Peter Kraneveld: Missed opportunities and practical solutions for SDG investing

SDG-based investing is discussed by investors, but presently impossible in practice.

In 2015, the UN agreed on a set of 17 development goals: the Sustainable Development Goals (SDGs). Unlike other political hobbyhorses designed by a committee, this idea took flight, even though it is clear that the timeline (2030) for achieving its targets is way too ambitious in view of the cost. Even a significant degree of progress on the SDGs will mean much to humanity, though, in humanitarian and political terms, but also in economic terms.
SDG-based investing is discussed seriously in the investing community, but nigh impossible in practice, as tools to construct SDG based portfolios are lacking or under construction. The signs are, that while projects and capital are available, there is a scarcity of contracts, or evidence of them. That likely means missed opportunities. Significantly, MSCI is working on an SDG index. It is posting its research on its web site and open to comments. A disquieting point is the small number of companies qualifying for the proposed index: around 250, representing 10% of the MSCI world index. If the new index is a success, these companies may attract a capacity premium, pricing the index out of the market.
Other obvious initiatives are hardly being discussed yet. The time seems ripe for a reform of microfinance. There are far too many reports of ”microfinance” used for luxury projects, ranging from condominiums for the wealthy to boutique hotels. Interest rates for real microfinance often border on the extortionate, while it is generally recognised that the default rate for genuine microfinance is low. Apparently, the small scale of the loans is still a major handicap. That could be taken away by financial intermediates, perhaps on a national scale, such as national development banks, that bundle the small loans, sell packages to institutionalinvestors and supervise loan conditions. That would in turn call for lower reserve requirements for the investors, in order to reflect the lower risk.
Investors, both institutional and multinational enterprises, will have to do their part. That includes measuring their own impact. If large investors can measure their carbon footprint and set carbon targets, they can measure their compliance with the SDGs. From there on, targets can be worked into the due diligence efforts of institutional investors. It should not be forgotten that a number of SDGs have a positive effect on developed countries also. One tempting thought is that every job created in a developing country (SDG 8) is one migrant family less, not even counting its wider economic, social and political effects. This in turn feeds into the image and trust of the investor. There are signs that the multinationals understand this, such as intra-enterprise non-profit funds that support the SDGs. Institutional investors seem to be lagging behind in this area. The SDG finance market needs further organisation. Several initiatives have shot up, often taking the form of an online tool for capital management (“platform”) that support the SDGs. While these are well meant, they collectively make large amounts of avoidable cost that must be deducted from the funds available to support the SDGs. Audrey Selian and her colleagues at Rianta Capital, based in Switzerland, researched this issue. Platforms generally welcome co-operation with other platforms, but in practice, they don’t co-operate. Each does its own data collection and uses its own software to manage the data. As a result, the data cannot be exchanged – Selian calls this missing “data liquidity” – whereby information is severely duplicated and there is a reluctance to use data from
other platforms. This situation means that each platform makes important development and start-up costs. Selian estimates that over a period of 5 to 7 years, an amount of USD $100-120 million was spent unnecessarily on bespoke system development costs. The problem doesn’t end there. Over 72% of these platforms have been established using grants, according to the aforementioned research. While that has positive effects on mission drifts, it also speaks loudly to how sustainable the platforms are themselves. In fact, the large majority are too small to attract a sufficient number of clients. Some have limited goals in terms of geography or economic sector, while others are too wide and shallow – making it even more unlikely that their fees will ever cover cost, so they are non-viable in the long term. Selian found that in a population of 35 platforms responding to her survey, 9 accounted for all the capital moved ($2.7 billion) and only three could be called of adequate size to be sustainable. Selian also proposes a solution: a connective tissue software tool that can be extended to suit the needs of each platform, known to IT professionals as an “open API”.This approach would provide a system to store basic profiles of capital and project suppliers as well as a format to ‘hold’ standard solutions. To be attractive, users must see the system as just. Participating platforms must be willing to share income honestly. If data are owned by users and protected, e.g. by blockchain technology, a success fee can be fairly distributed over the sources and supporters of the deal.
This solution would not just have financial effects in the sense of saving much money by eliminating overlapping and duplicative work; indeed, high transaction costs are severely hampering the development of the market in every SDG, everywhere. It would also enhance the quality of the data, in particular by assigning responsibility for the profiles, so that the trustworthiness of the participants can be better evaluated and developed. In addition, it would generate possibilities for mutual learning. Selian calls that “innovation liquidity”. In the long term, that may be the most beneficial effect for all of us.

Peter Kraneveld, former Chief Economist at PGGM, is a pension expert at PRIME bv.