On introducing the International Finance Corporation’s (IFC) work developing principles for the impact investment market in Bali last year, Jim Yong Kim, former president of the World Bank Group, said: “This has to work. If we don’t find a way to accelerate impact investing into climate-related issues, we are going to be in very big trouble.”
The risks and opportunities of climate change are among the many issues driving interest in impact investing. Clients’ increasing attention to how their money is invested is forcing money managers to act. Investors identifying commercial rewards in positive impact companies is another motivator.
Neil Gregory, chief thought leadership officer, economics and private sector development at the IFC, says: “The IFC is a long-time impact investor. We have a lot to offer to this market in terms of helping to clarify what it means to invest for impact.”
Gregory says the IFC identified a lot of confusion in the market. “A lot of people were offering funds called impact or SDG or sustainable with not much clarity on what those labels meant. That was really the motivation to draw on our own practices.”
For the past year, the IFC has been consulting on the Operating Principles for Impact Management – a set of nine principles to enhance discipline around impact investing.
Gregory says one of the biggest areas of discussion during the consultation period was the ninth and final principle around disclosure. In the draft document, it asks signatories to ‘Publicly disclose alignment with the Principles and provide regular independent verification to the extent of the alignment’.
The IFC will not review or audit this, but a secretariat will host a website with links to annual disclosure statements from signatories on how they are following the Principles, says Gregory.
He adds that Principle Nine requires an independent auditor periodically or what he calls a ‘review process’ that provides some third-party verification.
This ‘review process’ is a compromise, says Adam Heltzer, head of responsible investment at private markets investment manager Partners Group, which was part of a group closely involved in developing the Principles.
“There are some legitimate concerns that companies that are already on boot straps don’t spend extra resources,” he said. To account for smaller impact managers, an internal group within a company can act as a verification entity.
Reflecting overall on Principle Nine, Heltzer says: “There is a cautionary tale from the lessons learnt of the Principles for Responsible Investment (PRI) in that you have a set of principles that many managers have signed up to and then you fast forward ten years and then now you finally have an accountability mechanism (the PRI said it will start to delist laggard signatories last year).
“In the meantime there is a sense of delusion. So I think that people are saying ‘let’s not spend ten years where people can sign on to these principles and you have a 1,300-signatory base but it doesn’t mean very much’. Let’s add some teeth and some transparency early on, which I support.”
Another principle under the spotlight is Principle Three: ‘Establishing the investor’s contribution to the achievement of impact’.
Gregory from the IFC says: “Principle Three is more straightforward for private equity and explaining your contribution because you are putting additional capital into a company and you have a direct engagement with the management of the company. So I think the bar is harder to cross for public equity strategies to be able to follow the Principles. But we don’t rule them out.
“We think there are some strategies involving engagement which can make a credible contribution to impact. But the onus is on the signatory to explain how buying shares in the public markets makes a contribution to the ability of the company to have an impact.”
Principle 7: ‘conducting exits considering the effect on sustained impact’ will likely address early concerns in the impact investment sector of the way exits are managed.
Andy Kuper, founder and CEO at LeapFrog, a $1bn impact investor in the private equity space that has been running for over ten years, says: “The initial way it was conceived was that when the company was sold, someone would have to sign on the dotted line that they’d stick to the mission. Obviously, that is a very poor way to ensure continued social mission.”Kuper says Leapfrog and others helped shift the paradigm around this.
He says: “If you can build impact, or the mission, directly into the DNA of the company such that it is the competitive advantage of the company that derives from its impact — then you have the buyer attributing value when they buy the company.
“So for them to rip up the social mission would be to rip up significant financial value that they actually paid for.”
Leapfrog has a responsible exits framework that requires it to show how a sale is positive for the ‘emerging consumer’ where it focuses its impact.
The launch of the Principles in Bali last year involved the likes of Valdis Dombrovskis, Vice President of the European Commission and UBS Chair Axel Weber: suggesting high-level support.
But, Nick O’Donohoe, chief executive of UK development finance institution CDC that helped develop the Principles, raised concerns at the meeting about market reception.
O’Donohoe, who also sits on the board of the Global Impact Investing Network (GIIN) and has a long history in impact investment, told the audience: “At a recent GIIN board meeting the subject of the Principles consultation came up. My contribution was that this was a fantastic step forward here. I was frankly surprised about the reaction of some other board members. Their reaction was ‘the IFC a big, government-owned, bureaucratic organisation – what do they know about investment?’
“It is important to remember that it is not the case that every part of the industry buys into the IFC owning the Principles.”
Expanding on this with RI, O’Donohoe says: “The point I was trying to make is that although the IFC is very broadly recognised within the emerging markets investment world, once you go outside that, it is less well recognised. And it is a multilateral government-owned organisation so that attracts a certain level of suspicion.”
“I was trying to convey to the IFC that it has to be as collaborative as possible. You’ve got to reach out to as many people as possible. You can’t assume just because you have UBS on the panel, or TPG, you’ve got a handful of large investors, that somehow you’ve captured the hearts and minds of the impact investment industry.”
The GIIN was involved in the process of developing the Principles. It is also working on its own guidance to underpin impact investment entitled the GIIN Characteristics of Impact Investors. Director of strategy Sapna Shah says GIIN is thrilled and supportive that the IFC is working on the Principles and that its efforts are complementary.
The Principles are dovetailing with other major initiatives around impact investment. The Impact Management Project is looking to develop detailed norms for how enterprises and investors measure and manage impact. And the Global Steering Group on Impact Investment is working on ‘impact-weighted financial accounts’.
Overall, those involved in developing the Principles believes they will provide some much needed rigour to the impact investment industry.
Rekha Unnithan, who leads manager Nuveen’s $1bn impact investment team, says it will be good to have an industry resource. “With a critical number of signatories to this, it will give investors the ability to start comparing and contrasting impact management approaches and discern one from the other beyond a marketing deck.”
Kuper agrees that “impact washers” are going to find it increasingly hard.
O’Donohoe adds: “It will bring more clarity to who is really justified in calling themselves an impact investor. At the moment we’ve had every mainstream investment firm jumping on the bandwagon, and that in a sense is being driven by client demand from retail investors. I think at least having some basic principles that people can verify will weed out some of the organisations that are really using the term without having changed their investment processes at all.”
At the Bali launch, former World Bank president Kim described an initiative it had with BlackRock, which is starting to use World Bank data to populate its data-mining risk platform Aladdin investors (Asset Liability and Debt and Derivatives Investment Network) system used by many investors. Kim said the initiative could “impact the way risk is thought of and measured”.
The final Operating Principles for Impact Management is expected to be released this month with an official launch and the first set of signatories announced in Washington DC at the Spring Meeting of the World Bank Group and the IMF in April.