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Accelerating climate innovation with sustainable finance

Road To Forest Valley Podcast

Published on 2021-02-18

Listen the full podcast or read the article below!

Maria Eugenia Filmanovic is an expert in impact investing and explained the heart of her work: integrating traditional finance to meet the needs of new categories of responsible and ethical investors, interested not only in financial returns but also in pursuing social and environmental impact.

 

I've studied economics and finance but I've always been passionate about topics at the intersection between economics, politics and society, in particular in development economics. I always found fascinating how policy interventions can change behaviours and economic incentives, specifically in developing contexts. 

These were the days where a lot of research went into studying the pitfalls of age that's a source of economic development and around the same time there was the emergence of innovative business models centred around this concept of sustainable investing, impact investing.

I realized that it was sort of hard for me to be going into the perfect role after my university, but what I wanted to do is to get up to speed with the concept of economics and finance.

And hence I joined a very large investment bank to get up but with the idea that I would, at some point, right at the end of my three, four years into that role, that I would move into the impact investing space. 

I continued to monitor the impact of investing in a sustainable investing space, which was changing and it was starting to become mainstream in the field of finance. Certainly hasn't reached mainstream yet, but I hope we'll do in the next few years. 

2011/2012 were the years where sort of impact investing was starting to merge in initial finance. As I started to work in a very large bank, I was very lucky because the bank decided to acquire an impact investing boutique based in San Francisco. And as soon as that announcement happened, I asked if I could be moved to this team in San Francisco. They hired me into this very emerging team, and I've been in this team for four years now


 

The different approaches of traditional investment and sustainable one

 

Sustainable investing has to do with sort of investing in businesses that provide their services and products, they're offering a sustainable value proposition to consumers, businesses, et cetera. 

The difference you have when you're a sustainable investor is that typically you want to align yourself around two things: one is around businesses that from a thematic perspective are set to benefit from some of the very macro trends that are happening as the world is moving to a more sustainable future. It can be about issues around the environment, where we are thinking about ,the transition to a low-carbon economy, we are thinking maybe more about the transition to clean energy, for example. Or also on a social level, sustainability can mean inclusive growth. So it's really important to think about new innovative business models that are happening around education, for example, health care, etc.

The second is around well-governed backing businesses. It's like a lens that we call environmental social governance: ESG. It's a different approach relative to this impact on domestic or thematic investing because ESG is truly focused on identifying businesses that are well-behaved to respect their operations. How do they manage their risks? 

For example, if you're looking at a business operation, you'd be looking at what is their exposure to environmental risks around the supply chain or the social element. You'd be looking at things like: how are they incentivizing their employees? How are they thinking about the retention of those?
And then on the governance side, the G factor, you'd be thinking about: do they have enough independent decision-makers? Do they have women representation on the board? 

The ESG piece it's starting to be recognized as just backing really good businesses and ultimately should be ABC for any sort of traditional investment approach to wanting to seek those businesses.
But it has been different so far because the traditional investor community's not been educated to think about those things. 
That's how sustainable investing and ESG is different from more traditional investment approaches today.


 

The growth of sustainable investors

 

I would say that sustainable finance is still a niche, although it's starting to be broadly recognized as an important thing for large investment firms to be starting to focus on. 

From four years ago, the space has changed, in the sense that now pretty much every investment firm acknowledges that they need to focus on or are building capabilities within the impact investing on ESG space of generally called sustainable finance environment.

The field of sustainable investing from 2012 to last year has tripled in size to reach roughly 33 million assets, which globally, are managed with a sustainable finance approach and seems very high. But if you think about the level of assets that are out there, in the world, it's just still very much a fraction of that.

I don't know the specific percentage but the number of flows traded every day should be closer to 200 trillion every day traded. So 33 million is just a very small fraction of the whole that is traded every day. 
In 10 years it has tripled. But certainly, there's been great momentum in the last two to three years. The real turning point has been in 2018:  there's been a broader recognition around things like a revision around the Paris accord, for example, that was a wake-up call.

And specifically, there was a report by the IPCC - the scientific board of the united nations - they have made a kind of climate calculation on how long this world has left before the change becomes irreversible, and they said it's pretty much 10 years. That was a wake-up call. 

I think there have been other wake-up calls, for example, the CEO of BlackRock has published a letter to some of their largest investors and CEOs around the world. He said that climate risk is an investment risk: this was the moment when they realised that it was becoming very important material to the financial performance. Very large firms have been moving in that direction, but truly what has been the voice behind this, has been very large investor groups that have been pushing very large asset managers to want to focus on the estate history for a long time. I'm thinking about very prominent shareholder groups, for example, the Climate Action 100+ which is gathering some of the largest hundred investors in the world to be pushing some of the largest emitting firms around transitioning to a low-carbon journey. 

And certainly, this has been helped by regulation.

