Governments around the world are grappling with trying to distribute finite resources to solve an array of challenging issues, including the climate crisis, racial inequality, gender disparity, and biodiversity loss. This is before the devastating impact of Covid-19 is factored in. As the U.N. Commission on Trade and Development estimates, only half of the annual investment required to meet the Sustainable Development Goals (SDGs) will come from public funds, leaving an annual gap of $2.5 trillion. Similarly, the 2009 COP15 commitment by developed nations to mobilise $100 billion annually to help poorer countries deal with climate change, widely regarded as insufficient to adequately address the need in the first place, is only likely to be met this year - three years behind schedule. Clearly then, private investment has a role to play in addressing these funding shortfalls and drive positive societal change by developing solutions to problems traditionally seen as within the remit of the public sector.

IMPACT INVESTING

Impact investing is a way of achieving this. According to the Global Impact Investing Network (GIIN), impact investments are made with the intention to generate positive, measurable social and environmental impact alongside  financial return. The four fundamental tenets, as outlined by GIIN are intentionality; financial returns; range of asset classes; and impact measurement. As opposed to ESG investing or responsible investing, impact investments intentionally aim to generate social and environmental value. They seek a financial return on capital that can range from below market rate to risk-adjusted market rate, setting it aside from philanthropy. These returns can be sought by investing across asset classes. Finally, the investor must undertake stringent measurement and reporting of the social and environmental performance of their underlying investments.

Although impact investment accounts for a small proportion of total global assets under management (AUM) of over $100 trillion, the market has grown significantly over the last decade (GIIN estimates $1.2 trillion in AUM, while International Finance Corporation (IFC) suggests $2.1 trillion).

This expansion has accelerated the introduction of pioneering legislation. The Sustainable Finance Disclosure Regulation (SFDR), part of the EU’s Financing Sustainable Growth Action Plan, sets out the mandatory ESG disclosure requirements for asset managers. Depending on the level of sustainability and characteristics of the fund, the SFDR classification system either classifies it as an article 6, 8 or 9 fund.

Article 6 is the default classification. Regardless of whether the fund is promoted as ESG or not, asset managers must incorporate sustainability risks into investment decision making and the impact of sustainability risks must be described. Where an asset manager doesn’t consider sustainability risk in the decision-making process, the disclosure should explain why.

Article 8 and 9 funds, meanwhile, are both considered to be sustainable. Article 8 applies to funds that promote environmental and social objectives, even if they aren’t the core objectives. Asset managers must disclose the degree to which they invest in products with an environmental or social objective and whether the relevant investment product benchmark is consistent with the product’s promoted objectives.

Article 9 affects funds that have a sustainable investment primary objective, as opposed to a purely financial one. These funds are accordingly subject to the most stringent requirements and, in order to prove that the fund is having its intended impact, a suitable benchmark index must be used to measure its relative performance.

The EU Taxonomy (integrated into the SFDR) is primarily a classification system with a set of definitions and rules to determine which economic activities carried out in the EU are ‘green’ or ‘sustainable’. In a rapidly evolving landscape it can be hard to navigate which way is forward but while the public sector has insufficient resources to tackle many of the challenges facing society in 2023, there is a crucial role for private investment to play. It is important that investment firms adhere to increasingly stringent regulations and accurately demonstrate the positive impact of their funds. In doing so, they will be well placed to benefit from the momentum being experienced in the impact investing industry and attract the significant capital that continues to flow into it. With evidence-based and transparent disclosures we are supporting businesses to set robust impact investing strategies that benefit the environment and society.

Further information

Contact Blair Hershaw or Toby Hiram

In plain English: All Capitals Accounting