“And let it be noted that there is no more delicate matter to take in hand, nor more dangerous to conduct, nor more doubtful in its success, than to set up as a leader in the introduction of changes. For he who innovates will have for his enemies all those who are well off under the existing order of things and only the lukewarm supporters in those who might be better off under the new.”
– Niccolò Machiavelli (1528)
More than 30 years ago, as a young defense analyst in the City of London, I was invited to a Royal United Services Institute event where, for the first time, Gen. John Galvin, the Supreme NATO commander, shook hands with his opposite number, the head of the Warsaw Pact, Gen. Pyotr Lushev.
It was May 1989 and the Iron Curtain had been breached in Hungary. The Cold War was at an end.
The event was held in the banqueting hall of Westminster. On the ceiling was the magnificent painting by Rubens on the supreme and divine right of kings, commissioned by Charles I. Just above where Lushev and Galvin shook hands is the window through which Charles I walked to his beheading. I suspected someone in Whitehall of humorous cynicism.
Both events signified the collapse of systems, something that is again on tap. One might ask how as a society we could mobilize 5% of annual GDP to combat the potential destruction of London or New York, and yet today, be only at 0.5% for their probable destruction in my grandchildren’s lifetime as a function of climate change. Venice is already going. Some forecast we will breach 1.5 degrees Celsius of warming before 2030.
A report last year from the United Nations Conference on Trade and Development, or UNCTAD, and the Secretary-General’s office on the “progress” of the Sustainable Development Goals (originally slated to be achieved by 2030) found that we are 20% below the funding target of where we started in 2015. The annual Social Progress Imperative likewise documents the continued annual retreat.
The new target date for achieving the SDGs: 2093. We have gone from the Millennium Development Goals to the Centennial Development Goals.
Recognizing the problem
The urgency cannot be dismissed as I heard at one private bank philanthropic meeting: “The poor will always be with us.” Climate is recognized now as an existential threat.
All this after spending $3.5 trillion as a sector since 2015. It is hard to think of a larger-scale systems failure:
- Global foundations: $150 billion x 7 years
- United Nations: $150 billion x 7 years
- Development finance institutions: $40 billion x 7 years
- Impact investing: $1 trillion
As one of the pioneers of impact investment, I am a passionate believer in the role of finance to create real systems change as it has done throughout history.
That said, I am aghast at what I see today at the world’s reaction to the existential threat of climate to our children and the continued failure of progress on the Sustainable Development Goals by the very intermediaries tasked with solving these issues.
Most shocking to me is the lack of transparency.
I hear regular proclamations of “progress” on the Sustainable Development Goals. Numerous publications from the World Economic Forum, foundations, the Global Steering Group on Impact Investment, governments and UN agencies, as well as the G7 / GSG Impact Task Force report, all note that the ‘SDG funding gap’ is $2.5 trillion figure per annum, or 3% of global GDP.
The $2.5 trillion per year estimates, however, use figures from the UNCTAD reports of 2015 / 2017. We are implicitly led to believe that this also solves the climate crisis.
It is therefore worth glancing at the latest reports from UNCTAD, along with the UN Secretary-General’s annual reports on SDG progress and the latest musings of McKinsey. Put this together and factor in climate and we are looking at an annual financing gap of, not 3%, but 8-14% of global GDP, with a margin of error (according to the UN terms) of minus 50% or plus 200%.
And how to square the statement from Cliff Prior, the CEO of the Global Steering Group on Impact Investment, that impact investing has grown from $500 billion to nearly $1 trillion in the two years of COVID, with the decline in foreign direct investment of 65%? This $500 billion claim raised in two years is about the equivalent of four times the UN’s annual global budget, or six times the balance sheet of the World Bank .
Or do we genuinely believe, as Amit Bouri has written in ImpactAlpha, that only if we measure ESG better (in its silos) will we raise and align the trillions required. Of the $56 trillion – $140 trillion in “sustainable” or ESG assets, let’s say perhaps 10% is measured correctly and aligned. It is very clear that we have not progressed, but are going backwards.
