Sustainable Finance and Impact Investing

Alan S. Gutterman

• Publisher: Business Expert Press
• Year: 2021
• ISBN:
  9781637420034
• Topic: Economia
• Subtopic: Economia ambientale

This book provides readers with a basic understanding of sustainable finance and impact investing including history, definitions of impact, current trends and drivers, future challenges, and an overview of the key players in the global impact ecosystem.

The term impact investing first appeared in 2008. Today the most commonly used definition is investing made with the intention to generate positive, measurable social and environmental impact alongside a financial return. A wide range of individual and institutional investors that have already entered the impact investment marketplace and continued growing enthusiasm can be expected given that feedback from investors indicated that portfolio performance has generally met or exceed their expectations for both social and environmental impact and financial return.

Established companies have been compelled to respond to calls by institutional investors to incorporate responsible environmental, social, and governance initiatives into their business models as a condition to continued support in public capital markets. Other companies seeking to demonstrate to impact investors their commitment to environmental and social responsibility have opted for emerging forms of legal entities, so-called social enterprises, which explicitly incorporate sustainability and multi-stakeholder interests into their governance and reporting frameworks.

This book provides readers with a basic understanding of sustainable finance and impact investing including history, definitions of impact, current trends and drivers, future challenges, and an overview of the key players in the global impact ecosystem. The book also describes impact investment structures and instruments, social enterprises, and impact measurement and reporting.

CHAPTER 1

Sustainable Finance

In recent years governments have debated and established ambitious public policy initiatives such as the 2030 Agenda for Sustainable Development and its broad range of Sustainable Development Goals (SDGs) including reducing poverty worldwide and promoting sustainable economic growth and the Paris climate agreement of 2015. Funding these initiatives would require the deployment of massive amounts of external financing, much of which would need to come from governments in the form of “official development assistance,” which has been defined as government aid that promotes and specifically targets the economic development and welfare of developing countries. Multilateral development banks (MDBs), which are created by governments including the World Bank and International Monetary Fund, also play a significant role in stimulating and channeling aid into developed, low-income and emerging companies. Other significant forms of external financing assistance in the development sector include philanthropic assistance through foundations, international sovereign bond issuance across various multilateral institutions including MDBs, development institutions and supranational organizations, and climate finance through public–private partnerships. Capital for development projects is also being provided by financial institutions, insurance funds, pension funds, and impact investors, and organizations active in the startup community are ramping up their support for sustainable entrepreneurship. More and more companies are issuing financing instruments based on specific promises of use of the funds for environmental and/or social projects and stock exchanges are facilitating these offerings by mandating more robust environmental, social, and governance disclosures. The actions of all of these actors are influenced by the priorities identified by nonprofit think tanks, philanthropists, social change activists, and enablers and civil society.¹

Sustainable finance has been explained to be a long-term approach to finance and investing, emphasizing long-term thinking, decision-making and value creation, and has also been described as the interrelationships that exist between environmental, social, and governance (ESG) issues on the one hand, and financing, lending, and investment decisions, on the other and long-term-oriented financial decision-making that integrates ESG considerations.² On its webpage describing “sustainable finance,” the European Commission (EC) explained that the term generally referred to the process of taking due account of environmental and social considerations when making investment decisions, leading to increased investment in longer-term and sustainable activities. Examples of environmental considerations offered by the EC included climate change mitigation and adaptation, as well as the environment more broadly and the related risks (e.g., natural disasters), while social considerations refer to issues such as inequality, inclusiveness, labor relations, investment in human capital, and communities. The EC also noted that the governance of public and private institutions, including their management structures, employee relations, and executive remuneration practices, played a fundamental role in ensuring the inclusion of social and environmental considerations in the decision-making process. The EC’s view was that all of the components of ESG were integral parts of sustainable economic development and finance, and that sustainable finance should be understood as financing that can support economic growth and the reduction of pressures on the environment while simultaneously taking into account social and governance aspects.³

Sustainable finance has emerged in parallel to policy initiatives mentioned above as it has become clear that they cannot be realistically undertaken and completed without innovative private sector financing models that allow a wide range of potential investors to participate in high-growth, albeit risky and uncertain, opportunities. According to BNP Paribas, capital for sustainable finance is available from investors who want to take part in financing enterprises involved in projects with high environmental or social value, including projects that will have an impact that the investors may experience directly; socially responsible investment funds capitalized by institutional and private investors; pension funds and private banking and wealth management sources expected to grow significantly in the coming decades due to wealth transfers from Baby Boomers and Generation X to Millennials who surveys indicate have a strong commitment to incorporate social change into their investment decisions.⁴ Sustainable finance is just not about “doing good,” in fact consultants such as McKinsey have argued that companies with a robust ESG framework are more likely to add value as compared to companies that have not developed sustainable practices and that ESG creates value in several different ways including top-line growth, cost reductions, reduced regulatory and legal interventions, employee productivity uplift, and investment and asset optimization as key enablers in generating a long-term advantage.⁵

