaller companies, Muers admits. “But if impact investors are only working with big organisations, they are missing a trick and not necessarily delivering the scale of positive impact they want to,” he says.
Another approach to impact, often pursued by early-stage investors, can focus on choice of business model. There is “a clear link” between an impactful company’s sustainability and its competitive advantages, according to Snowball’s Boyle, pointing to portfolio company Grover as an example.
The Germany-headquartered company has adopted a circular business model renting out consumer electronics, like phones and gaming consoles. With an average 3.5 customers per product, Grover is both reducing its potential e-waste, by discouraging customers from purchasing their own electronics, and getting more value for money from each product.
This has been a particularly impactful business model during a cost-of-living crisis, says Boyle, with the company growing across wider Europe and the US.
Snowball runs a multi-manager impact fund consisting of over 40 environmental and social-focused investments, with the majority invested in through funds managed by 30 managers.
One of the funds in its portfolio, Aqua-Spark, is targeting small and medium sized enterprises (SMEs) across the aquaculture value chain that are contributing to the sustainable production of aquatic life, including fish and plants.
It led a US$9 million funding round to contribute towards financing Sea6 Energy, an Indian-based biotech firm that has developed a ‘SeaCombine’ that harvests and replants carbon-capturing seaweed on a floating farm. As well as capturing CO2 emissions, seaweed can contribute to the regeneration of marine ecosystems and be used to create bio-plastics and biofuel.
“One of the biggest challenges we are working on is measuring how our fund managers engage with end-users and stakeholders, as part of overall systemic change,” says Boyle. “We’re keen to collaborate to improve this, as the people most affected by the challenges we are seeking to solve are best placed to inform decision-making and determine how the wider financial system could operate.”
Regulators are now developing guide rails outlining what constitutes a credible impact-labelled fund, although some questions remain unanswered.
The UK Financial Conduct Authority’s (FCA) Sustainable Disclosure Requirements (SDRs) and the EU’s Sustainable Finance Disclosure Regulation (SFDR), in particular, “are crucial regulations” for the impact space, says BSC’s Muers, as both jurisdictions have incorporated a double materiality lens, pushing investors beyond considering sustainability from an enterprise value perspective.
In October 2022, the FCA published its SDR consultation, which included the introduction of three labels for sustainable funds. The ‘sustainable impact’ label specifies that a fund must have a clear thesis incorporated throughout its investment process to demonstrate it is achieving “positive, measurable real-world impact”.
The FCA will also be introducing restrictions on how certain terms – including ‘ESG’, ‘green’ and ‘sustainable’ – can be used in product names and marketing, giving regulated firms until 30 June 2023 to update their product material accordingly.
The consultation closed on 25 January, with the FCA planning to finalise its proposals by mid-2023, and rules on labelling and disclosure coming into effect from June 2024.
Meanwhile, Level 2 of SFDR asks investors to disclose the environmental and social principal adverse impact (PAI) indicators of their Article 8 and 9-labelled funds, essentially ensuring transparency of the positive and negative impacts of their investments.
However, a report published by think tank 2° Investing Initiative (2DII) noted that SFDR has introduced labels which “create additional confusion and greater risk of greenwashing, especially when combined with environmental impact claims”, highlighting the nascent state of impact measurement and management.
As well as floating its own green fund labels, the European Securities and Markets Authority (ESMA) has proposed separate anti-greenwashing rules, open to feedback until 23 February. These would require EU-domiciled funds with impact-related labels to meet an 80% sustainable investment threshold. Additionally, any fund with a sustainability-related label would be expected to ensure that 50% of that 80% threshold qualifies as sustainable under SFDR. ESMA plans to undertake further considerations for index and impact funds.
There is change in the US, too, with its proposed amendments to the Investment Company Act’s ‘Names Rule’, expanding these requirements to cover sustainability-labelled funds, including those with impact labels. Funds must ensure 80% of their investments match the label.
The Group of Seven (G7) countries also established the Impact Taskforce (ITF), a global initiative working to improve the measurement of business and investment impact and identify investment structures that can mobilise capital towards positive impact-generating projects. In its six-month progress review, published June 2022, ITF Chair Nick Hurd welcomed the adoption of ITF recommendations into disclosure proposals across the US and EU.
Under Japan’s Presidency of the G7, the ITF will be continuing its work throughout 2023, advocating for the implementation of its impact recommendations across jurisdictions.
There is little likelihood or demand for a ‘one size fits all’ model for impact investing. But Wellington’s Kooy-Henckel notes that “positively, the industry is coalescing towards a handful of impact measurement frameworks”.
Launched in November 2021, the Impact Management Platform was developed to improve cohesion between existing standards and support impact-related dialogue between the investment industry and policymakers, hosting impact measurement and reporting resources provided by standards-setters and frameworks.
Last month, IMP launched the System Map, which aims to help investors, companies and policymakers identify resources available to them and how they all “interrelate”. Serving as a ‘living document’ that will be continuously updated, it will further help users identify areas for potential alignment across guidance and standards, as well as gaps to be addressed.
Investors can also refer to GIIN’s COMPASS methodology, which gives practical examples outlining how an organisation can measure the impact of its investments in line with the UN Sustainable Development Goals. The network’s IRIS+ platform serves as an online resource listing over 700 impact metrics across a variety of international standards.
In 2022, GIIN launched the first in a series of new impact benchmarks to help investors assess and compare the impact-related performance of their investments compared to their peers. The network has also launched a corporate investing initiative to support companies looking to develop impact investing strategies and partner with impact investors to achieve their sustainability goals.
“The skill sets, expertise and knowledge of practitioners and investors in the industry will only become more sophisticated as the [impact investment] industry continues to scale,” says Amit Bouri, GIIN’s CEO and Co-Founder.
But are universal standards really necessary? Is it even possible to define every single potential avenue of environmental or social impact?
A “degree” of standardisation would be welcome to reduce the risk of impact-washing, says Muers from BSC.
“Because impact is so broad there’s a danger of hiding things in an impact strategy which are not aligned and may be damaging,” he notes. “It’s something investors need to be very conscious of and work hard to mitigate against.”
Further, without standardisation, there will “never be full comparability” between impact-labelled products, which is “problematic” for asset owners, adds Snowball’s Boyle.
But every investor has different values, and will want to focus on different impact themes, so any standards must be high-level so as not to restrict that flexibility, both Muers and Hailey from responsAbility Investments conclude.
“Structure through standardisation needs to come in around transparency,” Muers says. “Where is the money actually going? Are selected companies genuinely having a positive environmental or social impact on the world? It’s fine for different investors to have different areas of focus, but only if all investments are fully transparent, so a judgement can be made as to whether that product is effective.”
In the interest of increased transparency and avoiding impact-washing accusations, investors need to get comfortable with no longer “marking their own homework”, agrees Boyle.
“Until we reach a point of universal standards, publicly sharing independently verified claims […] must become best practice for the industry to move forward with accountability,” she says.
Snowball’s 2021 impact report reflects on the performance of both the firm’s impact investments and the managers it works with. It was assessed and marked by an independent third party, The Good Economy, which identified where there was room for improvement, with their recommendations disclosed within the report.
“The economic principles underlying our financial system did not account for ‘externalities’ and left others to solve the social and climate problems which were thrown off at scale,” Boyle concludes.
“It is possible now to find examples of better investing in action by thoughtful impact investors globally – this is non-extractive by design and ‘prices in’ our collective futures.
“Every financial investment shapes the world. The question is, what kind of world do we want?”