Sustainable finance though ESG and impact investing: navigating the intersection of profit and purpose.

What is Impact Investing?

Impact investing has gained significant attention in recent years due to its potential to create a more sustainable and equitable world. By investing in initiatives that address pressing social and environmental issues, impact investors can contribute to achieving the United Nations’ Sustainable Development Goals (SDGs) and create positive social and environmental outcomes.

Here are the basic criteria for impact investing:

• Intentionality: the explicit search for a positive social or environmental impact
• Additionality: the commitment and contribution of the investor enabling the investee company to maximize its social or environmental impact
• Measurability: the measurement of the impact, a follow-up of the results and a continuous evaluation process

Most impact funds focus on private equity companies with diverse themes but whose objective is to generate positive impact (some examples of themes: job creation, access to education, reduction of energy consumption…)

How to measure impact in Impact Investing?

However important; measuring the impact of an investment can be challenging. There is no recognized or validated methodology that enables investors to measure the net impact of such an investment.  Impact investors need to be able to demonstrate that their investments are generating measurable social or environmental benefits in addition to financial returns.

To measure impact, impact investors use various tools and frameworks such as the Impact Management Project (IMP), the Global Impact Investing Network’s (GIIN) IRIS+ metrics, or the Sustainable Development Goals (SDGs). These frameworks allow impact investors to identify and measure the social and environmental outcomes of their investments and ensure that they align with their investment objectives.

The question is raised by some actors to develop a dedicated label, a frameworks or regulation at an EU level, such as the ISR Label or the SFDR regulation (more info on this topic here).

Impact measurement and evaluation: beyond the numbers

Impact investing is an investment approach that seeks to generate a measurable, positive social or environmental impact alongside financial returns. Impact evaluation is a critical component of impact investing, providing insights into the effectiveness of an investment and identifying areas for improvement but as there is no existing common methodology or metric and as impact is really hard to measure quantitatively it is important to incorporate qualitative data and feedback from stakeholders.

What is the Difference Between Sustainable Finance and Impact Investing?

Sustainable finance and impact investing are two related but distinct concepts. Sustainable finance refers to financial activities that take into account environmental, social, and governance (ESG) factors in their decision-making processes. This can include investments in companies that prioritize sustainability and social responsibility, as well as financial products and services that promote sustainable development. Sustainable finance can be practiced across various financial sectors, including banking, insurance, and capital markets.

Impact investing, on the other hand, refers specifically to investments made with the intention of generating a measurable social or environmental impact alongside a financial return. Impact investing involves investing in organizations or projects that address specific social or environmental issues, such as poverty, climate change, or access to healthcare.

In other words, sustainable finance is a broader concept that encompasses all financial activities that consider ESG factors, while impact investing is a subset of sustainable finance that focuses specifically on investments that generate positive social or environmental impacts.

Both sustainable finance and impact investing are important tools for promoting sustainable development and addressing global challenges.

What is the Role of ESG in Impact Investing?

ESG factors are used to evaluate the social and environmental impact of an investment, as well as the governance practices of the company or organization receiving the investment.

Environmental factors consider the impact of an investment on the environment, such as carbon emissions, resource use, and waste generation. Social factors focus on the impact of the investment on society, including human rights, labor standards, and community engagement. Governance factors assess the management and governance practices of the company or organization receiving the investment.

By integrating ESG considerations into their investment process, impact investors can identify investments that have a positive impact on society and the environment, while also minimizing potential negative externalities. For example, an impact investor might invest in a company that produces renewable energy and has strong governance practices, demonstrating a commitment to sustainability and ethical behaviour.

ESG considerations also help investors to manage risks. By identifying investments that have strong ESG practices, investors can minimize the risk of reputational damage, regulatory fines, or other potential legal or financial risks associated with investments that do not meet ESG standards.

Integrating ESG criteria and impact investing: best practices and examples:

• Define ESG criteria: Start by defining your ESG criteria based on your impact objectives. For example, if you want to invest in renewable energy, your ESG criteria may include criteria related to reducing carbon emissions, using sustainable resources, and avoiding harm to wildlife.
• Screen investments based on ESG criteria: Use your ESG criteria to screen potential investments. This can be done manually or with the help of ESG rating agencies that provide ESG data and analysis.
• Conduct due diligence: Conduct due diligence on potential investments to ensure that they meet your ESG criteria. This may involve reviewing financial statements, environmental impact reports, and governance practices.
• Monitor investments: Continuously monitor your investments to ensure that they continue to meet your ESG criteria. This may involve tracking environmental impact metrics, labor practices, and other ESG factors.

Here are some examples of how ESG criteria can be integrated into impact investing:

• Green bonds: Green bonds are a type of bond used to finance environmental projects. Investors who buy green bonds are typically seeking to support projects that have a positive impact on the environment. Green bonds can be screened and evaluated based on ESG criteria to ensure that they meet investors’ sustainability goals.
• Social impact bonds: Social impact bonds are used to fund social programs that have a positive impact on society. Social impact bonds can be evaluated based on social and governance factors to ensure that they are addressing social needs and are being managed effectively.
• Renewable energy funds: Renewable energy funds are mutual funds or exchange-traded funds (ETFs) that invest in companies that produce renewable energy. Renewable energy funds can be evaluated based on ESG criteria related to reducing carbon emissions, using sustainable resources, and avoiding harm to wildlife.

Is it Possible to Conciliate Return on Investment and Impact Investing?

One of the biggest concerns of impact investing is whether it’s possible to generate a return on investment while also achieving positive social and environmental outcomes. Many investors worry that prioritizing impact objectives may lead to lower financial returns. However, studies have shown that impact investing can be a profitable venture.

According to a report by the Global Impact Investing Network (GIIN), 90% of impact investors reported meeting or exceeding their financial performance expectations in 2019 (source).

Furthermore, a study by the Harvard Business School found that companies with strong sustainability performance had better stock price performance than those with weaker sustainability performance (source). This indicates that investors who prioritize ESG factors may be able to identify companies that are more likely to generate higher returns.

However, it’s important to note that impact investing isn’t a guaranteed way to generate high financial returns. As with any investment, there are risks involved, and not all impact investments will perform as expected. It’s important for investors to conduct due diligence and evaluate potential investments based on both financial and impact performance.

In addition, impact investors may need to be patient and have a longer-term investment horizon. Impact investing is generally a long-term investment. Some impact investments may take longer to generate returns than traditional investments. This means that investors may need to be willing to accept lower returns in the short term in order to achieve long-term impact objectives.

However, it’s important for investors to conduct due diligence and evaluate potential investments based on both financial and impact performance.

In conclusion, sustainable finance through ESG and impact investing is an increasingly important and promising field, as investors seek to align their financial goals with their values and contribute to a more sustainable future. Impact investing allows investors to support social and environmental causes while also generating financial returns. ESG criteria help investors to identify companies that prioritize sustainable practices and are more likely to generate long-term value.

Measuring and reporting on impact is crucial for ensuring transparency and accountability in impact investing.

Looking ahead, the future of sustainable finance is bright, with trends pointing to continued growth and increasing importance. Governments and organizations are recognizing the need for sustainable practices and are taking steps to promote them. This creates new opportunities for investors to make a positive impact and generate returns. As we move towards a more sustainable future, sustainable finance through ESG and impact investing will undoubtedly play an important role in shaping the financial landscape.