The interest of the EC in sustainable finance has been driven by the European Green Deal, which is a growth strategy announced in December 2019 that seeks to make Europe the first climate-neutral continent by 2050. The EC has acknowledged that the scale of the investments necessary to achieve the desired transition to a climate-neutral, green, competitive and inclusive economy is beyond the capacity of the public sector alone (e.g., in January 2020, the EC presented its European Green Deal Investment Plan that called for the mobilization of at least €1 trillion of sustainable investments through the period ending in 2030) and has committed to an action plan on sustainable finance in which the financial sector (e.g., asset managers, insurance companies, and investment or insurance advisors) supports the European Green Deal by reorienting investments toward more sustainable technologies and businesses; financing growth in a sustainable manner over the long term; and contributing to the creation of a low-carbon, climate resilient, and circular economy.⁶

The financial services industry has taken notice of importance of sustainable finance and the market for sustainable investment opportunities has been growing steadily as more and more industry participants are recognizing the long-term benefits of a more sustainable economy and incorporating sustainability considerations into their strategies and operations. According to data from the Global Sustainable Investment Alliance (GSIA), global sustainable investment assets reached $30.6 trillion at the start of 2018, a 34 percent increase from 2016, and the volume of global sustainable investment assets as a percentage of all assets under management around the world increased from 28 to 35 percent over that same period.⁷ Reports based on data collected by the GSIA noted that the number of signatories to the Principles for Responsible Investing (PRI) had grown to 2,450 by June 2019, compared to 63 signatories at the time that the PRI was launched in 2006, and that aggregate assets under management for the group was $82 trillion. In October 2019 the International Monetary Fund reported that ESG funds accounted for around $850 billion in assets. While early adoption of ESG factors among funds has been primarily on the equity side there have been indications that fixed income investors are becoming more comfortable with the concept as demonstrated by the growing rate of issuance of sustainability-linked bonds (“green bonds”).⁸

Principles for Responsible Investment

The six UN Principles for Responsible Investment (“Principles”) (unpri.org) are a voluntary and aspirational set of investment principles that offer a menu of possible actions for incorporating ESG issues into investment practice. The Principles were developed by an international group of institutional investors, for investors, through a process convened by the UN Secretary-General, and signatories are required under the Principles to make the following commitment:

“As institutional investors, we have a duty to act in the best longterm interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognize that applying these Principles may better align investors with broader objectives of society. Therefore, where consistent with our fiduciary responsibilities, we commit to the following:

Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes.

Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices.

Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.

Principle 4: We will promote acceptance and implementation of the Principles within the investment industry.

Principle 5: We will work together to enhance our effectiveness in implementing the Principles.

Principle 6: We will each report on our activities and progress towards implementing the Principles.”

The Principles include a menu of possible actions for incorporating ESG issues for each of the six Principles listed above. For example, with respect to “active ownership” (Principle 2), investors are asked to consider developing and disclosing an active ownership policy consistent with the Principles; exercising voting rights or monitoring compliance with voting policy (if outsourced); developing an engagement capability (either directly or through outsourcing); participating in the development of policy, regulation, and standard setting (such as promoting and protecting shareholder rights); filing shareholder resolutions consistent with long-term ESG considerations; engaging with companies on ESG issues; participating in collaborative engagement initiatives and asking investment managers to undertake and report on ESG-related engagement.

Source: https://unpri.org/pri/an-introduction-to-responsible-investment/what-are-the-principles-for-responsible-investment

Consistent with its leadership in other areas of sustainability and corporate social responsibility, Europe had the largest pool of sustainable investment assets globally as of 2018 and commentators have noted that sustainable investing has been broadly adopted in Europe and has reached the highest level of maturity compared to any other region. The United States trails slightly behind Europe and data indicates that Asia is progressively catching up and that sustainable investing is gaining more traction in Asian countries outside of Japan, which was one of the earliest adopters of ESG-based investing. China has been particularly aggressive—it had the second biggest green bond market in the world as of the end of 2018—and Australia, Hong Kong, and Singapore have launched initiatives to promote sustainable investing.⁹

At the same time, there has been a surge in regulatory focus on sustainable finance and developing approaches to integrating sustainable finance into the mainstream frameworks of governments, multinational enterprises, and the global financial services industry. For example, in May 2018 the EC released its Sustainable Finance Package, a set of legislative proposals focusing on driving more capital toward sustainable investment projects and encouraging participants in the financial sector to change their operations so as to reduce environmental risks. Key features of the package included adoption of an EU-wide classification system for sustainable investments and “environmentally sustainable economic activity,” requiring asset managers and institutional investors to demonstrate how their investments are aligned with ESG objectives and disclose how they comply with their duties and creation of a new category of benchmarks of standard indices and standardization of formatting for reporting of ESG disclosures. In As...