ImpactAlpha, Oct. 15 – Scaling impact investing with integrity requires, well, integrity. The International Finance Corp. has a plan for that.
The IFC, the private sector arm of the World Bank, upped the ante on impact investment practices earlier this year with the introduction of the Operating Principles for Impact Management. Come next April, the first anniversary of the pact, the original 60 signatories are due to publicly disclose – and verify – their plans to align with the principles.
The nine principles codify best practices in impact measurement and management. They include defining strategic impact objectives, managing impact, monitoring the progress of each investment and considering the effect of exiting on sustained impact. Principle No. 9 requires firms to publicly disclose alignment with the principles, and provide regular independent verification of the alignment.
That means in April, a year after the first impact investing firms signed on, the “verified” practices of 60 leading impact investors will be publicly available to read and compare for the first time.
“It’ll be a real step change in transparency,” says Neil Gregory, the IFC’s chief thought leadership officer. At this month’s Global Impact Investing Network investor forum in Amsterdam, Gregory was upbeat about uptake of the principles. At least 18 additional firms, including Neuberger Berman, Christian Super and Finance in Motion, have signed onto the principles since their April launch.
The IFC has said the principles will “bring greater transparency, credibility, and discipline to the impact investing market” and combat “impact washing.” Unlike many pledges and commitments, the IFC principles have teeth through its disclose-and-verify principle.
“It’s not something you can just sign up to and worry about implementation later,” says Gregory.
Gregory anticipates a race to the top, as public disclosure and verification puts pressure on fund managers to raise their game. The IFC is now pushing adoption among asset owners, who have long sought a mechanism to authenticate impact among fund managers. In addition to Christian Super, asset owners on board include Zurich Insurance, AXA Insurance and Prudential Financial.
“They will use it in deciding where to allocate funds and that will really drive adoption by the asset managers,” he says. “Watch this space.” Excerpts from Gregory’s interview with ImpactAlpha:
ImpactAlpha: What’s been the uptake of the IFC’s impact principles?
Neil Gregory: We’ve been pleasantly surprised at how many signatures we had right from the start. We had 60 already in April. Now it’s another group of 18 that have joined since April. There’s many more that we’re talking to in various stages of becoming signatories. The ones who aren’t quite there yet, in some cases it’s because they’re working through the principles and what it will take to get into compliance with them. We’re actually quite happy to see that because these are principles that have some teeth in the requirements. It’s not something you can just sign up to and worry about implementation later. We know that many more are looking at what it will take to get into alignment.
There are others who are raising funds and in the process of developing impact funds, who are saying, “We’re looking at the principles and when we are ready to launch the fund then we’ll sign onto the principles.” I think you’ll see a steady stream of additional names being added.
ImpactAlpha: Do fund managers have to align with all nine principles to sign up? Or is there just a threshold they have to meet?
Gregory: There’s no threshold. We expect everybody that signs to be committed to all nine. But it’s based on self-disclosure. We’re not going to police how good the compliance is with the principles. It’s up to each institution, within 12 months of signing, they need to publicly disclose how they’re implementing the principles. They may be doing better in some areas than others. The onus is then on the signatory to disclose if there are some areas that are a work in progress, or maybe they think it is less relevant because of the particular asset class or type of fund they’re in.
For example, a debt fund would say, “Well, the exits principle isn’t relevant to me because I’m in a debt fund.” It’s based on transparency and self-disclosure and what the signatories feel comfortable publicly standing up and saying about their implementation.
ImpactAlpha: Tideline’s Ben Thornley wrote a post saying the ninth principle around disclosure is key because it is the accountability mechanism.
Gregory: The ninth principle actually goes beyond disclosure. The first eight principles go through the various stages of the investment cycle and the disclosure statements that will explain how you do all of those things. The ninth one, in addition to self-disclosure, you then have an independent party come in and review your practice. There’s some third-party credibility saying, “Yes, you actually do what you say you do.” That really adds the extra credibility.
