Impact investing focuses on investing with the goal of environmental and social impact in addition to financial return. It has grown significantly over the years and the International Finance Corporation (IFC) estimates that investor demand for impact investing could be $26 trillion.
Despite the scale and scope of investments, impact investing is neither clearly defined nor does it have clearly defined principles. IFC therefore has set out to remedy this and catalyse the impact investing market in reaching its potential size. The IFC spent about 18 months collaborating with key stakeholders — leading asset managers, asset owners, development banks and other financial institutions. This led to the development of the Operating Principles for Impact Management which offer investors clarity and consistency on what constitutes impact investing.
The voluntary principles, released recently, aim to guide investors toward building impact into their investments at all stages of the investment lifecycle, including monitoring and reporting. However, they stop short of dictating which impacts should be targeted or how they should be measured and reported.
The nine principles are grouped into the five stages of impact management system (strategy, origination and structuring, portfolio management, exit, and independent verification). The Principles aim to ensure that impact considerations are integrated into investment decisions at all points of the investment lifecycle.
1. Define strategic impact objective(s), consistent with the investment strategy: The Manager shall define strategic impact objectives for the portfolio or fund to achieve positive and measurable social or environmental effects. These goals are aligned with the Sustainable Development Goals (SDGs), or other widely accepted goals.
2. Manage strategic impact on a portfolio basis: The Manager shall have a process to manage impact achievement on a portfolio basis.
Origination and Structuring
3. Establish the Manager’s contribution to the achievement of impact: The Manager shall seek to establish and document a credible narrative on its contribution to the achievement of impact for each investment.
4. Assess the expected impact of each investment, based on a systematic approach: For each investment the Manager shall assess, in advance and, where possible, quantify the concrete, positive impact potential deriving from the investment.
5. Assess, address, monitor, and manage potential negative impacts of each investment: For each investment the Manager shall seek, as part of a systematic and documented process, to identify and avoid, and if avoidance is not possible, mitigate and manage Environmental, Social and Governance (ESG) risks.
6. Monitor the progress of each investment in achieving impact against expectations and respond appropriately: The Manager shall use the results framework (based on Principle 4) to monitor progress toward the achievement of positive impacts in comparison to the expected impact for each investment.
Impact at Risk
7. Conduct exits considering the effect on sustained impact: When conducting an exit, the Manager shall, in good faith and consistent with its fiduciary concerns, consider the effect which the timing, structure, and process of its exit will have on the sustainability of the impact.
8. Review, document, and improve decisions and processes based on the achievement of impact and lessons learned: The Manager shall review and document the impact performance of each investment, compare the expected and actual impact, and other positive and negative impacts, and use these findings to improve operational and strategic investment decisions, as well as management processes.
9. Publicly disclose alignment with the Principles and provide regular independent verification of the alignment.
Implications of the Principles
Sixty companies have also committed to adopt the principles. With more impact investors joining the fray, stakeholders are likely to guaranteed that a recognised process is being followed and there is a verification to reduce possibility of adverse events.
The Principles for Impact Management provides clear a common market standard for what constitutes an impact investment. A common language will help accelerate the deployment of capital seeking impact that is currently sitting on the fence. A likely impact of the clarifications is that it will help fill up the funding gap for SDG projects. This will help accelerate the achievement of SDG goals. The release of the Principles is just a start because the social challenges that the world faces are enormous and seemingly impossible. Investors and institutions need to come together to make investing for impact a success.