Changing finance or financing change: investing for impact
Demand for sustainable impact investments has grown exponentially over the recent past in Canada.
The latest Responsible Investment Association’s (RIA) 2018 Canadian Impact Investment Trends Report, reveals that assets under management in impact investing in Canada grew to CA$14.75bn as of year-end 2017 - up by 81% from $8.15bn two years earlier- wealthy individual entrepreneurs, family offices, Canadian foundations, trusts, endowments and pension schemes - keen on putting their money behind companies that make a positive difference in the world - are a key part of this. There is momentum amongst high-net-worth advisors, family offices and wealth managers to access impact investments yet no consistent measurements and definitions. To this end, Earth Capital has defined best-practice for what Canada-based institutional investors should consider being the key benchmarks that can help them meet their client’s objectives for impact investment.
Impact investing v ESG – the distinction
Both the agreement of climate goals in the Paris Agreement in December 2015 and the broader delivery of the 17 UN Sustainable Development Goals (SDGs) from earlier that year have done much to increase the flow of capital into the low carbon, sustainable and ‘just’ economy, particularly galvanising new investor focus in impact investing. With this impetus has come a clear recognition of the distinction between traditional ESG integration and the new impact investing market.
Impact investing involves making profitable investments with the conscious ‘forward-looking’ intention to generate positive, measurable, social and environmental impact, alongside a financial return. This goes beyond ESG integration which is only a ‘backwards-looking’ reporting of ESG performance, and which may still permit investment in industries that can have negative environmental and social outcomes. Impact investing looks to anticipate future societal and environmental needs and deliver positive returns for people, planet and profit.
An ESG integration strategy identifies companies in a sector that perform better than peers in ESG metrics, and implements tilts, exclusions, or active engagement to weight and improve portfolios’ ESG performance. If this is not combined with some form of exclusion-based screening, it may leave portfolios with significant residual exposure to a range of fossil fuel-intensive industries, or sectors like tobacco. Contrastingly, an impact investing strategy, takes concrete action by investing in ‘pureplay’ investments focused on actionable positive environmental and social outcomes. Both strategies seek to improve outcomes, but impact investing allows investors to make more focused and measurable contributions. ESG is often seen as changing finance, but only impact investing is consciously financing change.
Private Equity for Impact Investing
ESG integration in large-cap listed equity and fixed income typically focuses on larger long-established businesses with significant inertia and long capex cycles. Although ESG data is becoming available, improvements in environmental and social performance may be slow, long-term projects. In contrast, private equity, unlike these other asset classes, is the best approach for impact investing by giving exposure to ‘pureplay’ sustainable business models in technology and services. These offer transformational environmental and social impact from the outset, with fast-moving business models and nimble market penetration.
Cutting through complexity in impact measurement
To date, growth in impact investing has been constrained by the wide range of definitions and measurements of ‘impact’. The current wide number of bespoke approaches now needs to coalesce rapidly around a small number of consistent and understandable impact measurement standards. We cannot let the ‘perfect’ be the enemy of the good. Time is pressing to make impact investments. We have reviewed the approaches currently used by a range of funds and have identified key themes that characterise different approaches taken. These are set out in Figure 1, which is defined by two key questions for an impact measurement approach in private equity.
FIGURE 1. Cutting through complexity in impact measurement
Do you attempt to measure all investments with the same set of consistent whole life measures and data sets, or rather select bespoke sets for each situation?
2. Do you do ‘deep dive’ ‘vertical’ quantitative analysis, or rather apply a shallower ‘horizontal’ scorecard approach?
Although the ‘quant impact’ approach is normally only used for listed equity strategies, the other three methodologies are in current use in impact private equity.
Quantitative analysis such as ‘Impact return on investment’ can neatly parameterise in dollar or money multiple terms, but it is only as good as the data it is fed and can be complex to implement and hard to audit. If data is incomplete, its analysis risks becoming spurious. While the advent of blockchain or ‘big data’ approaches may assist in these, this remains a future development for private equity.
Selective ‘self-certified’ choices of KPIs bespoke to each investment are appealing from an ease of adoption perspective but have significant drawbacks. These ‘mission alignment and measurement’ scorecards may choose only metrics that are easily measurable and look good. This is symptomatic of the trend to report only positive impact and avoid negative. It is especially vital to include supply chain and end of life impacts in measurement. The 2017 GIIN survey The state of impact measurement and management practice reveals that two-thirds of the impact investment sector only report positive impact, and only 18% measure negative and/or net impact for all of their investments. Even if this is addressed, bespoke KPIs will limit the ability to make a comparison of impact across different investments or to consolidate at fund and fund manager level.
There are several further approaches used in impact investing.
Social impact measurement often uses ‘theory of change’ models, however in a ‘live’ investment environment, the goal setting and measurement involves effectively the same as the mission alignment and measurement selective scorecard above, i.e., identify KPIs bespoke to each investment, and then measure against them.
Control groups are an academic approach to compare investment outcomes against a randomised control group. This can be challenging to implement in many real-world impact investment situations, as a duplicate potential investment must be identified and then kept ‘uninvested’ and measured for the lifetime of the actual investment.
Additionality is also studied in impact investing but its quantification in real investment situations must be through either:
‘Full measurement’ approaches which require control groups with the inherent difficulties explained above, or
A KPI scorecard ‘low, medium or high’ which is a subset of the KPIs in the ‘mission alignment and measurement’ discussed above.
SDG based labelling of impact strategies can be used for high-level sector mapping, but the SDGs do not lend themselves easily to quantitative holistic impact measurement. They can, nonetheless, help to define impact metrics for specific target areas.