The best one can say is that many of these professed figures are the result of quantitative easing on an existing capital structure that would appear to be negatively correlated to the achievement of the SDGs. As even Goldman has noted, quantitative easing has created the greatest inequality in history, with today six people now owning more than the bottom three billion of the world’s population, from sixty-six thousand in 2013 and sixty-six million in 2008.
Or in plain English, the more we have proclaimed progress in the mobilization of assets and impact, the further we have gone backward.
Taking the task force to task
It must be clear by now that there are more structural issues at play and that the framework itself should be questioned. The cynics amongst us may even argue that is why many in the current intermediary framework continue to use analysis that is seven years out of date ?
Reading the report of the G7 Impact Task Force, convened by the Global Steering Group on Impact Investing (known as ‘the GSG’), requires a similarly critical lens on the estimated $2.5 trillion per annum gap. The model remains focused on a VC vision, coupled with a ‘blended’ approach where there is simply not enough subsidy to go around.
These financial tools are of course part of the solution. But to depict them as the solution feeds into the fragmented and siloed mindset of our sector. The institutional, sectoral and practitioner silos in which we operate create a lack of economies of scale and hence a clear limit to the financial tools that can be applied.
Former President Clinton noted that “the problems of the twentieth century have been solved by someone somewhere. The challenge for the 21st century is how we scale them.” Yet the absence of incentives to collaborate and scale are killing our chances of making material progress toward the SDGs and climate.
The GSG / G7 Impact Task Force report argues for measurement – a no-brainer. But in three sub-reports, it fails (or fudges) or is simply wrong on a number of critical issues:
- What the task force proposes to measure (and the implications of what it does not), and to whose benefit and detriment. If, for example, one just measures the damage to business (known as ‘negative externalities’) and ignores the value created of both innovative social interventions (the ‘positive externalities’) and the value of the sequencing of these interventions now facilitated by technology, you end up in a mechanism where society’s limited and valuable subsidy is channelled to the interests of business in a self-regulatory framework. In a highly fragmented sector, that ignores the value of collaboration and scale
- The opportunity of systems-approaches leveraging technology, which has revolutionized every other sector of the economy. The report notes its importance, then strongly suggests it is not currently possible in development –simply wrong. These technologies are built and available.
- The danger of politicization of the multilateral system. Should the data commons be public, multilateral, interrogatable and open, integrating multiple theories of change? Or private, national and closed ?
Should we really be assuming that the ‘business agenda’ is the same as ‘society’s agenda’?
Perhaps worst of all, the report is silent on the required catalysts, the capital sources, and the legal and regulatory processes we need to apply so that the $130 trillion we need can be aligned to measurable outcomes of the crises we face. As configured it is simply a list of products that will need subsidy without the context of how they need to be framed in what are systems issues.
The world waited with baited breath for the outcomes from COP 26. We heard, from Mark Carney and the Glasgow Financial Alliance for Net Zero, of the finance community coming to the rescue with $130 trillion.
But as Hiro Mizuno, former head of the world`s largest pension fund and now a UN special advisor, noted in December, that figure is simply the total of funds they already have under management. Unless they produce actual plans for aligning this capital, it will go down, Mizuno said, as “the biggest greenwash in history”.
Mizuno went on to note that by definition, most of these funds and certainly the passive ones track the indexes. So unless the benchmarks include a climate measurement, the pledge itself will be, like the UN PRI, a pledge on steroids, and nothing more. The current $130 trillion asset allocation is substantively misaligned with climate investment requirements (which requires investment in SMEs and Developing World) .
Finally, BlackRock’s Larry Fink, as a key visible finance player in this space, has noted he is looking for blended value (i.e., in coded language, subsidy) to engage. Yet one glance at the current strategic subsidies available will tell you that as configured, these will not work.