The GIIN talks a lot about “scaling up with integrity.” We’ve put principle nine in to address this integrity piece. This is what the market is looking for. The market is like, “You say you’re going to do all these things, why should we believe you?” Well now you can say, “We have this independent party that has come in and looked at what we’re doing and is prepared to vouch for that.”
We’ve done this ourselves for the last six or seven years. In our annual reports we’ve published an assurance statement. We have ours done by an auditor which says they’ve reviewed our impact management system and we are following the system.
We’ve already seen a couple signatories already announce they’ve done it. What’s going to be very exciting over the next six months is, you have this first group of 60 who signed in April. By next April you’ll have at least 60 of these public disclosure statements, which we’ll all be able to read for the first time. It’ll be a real step change in transparency. People say, “What is KKR really doing?” or “What does IFC do?” or “What does FMO do?” or “Actis?” Now you’ll be able to go to one website and click on each of these disclosure statements and, side by side, you can compare.
To be able to compare side by side over 70 impact investors, we’re all going to learn such a lot. We’re going to look at that and say, “Where do we see convergence? Where do we see gaps? Where do we see innovation? I think it’s going to be helpful to everyone in the industry to have that level of transparency that we haven’t had before.
ImpactAlpha: Aside from integrity, what else do you expect the principles to do for the market? What do you expect two years from now?
Gregory: Two years from now, our aim is that we have a large part of the market following the principles, so it really becomes the norm. Then at that point, if you’re an asset owner wanting to put some money into an impact strategy, the first question we want you to ask is, “Is this asset manager or is this institution going to manage my money following the principles?” It becomes a starting point for anybody screening where to invest.
The key to getting there is getting more asset owners engaged. In the first round we got most of finance institutions, impact funds and asset managers signing on. We have a few asset owners, we have Zurich Insurance, AXA Insurance, Prudential Financial, Christian Super. They will use it in deciding where to allocate funds and that will really drive adoption by the asset managers.
ImpactAlpha: Do you believe overcoming the integrity gap will bring more money into impact investing?
Gregory: That was part of the motivation from the start in developing the principles. We were talking to asset owners and saying, “What will it take for you to invest more for impact?” This was one of the key things they’re asking for. They said, “We need to know when something is labeled an impact fund how they’re going to actually manage our money and is it comparable to how you would manage it at the IFC? Or how another development finance institution would manage it? Or how TPG would manage it? Or somebody else.” This is responding to what the asset owners are looking for.
ImpactAlpha: Will the principles be a challenge for first-time funds, particularly in emerging markets?
Gregory: The new funds and the smaller funds, they tell us they find the principles helpful in that they’re doing this for the first time and it gives them a roadmap that these are the bases that we need to cover. The thing they worry about is the implementation cost, particularly around verification, the reporting. What we always say to them is that, “We wrote these at the level of principles because the implementation is going to look very different for an organization like us, where there is a $57 billion portfolio, vs. a $50 million family office running a small fund in one sector.”
People are exploring different ways of implementing different aspects of the principles. Publicly, there will be peer pressure so that everybody’s going to know what other people are doing. If those strategies don’t look as thorough or credible they’ll be pressure to raise the game. It’ll be differentiated. If you have a small fund, and are just getting money from a couple of family offices, maybe those two asset owners are happy with what you’re doing then that’s good enough. If you’re a big institution and you’re trying to play at different scale, the market expectations are going to be higher.
For us, our annual report will come out by the annual meetings (in fall 2019). We have our disclosure statements in there. The statement from our assurance provider will be in there. I think that’ll be the first one you’ll be able to look at. Many others are in the process of preparing them now.
The independent verification, depending on your size, if you’re a big institution like us, we’ll do it annually as part of our annual audit process. The smaller funds, maybe they just do it once in the lifecycle of the fund. They do it during the fundraising phase and that’s something they make available to potential investors. We don’t expect everyone to do it on an annual basis. It’ll probably be a Big Four auditor for the biggest institutions. Tideline just did it for Leapfrog Investments.
The key thing is: What are you publicly prepared to tell the market you’re doing. Everyone is going to feel the pressure to be credible. Watch this space.