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Impact investing: What it is and how it might help climate finance


Getting on for a decade ago, working for the Omidyar Network, I was tangentially present around the birth of the Global Impact Investing Network  or “the GIIN”, an organisation designed to do what its name suggested and bring together actors in an investment space for which a new name had just been invented, “impact”.  For the GIIN’s explanation of impact investing, see the box.

Impact investing as defined by the GIIN

Impact investments are investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return. Impact investments can be made in both emerging and developed markets, and target a range of returns from below market to market rate, depending on investors’ strategic goals.

The growing impact investment market provides capital to address the world’s most pressing challenges in sectors such as sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services including housing, healthcare, and education.

As can be seen from the definition above, impact investing has many overlaps with climate finance. On the mitigation side, it is a big financier of things like rooftop solar and “climate smart” agriculture, and on the adaptation side it creates micro-insurance and other affordable financial services, as well as improved community resilience through better housing and health and education services.

It has to be said that the impact investing community itself hasn’t really picked up on this crossover yet, although one of its sector blogs, ImpactAlpha, is starting to make the connection and reported COP23 quite extensively.  Although many funds and managers are organising themselves around the SDGs, like their mainstream investor cousins they haven’t really spotted the potential pipeline in the NDCs, although these are actually far more concrete national undertakings and plans than most of the SDGs.

In it’s most recent market survey the GIIN estimates the impact investing market to have been worth some $114 billion in 2016 – and that’s in terms of assets under management during the year, of which some $22 billion was new money.  While the GIIN points out that this is a “floor” for the value of impact investing (since it necessarily surveys only that part of the market it can access), even doubling the estimate of new money would still make the impact market no more than a minor contributor to overall Paris finance needs, which are in the trillions annually.

So why might lessons from the impact investing market be important for the climate finance market, as we define it at[1]?  There are three main reasons.

A community that has found itself

First, impact investors have recognised the market they are seeking to build as an asset class[2] and themselves as a community.  The GIIN as a network brings this community together, its membership of around 260 comprising not just asset owners and managers, but also what it calls “service providers”. This catch-all category includes intermediaries, lawyers, NGOs, universities and government agencies.  The special interests of leading asset owners and managers are represented by their membership of an “Investors Council” that focuses on investment practice issues.

The climate finance sector hasn’t recognised itself in this way as yet, though initiatives such as the NDC Partnership and think-tanks such as CPI through its landscape and “lab” work are engaged on this work of helping to build mutual recognition and bring people together. and the Climate Finance Accelerator are also aimed at this objective.

On a “finger-in-the-air” basis, we believe there are about 20,000 people around the globe – in government offices, national and international development banks, commercial banks, institutional investors and corporations  – who are going to make the money-flows happen to implement Paris.  So this community is of a manageable number to find itself, and to connect to bring the right collections of people together to get things done.

A common taxonomy

The impact investing world very quickly recognised that in order demonstrate that investments were indeed delivering social and environmental pluses, as well as financial returns, was that it needed some agreed way of measuring these impacts. To do this, the GIIN created the ‘IRIS’ taxonomy, a catalogue of agreed metrics that is used not just by individual investors and managers, but by third-party rating systems as well.  As the GIIN notes, among other benefits, the common categorisation allows investment to be aggregated and compared across portfolios.

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The climate finance market isn’t as entirely defined by metrics as the impact market is, though these are obviously important.  What it does have a vital need for is the ability to aggregate of projects, since in many cases and countries, these will be too small individually to get onto the radar of mainstream finance.  It would be relatively  simple to produce a catalogue of climate actions, both in mitigation and adaptation, down to a level of sub-categorisation that makes it possible to classify projects of a similar type but without too much specificity on exact technologies.

Once we have aggregation, we can have standardisation.  No market has ever grown to true scale without this.  The reason that hundreds of thousands of cheap and highly reliable cars roll off production lines around the world each week is that a large proportion of the parts in them are exactly the same, with largely cosmetic design tweaks to meet local tastes or brand expectations being the only real differences. Manufacturers and regulators have also standardised things like the positioning of instrumentation, so that you can get in practically any car in the world and know where you’ll find the accelerator pedal.

In climate finance, instead of Nissan Leafs we are still building 1930s Bugattis:  hugely expensive, taking an age to turn out, with all the parts hand-tooled, none in common even between models of the same brand, and each with a completely different set of controls and instruments needing a specialist chauffeur to drive them.  Here’s the Type 41:  stunning to look at, but just seven were turned out in the six years they were made, a year for each being about the time it takes (if you’re very lucky) to put a climate finance deal together at present.

We don’t have the luxury of time to work like Enzo Bugatti, so all parties with money available – DFIs, governments, climate funds, philanthropy – need to think about the over-complexity of many of their agendas and processes. This is the principal reason driving the production of bespoke behemoths rather than the cheap and cheerful run-arounds we mainly need.

But the UNFCCC isn’t helping itself either on this front. It was disappointing to see the document published by them at the recent COP, addressing the format for the next iteration of the NDCs, due by 2020.  If these “NDCs v2.0” used a standard categorisation (which could be created in 2018), this could be a great way for countries – and especially developing ones that need the most help – to showcase the project pipeline contained in their national plans and aggregate these with other countries’ pipelines where appropriate, to create financeable regional pipelines.  I can’t claim to have studied every one of this rambling document’s 179 pages, but as far as I could see there was almost no mention of finance for NDCs at all.  If not corrected as the NDC format gets finalised next year, this will be a major missed omission.

 Mastering blended finance

The third thing that climate finance could learn from impact investing is the use of blended finance.  Talk of this was everywhere at the COP – a great signal that more people are recognising its centrality to much of the harder-to-do finance underpinning Paris, which requires hybrid approaches.

Unfortunately there’s still some basic malfunctioning in the system, which revolves around the issue of who will take the riskiest (usually called “junior”) positions in these hybrid structures – the vital piece of money that makes the overall financing package work.  For example, much of the time at current GCF Board meetings is taken up by lengthy arguments over why the Fund should be taking more junior positions than the DFIs in the deals that the latter bring to them.

Why indeed? Surely the DFI’s as well as the GCF should be taking these junior positions in order to crowd in more private finance overall?  As things stand, the levels of private finance being brought in per dollar of public funds (the “leverage ratio”) is still way too low in most cases.  In the last reported year, the IFC, for example, says that it “used $188 million of donor funds to catalyze $726 million in private investment”, a leverage ratio of under 5.  This ratio can and should be more like 15x – the target now set for the European Investment Bank[3]. Only MDB and DFI shareholders can fix this problem by changing the agendas and incentivisation structures of the institutions they govern.

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[1] Namely both public and private finance for the NDCs and related national low carbon strategies

[2] That is, under a typical definition, “a group of securities that exhibits similar characteristics and behaves similarly in the marketplace”

[3] In the final microfinance impact investing transaction I completed at Morgan Stanley, the leverage of the most risky piece was 20x

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