Out-Law Analysis 5 min. read
25 Oct 2018, 11:56 am
The draft Impact Investment Guidelines are designed to create standardisation across the development community and ensure that projects or investments which are billed as making an "impact" do in fact meet goals such as those as set out in the UN's Sustainable Development Goals (SDGs). However, the guidelines do not always go far enough, and this can hopefully be addressed in the final version. There have also been some questions about whether the IFC is the appropriate body to be bringing this form of guidance to the market.
The guidelines are primarily targeted at asset managers. They may be applied at the institutional level or at the level of fund manager for a specific impact targeted fund, through becoming a signatory to the principles outlined in the guidelines.
Impact investment is the practice of investing in a manner which benefits economic or social development or the environment. The concept is usually used in the context of private sector investment, particularly in developing markets.
The IFC guidelines favour alignment with and achievement of the SDGs developed by the UN, which serve as a benchmark for achieving sustainable development up to 2030. However, other widely accepted goals may instead be targeted. The IFC and other contributing parties, which include asset managers and owners, development banks and financial institutions, hope that the guidelines will ultimately lend greater legitimacy to the concept of impact investment, and so draw in more public support and further investment.
The guidelines are designed around nine principles, framed around the life cycle of an investment. The IFC describes these principles as the "essential features of managing investment funds with the intent to contribute to measurable positive social, economic or environmental impact".
The principles fit into the project life cycle as follows:
Establishing the strategic intent of the project first requires the institution or fund to set objectives which align with the widely accepted goals for achieving impact (principle 1). The most notable would be the SDGs, but regionally specific programmes, for example, could be relied on instead.
The other element of strategic intent is to create processes allowing the impact objectives to be managed at portfolio level, in the same way as financial performance would be (principle 2). This requires cohesive planning across the whole investment portfolio so that the investments achieve the stated impact objectives on aggregate, rather than individually.
However, the guidelines do not appear to go far enough here. Alignment with the SDGs implies that the majority of investments will be structured with sustainability in mind. However, the principles do not really build in a mechanism for ensuring sustainability actually occurs beyond this stage. Although achievement of results will be evaluated and corrective action taken during portfolio management stage, there is no requirement to plan for sustainability on exit or determine the likelihood of this being achieved. Moreover, there is no requirement for follow-up evaluation on whether the investment continues to provide benefits to the targeted beneficiaries. Without this, one of the main purposes of impact investment may be lost.
At this stage of the investment, the primary considerations are to identify the specific impacts to be achieved as well as the negative effects. Principle 3 requires the investor to first be clear about the means through which it will make its contribution. This could be through financial instruments or assistance, technical assistance or something else, and may be defined either at portfolio level or by individual investment.
This is then followed by assessing what impact the investment itself will have; addressing specific questions on what the intended impact is, who will benefit from the impact and what the significance or magnitude of the investment is (principle 4). The corollary is the need to evaluate whether there will be negative effects, and how these can be addressed, monitored or managed (principle 5).
At portfolio management stage, the principles require quantification of the actual achievement of the impact investment. Each individual investment is therefore monitored on an ongoing basis against the results framework developed during the structuring phase. The guidelines require that corrective action by taken where the assessment shows that the objectives of the investment may not be met (principle 6).
This stage requires consideration of the sustained impact of the project and improving future interventions. Firstly, the effect of the exit and how it is carried out must be considered in terms of the sustainability of the investment (principle 7). This principle appears to require that the exit process does not detract from sustainability rather than requiring that sustainability is actively promoted at this stage.
Once exit has been achieved, the overall performance of the investment must be evaluated for the primary purpose of refining the structure of future investments and improving how they are managed (principle 8).
The final principle deals with independent verification, and is relevant across the entire life cycle of the investment. This can take a number of forms, including financial audits.
The two main elements of independent verification are disclosure, and the verification itself. The disclosure element applies to both the degree of alignment between how the investment is managed and the nine principles, and disclosure of the verification processes and the results thereof.
One area of concern is that the independent verification process may allow too much leeway for fund managers or institutions, therefore diluting the value of the verification process. Since no particular mechanism is specified for independent verification, investors may take the least effort approach, and would also be incentivised to avoid full audit processes where an investment is struggling to achieve the desired impact or alignment with the guidelines.
There have been some questions about whether the IFC is the appropriate body to be bringing this form of guidance to the market. Although the IFC is well positioned to develop these guidelines from the point of view of experience and expertise, the concern seems to be that the principles have been imposed from 'on high', without full input from the entire investment community. Further, where the underdeveloped nations in which these impact investments occur have not been party to the process or do not fully buy into the principles, they may struggle to gain traction.
It also remains to be seen whether adherence to the guidelines will actually result in the desired improvements. A parallel can be seen in the reaction to the Equator Principles on managing environmental and social risks, also developed by the IFC and widely adopted by a number of financial institutions. However, in some cases where the official position is that the Equator Principles have been adhered to, NGOs dispute that the projects are actually environmentally adherent. This has cast some doubt on the effectiveness of the principles in achieving the aim of being a transparent, objective measure of project performance. If the same criticisms arise in respect of the guidelines, their usefulness will be diminished.
Reuben Cronjé is a project finance expert at Pinsent Masons, the law firm behind Out-Law.com.
