The many ways in which investors screen investments and how that can contribute to positive impact in the long run.
In impact investing, the focus has always been on using capital to enable positive social and environmental gains, along with financial returns. In the last fifteen years, ESG (Environmental, Social, Governance) guidelines – first jointly formulated by the International Finance Corporation (IFC) and the Swiss government – have also come into the picture to complement several impact investing principles that were already in place. Collectively, these principles form a framework to help businesses mitigate risk and optimize returns.
Increasingly, ESG and impact investing guidelines are gaining currency beyond risk management and are being viewed as a key component of responsible investing under which potential investments are screened on several criteria, including environmental impact, sustainability of business practices, working conditions, governance and more. This trend probably has something to do with more socially conscious millennial investors entering the fray.
Across the globe, however, there are differences in the degree to which this approach has been embraced by investors. While it’s largely the norm in North American and European markets, it’s still a nascent concept in many emerging markets. In India, for example, these guidelines sometimes do make it into compliance documentation – primarily in later stage investments – but is not yet a mainstream standard across the board. Latin America also has a mixed record when it comes to ESG investing while Africa appears to be ahead of the curve, possibly due to more investments from Development Finance Institutions (DFIs) and heightened awareness of related issues in that part of the world.
Does that mean that investees in some markets are always held to different standards when it comes to social and environmental impact? The answer really depends on the entities who are bankrolling these efforts. For example, funds that receive money from IFC are required to train all their portfolio companies on prevailing ESG standards. There are other institutional investors who also insist on ESG as a requirement for any investments that they back.
Research shows that socially responsible business practices are good for the bottom line. Studies conducted on both public and private companies indicate that companies that manage their risks on the social and environmental side do much better in the long run. Unfortunately, more investors – particularly early stage ones – need to consider this evidence while making their investing decisions. If you are already accounting for and managing other risks – spanning currency, growth, culture and more – this is just one more layer that should not be ignored. Especially, in a social media-driven world, the reputational cost of ignoring it can be very high and may even spell death for the business.
And it’s not designed to be hard to implement. For the most part, the guidelines have been formulated so that they are applicable to the vast majority of industries and geographies. Investors also ensure that the compliance burden on an early stage company is much lower than on one that is further along in the growth cycle.
In India, as in other markets, there are genuine concerns regarding environmental impact, governance and employee welfare that businesses should address in their operations. But it is true that not everything can be driven by investors. Public demand and policy are also needed to tip the scales in many instances. For example, if we want to hold businesses up to a higher environmental standard in their use of packaging materials, government regulation may be more effective than investor pressure in bringing about quick and lasting change.
Still, the potential for investors to make a difference in many cases is significant. Take, for example, a business that produces bamboo plates as a sustainable alternative to plastic or styrofoam ones. Funding can enable a bigger platform for the company on the road to scale. The larger business goal is to maximize positive impact by getting the plates into more stores and online marketplaces from where they can displace plastic plates. But investors also have to scrutinize the operation in a few different ways. Are the employees making the plates paid fairly? Are working conditions safe and healthy? Is there transparency in terms of financial accounting and reporting? Is the bamboo sourced in a sustainable manner without displacing other forest ecosystems? These questions can help investors guide the company in managing risks and avoiding negative impact.
Technology can further complicate the picture. With new kinds of technologies coming in, there are other social risks involved that people may not be entirely privy to at this point. Investors don’t know what other issues or dilemmas will crop up as machines invade our lives in a bigger way, but by keeping the lines of communication open between us, we may be able to figure out how to collectively navigate these issues.
There are many ways in which the principles of impact and ESG investing can be deployed for the greater good. As they become the norm internationally across funds of all sizes and with different focus areas, they are likely to create real, measurable and lasting impact.
As communicated to Viewpoint.