If (according to the OECD) total overseas development assistance, or foreign aid, is 0.5% of global GDP, and global foundations roughly represent another 0.5%, the maths quite simply means (with costs factored in) that you need to leverage capital by 18 to 28x to hit SDG targets. The well-respected London think tank ODI noted that currently, blended value models are leveraging capital by only 0.7 – 1.14 times, meaning each dollar of subsidy generates only between 70 cents and $1.14 of commercial capital. According to UNEP, at least 85% of audits for 75% of companies do not even measure their climate impact.
Like Greta Thurnberg, young people are so much more prone to calling bullshit. Perhaps with age we become enthralled with our vistas of naked emperors who don’t get called on their machinations. At some point, the simple maths will hopefully create cognitive dissonance that we are not progressing. The strategy is already not working.
But for one moment let’s pause to compound all the above with the growth of developing world youth populations, now increasingly conscious through the social media, which fuels migration … and juxtaposed with aging populations in the West and China, all with huge unfunded, unaccounted domestic pension and health liabilities that reach 40%+ of most government budgets.
We have the ingredients for a perfect storm, even ignoring Black Swan events like COVID or antimicrobial resistance thrown in for those who thought COVID was bad.
What could be
As a rookie broker at Merrill Lynch at the beginning of my career, I was lucky enough to meet in the lift the CEO, who was doing his speech to our New York training course that morning. I asked him what his speech was going to be about. He tapped his Mickey Mouse watch, noting, “… have something people don’t expect and follow the money”.
Let us now take his advice concerning the $130 trillion. The good news is that the catalytic capital, as will be noted below, is not the issue. Nor even is the innovation (if Clinton is to be believed). So what is the issue?
This is of course an uncomfortable change-management question for the existing status quo intermediaries and a question of the profitability and risk management for the new intermediaries. It hits squarely at the heart of the essential social contract between business, government, and civil society. (This is a question I have seen either repeatedly stymied or ignored too many times in my time in this sector since I joined Ashoka from mainstream banking).
Let’s start with the status quo bankers. Or the $1.5 trillion+ held in global foundations’ core funds, mostly 95% unaligned with their core mission(s), tactically and strategically run contrary to their stated social function. Perhaps we should ensure their tax break is a function of the social impact created, not just in the front-end act of giving, but in the back-end act of assessing what happened. Lest we lose faith in humanity, there is precedent for all three: There are small innovative foundations (Heron, KL Felicitas) that align 100% of their portfolios. A tax regulatory code (ignored in both G8 and the new G7 Impact reports) that promotes impact investment could be more broadly applied (like the PRI code passed by Congress in 1967).
There is even an accounting policy that could track how effective a government subsidy is (the Congressional Budget Office’s annual review of the Community Reinvestment Act). Perhaps the chief cooks in the kitchen would do well to take a harder look at their larders.
Or how about aligning the more than $3 trillion in local-currency pension funds in the developing world with their own essential sustainable development? Instead of convening endless product seminars about how bonds can be done in product silos, how about creating a profitable, blended Western guarantee entity, requiring less than 5% of the capital of a “classic blended” model, that guarantees and aligns all local currency pension funds to invest locally? In the process, that could take 70% of the risk out of development funding by negating much of the foreign exchange risk. Based on a 20-year record of $21 billion of deals, this creates a 20%-plus IRR, where the higher the social impact, the higher the return and where over $45 billion of these deals have historically been done.
This is of course not necessarily in the interest of some – including those who would argue that it is the banks and rating agencies who hold the key. Yet, is the track record of global lending in hard currency an exemplary and sustainable one, in the face of the climate challenge? My response: No.
How about utilizing exactly what the bankers did, and that the rest of the economy has done: Ride on the back of the technology and legal revolutions to create a transparent technically robust and trackable multi-sided aggregation of development markets?
On the cost side, the opportunity to “plug and play” financial and entrepreneurial solutions already created, and to drive cost-efficiency of scale into development, would allow a much wider range of financial tools and capital to be applied. An intellectual property regime that could fast-track the profiling and value-capture of ground-level innovations would go a long way to monetizing and scaling models that otherwise ‘don’t travel’ for lack of funding. Both could sit in a process that also transparently tackles corruption, by empowering communities as consumers and auditors of social goods. We’d have plenty of options when it comes to systems-planning technology platforms, which the World Bank has estimated could reduce 45% of the cost from the SDGs.
