Impact investment is growing rapidly. Why? What are the developments? And how is this sector driving the transition to a sustainable and inclusive society? In 6 articles, we highlight the developments, opportunities and risks of Purpose & Impact investment. This is the third article, previously published on: Sustainable Investing
By Martin de Jong & Anne Rademaker
The UN, which will celebrate its 75th anniversary in 2020, is having a major impact on business through the Sustainable Development Goals (SDGs). It seems that now more than ever, companies understand that solving global problems is also part of their business. Now that the SDGs have reached a third of their duration, companies and investors are beginning to embrace the SDGs as a way to demonstrate their social performance. Investors are embracing companies that contribute to SDGs. Companies themselves are more than willing to claim their share. Environmental, Social and Governance (ESG) rating agencies are including SDG performance in their ratings and creating pretty-looking SDG scoreboards. Sounds good on paper, but in practice it’s not all positive
Growth from ESG to SDG investment?
It seems logical: From ESG investing to SDG investing. From a corporate agenda to a global agenda. More on ESG investing in Article 1 of this series. Shortly after the launch of the SDGs, the first initiatives for responsible and SDG-aligned investment funds began. The UN embraced this because large investments are needed to achieve the SDGs, not only by governments, but also by private parties.
Starting in 2017, more private parties began combining their responsible investment programs with SDGs, such as the Principle for Responsible Investment (PRI) initiative and the Global Impact Investing Network. This resulted in a number of institutional investors setting up funds or assigning the SDGs to their existing funds. This not only satisfies a wide(er) range of stakeholders, it also ensures long-term value creation that benefits the environment and society as a whole.
SDG rating
In general, investors base their investments on third-party information, as this is seen as the way to assess a company’s social impact. There are a few major “third-party” or ESG rating agencies that base their ratings on:
- Proprietary/diverse methodology and big data;
- Annual corporate reporting;
- Public information on various websites;
- For specific cases, additional ESG questionnaires;
- And in even fewer cases, interactions with Investor Relations (IR) of the company.
Despite the various methodologies used, it is common to provide the SDG rating: some tools include ISS, MSCI, Sustainalitics because it gives impact investors a better understanding of a company’s true impact.
SDG-washing
In general, it seems very interesting to bring SDGs into your organization and attract investors. To understand whether lending through publicly traded bonds will have a positive social impact, there are standards available that can be used by issuers to clarify the purpose of a bond. The so-called Green Bond Principles (GBP) have been used for years and the Social Bond Principles also apply (note: the new EU Taxonomy could replace them, at least in the EU). The UN will launch their own standard for SDG bonds: it is currently in the “public consultation” phase. According to UNDP SDG Impacts director Elizabeth Boggs Davidsen, the standards will help against “SDG-washing. By this she means labeling investment opportunities as SDGs when they are not or are difficult to determine. What the UNDP sees are misguided funds and companies that use the SDGs as a target, when in fact it’s just about attracting impact investors. And this is a serious problem for three reasons:
- Deliberate deception can lead to distrust of companies in general;
- The risk that the SDGs will not be achieved by 2030;
- A business has a very limited effect on improving society.
The term “SDG-washing” is derived from “Greenwashing,” referring to the claim of a company or a product/service to be good for the environment when it is not. One of the objectives of the already mentioned EU Taxonomy is to reduce Greenwashing. SDG-washing seems to go hand in hand with the poor quality of sustainability reporting. While the financial part of an annual report has an internal and external team, sustainability reporting even within large companies is only the focus of a few. And in SDG alignment, it is old wine in new bags. Only a few companies build their strategy on SDG contributions. As a result, companies exaggerate when mapping their sustainability efforts toward the SDGs. There are control mechanisms to avoid this risk, for example, the GRI has published a reporting standard for SDGs and external validation is one way to create a reliable SDG claim.
SDG opportunity
Awareness and willingness to take action on most SDGs will have an impact. For companies even more so because it affects two sides: social impact and financial impact. The latter can create a major shift from short-term profits to long-term performance (more on this in article 6 of this series). Social impact will have all kinds of internal and external positive effects on society and the 17 SDGs. This raises another question, “There are 17 SDGs, should a company work on and report on their impact on all 17?” A company will have an impact on all 17 goals, but to create a reliable (unadulterated) impact, focus will lead to change. We believe it is stronger if the scope is limited to a maximum of 3 SDGs and within those 3 SDGs, a delineation is needed to select (out of 169 possible) SDG goals. This scope should fit with a company’s core business and strategy and purpose. The impact will affect not only the company’s agenda, but more importantly the global agenda. With credible reporting and IR in place, this will have a solid impact on a company’s ESG rating. More on capitalizing on ESG opportunities in article 2 of this series.
SDG investing
More and more companies are reporting on their SDG performance, creating an opportunity for investors to invest based on SDG. We have argued that the UN SDG framework has the potential to provide guidance for companies and responsible investors to focus their efforts. But we have also seen that SDG investments by private parties are still relatively small and ESG investing is leading the way. This can work both ways, as ESG does not exclude SDG; moreover, including SDG in your strategy will have a positive impact on your ESG performance. And while there is plenty to improve on the credibility of claims, the SDG framework is well suited for companies and investors to invest with impact.
About the authors:
Martin de Jong is founder of Empact, impact consultancy and works for (international) clients in the field of Social Strategy, ESG and Impact Valuation. He is former Director of Social Value VodafoneZiggo and Sustainable Business Manager Vodafone PLC. He is a guest lecturer at several universities on sustainable business.
Anne Rademaker is founder of Rademaker Consulting and works with strategic partners (both public and private) to accelerate the transition to a global circular economy. Anne works with Martin for Empact’s ESG & Impact clients. She is a former Senior Consultant at EY with extensive knowledge in Finance, Risk and Process management.