However, a ‘whole life’ scorecard approach is one we believe delivers consistent and robust impact measurement in private markets. Key performance indicators are selected across ESG tests. The scorecard is easy to implement and is not onerous to complete with portfolio companies. Start of life and end of life impacts are included, and negative impacts are considered and measured. The ‘whole life’ scorecard allows portfolio company improvement to be measured over time, comparisons can be made between investments, and it allows aggregation at both the fund and fund manager level.
Impact investing methodologies will undoubtedly continue to evolve, certainly in response to rising demand for strategies that go beyond ESG integration to produce measurable societal benefits and support a transition to a low carbon, sustainable and just economy. Initiatives like the IFC’s Impact Management Framework and the Impact Management Project are invaluable in this evolution process.
However, the global urgency of environmental and social needs means that impact investment must press ahead at speed. The simple measurement approaches set out in this paper provide the measurement framework to enable this. Private market asset owners and asset managers will benefit from quick and straightforward impact approaches across both existing portfolios and new investments.
By Gordon Power: Co-Founder of Earth Capital Holdings, CEO & Chief Investment Officer; Richard Burrett: Chief Sustainability Officer and Jim Totty: Director of Investment, of Earth Capital
Six issues at the top of tax and finance leaders’ agenda
New Deloitte research reveals that tax leaders are under increasing pressure to add strategic value as companies accelerate business model transformation, from undergoing digital transformations to rethinking their supply chains or investing in green initiatives.
According to Phil Mills, Deloitte Global Tax & Legal Leader, to “truly deliver value to the business, the tax function needs to rethink its resourcing model and transform its technology infrastructure to create capacity and control costs”.
And the good news, according to Mills, is that tax and business leaders have more options at their disposal to achieve this.
Reflecting the insights of global tax and finance executives at global companies, Deloitte’s Tax Operations in Focus study reveals the six issues at the top of tax and finance leaders’ agenda.
Trend 1: Businesses seek more strategic counsel from tax
Companies are being pushed to develop new digital products and distribution channels and accelerate sustainable transformation and this is taking them into uncharted tax territory. Tax leaders say their teams must have the resources and skills to give deeper advisory support on digital business models (65%), supply chain restructuring (49%) and sustainability (48%) over the next two years. This means redrawing the boundaries of what tax professionals focus on, and accelerating adoption of advanced technologies and lower-cost resourcing models to meet compliance requirements and free up time.
According to Joanne Walker, Group Tax Director, BT Group PLC, "There’s still a heavy compliance load today, but the vision for the future would be that much of that falls away, and tax people become subject matter experts who help program the machine, ensure quality control, and redirect their time to advisory activity.”
Trend 2: Tipping point for resourcing models
Business partnering demands in the tax department are on the rise, but 93% of tax leaders say their department’s budget is remaining flat or falling. To ensure that the tax function can redefine itself as a strategic function at the pace that is required, leaders are choosing to move increasing amounts of compliance and reporting to a combination of shared service centers, finance departments, and outsourcing providers that have invested in best-in-class technology.
Trend 3: Digital tax administration is moving faster than expected
in addition to the rising focus of the corporate tax department partnering with their business counterparts, transformative changes to the way companies share tax information with revenue authorities is also creating an imperative to modernize operations at a faster pace. Nine in 10 (92%) respondents say that shifting revenue authority demands on digital tax administration will have a moderate or high impact on tax operations and resources over the next five years—and several heads of tax said the trend is moving faster than expected.
"It’s really stepped up in the last couple of years," says Anna Elphick, VP Tax, Unilever. "Tax authorities don't just want a faster turnaround for compliance but access into a company’s systems. It's not unreasonable to think that in a much shorter time than we expect, compliance will be about companies reviewing a return that's been drafted by the tax authorities."
Trend 4: Data simplification and lower-cost resourcing are top priorities
Tax leaders said that simplifying data management (53%) and moving to lower-cost resourcing models (51%) must be prioritized if tax is to become more proactive at delivering strategic insights to the business. Many tax teams are ensuring that they have a seat at the table as ERP systems are overhauled, which is paying dividends: 56% of those that have introduced NextGen ERP systems are now highly effective at supporting the business with scenario-modeling insights. Only 35% of those with moderate to low use of NextGen ERP systems said the same.
At Stryker, “we automated the source P&L process for transfer pricing which took a huge burden off of the divisions," says David Furgason, Vice President Tax. "Then we created a transfer price database to deposit and retrieve data so we have limited impact on the divisions. We are moving to a single ERP platform which will help us make take the next step with robotics.”
Trend 5: Skillsets are shifting
Embedding a new data infrastructure and redesigning processes are critical for the future tax vision. Tax leaders are aligned — data skills (45%) and technology process experience (43%) are ‘must have’ skills in a tax department of the future, but more traditional tax specialist knowledge also remains key (40%). The trick to success will be in tax leaders facilitating the way these professionals, with their different backgrounds, can work together collectively to unlock lasting value.
Take Infineon Technologies, which formed a VAT technology and governance group "that has the right knowledge about how to change the system to ensure it generates the right reports", according to Matthias Schubert, Global Head of Tax. "Involving them early was key as we took a greenfield approach, so we could think about what the optimal processes would look like and how more intelligent systems could make an impact
Trend 6: 2020 brought productivity improvements
Improved productivity (50%) and accelerating shifts to remote working (48%) were cited as the biggest operational benefits to emerge from COVID-19-driven disruption. But, as 78% of leaders now plan to embed either hybrid or fully remote models in the tax function long term, 34% say maintaining productivity benefits is a top concern. And, as leaders think about building their talent pipeline and strengthening advisory skill sets, 47% say they must prioritize new approaches to talent recognition and career development over the next two years, while 36% say new processes for involving tax in business strategy decisions must be established.