On the revenue side, to the issue of measurement – of return and value – reputed players like McKinsey, World Bank, Accenture, and Stop TB in issues as diverse as health, road safety, education, and WASH have all calculated (as called for by the UN Secretary General) that societies’ stakeholders collaborating and working together in a systems approach would generate markets worth hundreds of billions annually. Hazard the thought that we think how we sequence (a word we do not even use) our interventions and do it in a data frame that can marry competing “theories of change” predictively.
These markets bear financial leverage ratios of one dollar invested to create $6 (in WASH), to $1: $50 (in health and education) of future value unlocked. Why not create equity vehicles structured so that the ‘quicker you solve the issue, the higher the return’?
Who benefits?
Post-COVID, it’s all about how quickly we can get back to work. The future economic value (called equity in investment), to all of us involved in so-called “not for profit” interventions, is a function of our ability to respond with urgency and efficiency, not to mention material alignments of interest. The technology and processes to predictively do this already exist, though, shockingly, the GSG / G7 report noted that they could not be applied to development.
Legal and technology frames do now exist to track, audit, and pay for granular interventions in the context of a systems frame. Simply look at the very aspect of your own life from AirBnB to Uber. The defense industries (hard power) do it in dynamic real time. Why can’t it be applied to development despite what the GSG G7 report notes ?
Can we (as I believe) work equitably (in both senses) for a greater win-win? In a legal structure where all stakeholders’ incentives are equitably aligned? Where the social entrepreneur, with sweat equity, owns an equitable part of the upside of their innovation? In a collaborative and partnership structure with fellow social entrepreneurs and the commercial sector? Where the value of systemic collaboration mean the higher the social impact the higher the economic return? Where the actual consumer (the community) becomes an owner and auditor? Where there are much larger systems opportunities for the commercial and banking sector as well? And where data becomes a real time management and pricing tool and, as an aside, helps tackle corruption?
The capital to leverage, and the legal and technology solutions we require, are all there and built to solve the problems we face. Since McKinsey, the World Bank and Accenture and others have priced the externalities, we even know the potential returns. Let’s turn from an unfinanceable problem and instead recognize this as future economic value created for all humanity.
It is the same process we have seen throughout history in which legal and technology innovations reframe financial systems. From the 12th-century Templars to the first pan-European bankers in the mediaeval struggle between the powers temporal and spiritual. From the drivers to the nation-state by the bond markets from the 14th century onwards. From the 18th century dominance of the Anglosphere built on central banking, capital markets, and efficient taxation. All represent financial innovations in which political impact is leveraged by technology and legal innovation.
The question as ever is: by whom and to whose benefit? As climate is an urgent, existential threat to all humanity, we cannot cynically shrug this time, noting that “the poor have always been with us.” We need to ensure our system mobilizes capital rapidly and equitably for all humanity, and not just indulge in a reallocation of a shrinking subsidy pool that is not working. Equity is not just paying lip service to engage the community. It is practically about aligning the incentives for all societies stakeholders to ensure the required social outcome for all
It is crystal clear is that the current strategy cannot mathematically solve the problem. If we don’t acknowledge this problem, we are effectively engaging in a massive betrayal of future generations.
It is clear a new system is needed. As we move to the construction of the new cathedrals of development, this must be driven not by today’s legally siloed hierarchies, but with the use of open, networked technology and legal systems. It has ever been thus.
Arthur Wood, the founding partner of Total Impact Capital, is a former investment banker specializing in product development and change management. With nearly two dozen organizations in metrics, legal, finance and systems thinking, he is integrating existing and newly built processes to propel collaboration and scale in development to deliver the SDGs and to provide the plumbing to supply social organizations with access to large-scale capital.