The EU's program "Agenda" has been one of the pioneer agendas from a regulatory perspective to want to push on this. And since then, many companies have started to do so in recent years: have started to make commitments to be carbon neutral or net-zero by 2030, 2050.

It's been a broader alignment from a vision perspective and regulatory perspective to want to move to a more sustainable future. There has been a lot of focus on the environment and I think it's easier from a purely visual point of view because everyone sees the climate risks so it's easier to align. 

We haven't reached that momentum around social themes because they typically tend to be very localized and require context. But I think due to COVID things are changing around social themes as well. So hopefully there'll be more coordinated actions on those fronts too.

 

How to assess the impact of sustainable investments

 

Measuring investment opportunities in terms of sustainability is probably the hardest exercise that any impact investor or sustainable investor is struggling with at the moment.  

I don't think the industry has cracked the code on it already, although there's a broader recognition that it's fundamental to be able to justify some of the investments. 
There are aspects of the impact that are just easier to measure: it's easier to do it on the environmental side because the number of the tons of CO2 equivalent that you've removed or avoided it's just easier to measure relative to how you impact someone's social life such as their education or health care. 
There have been initiatives that have happened in this space, like one that it's starting to be recognized as probably the most credible as it relates to impact measurement, reporting and assessment: the Impact Management Project or IMP.
They developed this concept of needing to look at five dimensions on how to assess impact. Firstly is what impact you're delivering, so it has to do with the outcome. The enterprise is contributing to whether it's a positive or negative impact, which stakeholders are experiencing the impact and how underserved they are with the outcome you're looking to generate. 

Then, how important the outcome is to the stakeholders and specifically how long? So there's a concept of the duration of impact contribution whether the investor's efforts have resulted in outcomes, they were likely better than they would have occurred otherwise. It's more of a sort of additionality point as well. 

And then there's also the concept of risks, which I think is important. It's how the impact you've envisaged is turned out to be different than what you'd expected. It's a lot around negative intentionalities of impact.

Per esempio, storicamente ho guardato molto al FinTech come un modo per migliorare l'inclusione finanziaria. Ma se si guarda a concetti come la microfinanza, per esempio, e l'impact investing in generale, i settori sono iniziati proprio nella microfinanza. Ci sono stati molti problemi intorno ai prestiti predatori che alla fine hanno portato ai suicidi di persone che erano in circostanze in cui non sarebbero state in grado di affrontare quei prestiti.

It's really important to have a very nuanced understanding of impact, and I think this comes with experience, it comes with time. It's certainly very hard. And, as I said, I don't think we've cracked the code yet in the industry, but there are promising assessments, and frameworks that are starting to come through and the hope is that there will be a very standard way to look at impact just because it's nuanced and I think it's harder to do it at a global level. 

 

 

Risks and returns of sustainable investments

 

The success of the sustainable investment field has come about because this issue has finally entered the discussions of very large councils that are beginning to recognise that this dimension cannot be ignored.

This has been the biggest win of this industry because now at least it forces a discussion around the assessment of how my business is going to be benefiting from these thematic macro trends of sustainability but also the risk of it: now if you are not transitioning your business, you would be a laggard compared to others who have made the move.
And similarly, on the governance side of these businesses, they want to understand the risks around ESG reality, for example. There is just going beyond the thematic alignment of these macro trends around sustainability. 

If you look at it more globally, I don't think there is a specific win outside innovation that's happening in the field of clean energy. For example, if we look at solar and wind, certainly those technologies have come to cost parity, or even in some markets to be even cheaper than just traditional energy. This innovation has led to an accelerated uptake in the development of these solar and wind farms. As you can see, if you look at the data in the last five years, that's certainly been increasing in the energy mix of developing countries.

There's certainly, as I said, a broader agenda around wanting to scale that in very large corporations that have made significant commitments to want to focus on renewable energy going forward. But renewable energy is just a very small piece of anything that's happening around.
Energy innovation, in general, brings many innovations such as improving energy storage, for example, because one of the problems with renewables is that when you add more energy suddenly you create intermittencies in the energy grid and the grid itself is at risk. And so what you need to do is to have storage to regulate these new energy sources going into the grid. 

Other innovations related to carbon capture and storage, for example. Because the broader recognition that the industry has now is that we're a little bit too late in the game of transitioning to a net-zero. And so if you can't do it by just reducing your carbon emissions, at some point you need to remove carbon from the atmosphere, and that's a big challenge technologically.

A lot of technologies that are out there haven't reached cost parity to be moved into wider adoption like solar and wind have done in the last 10 years or so.
Around big climate issues, like social issues, there is a need for big and many innovations, because these are huge, addressable markets. 

There is evidence as I said before in solar and wind, that when a lot of investment goes into these fields, you can actually lower the costs and then hope for wider adoption.

The role of capital is that you can channel capital to the most important issues, recognized by the investors perspective as the ones that have large addressable markets, but also where they could be profitable business models going forward. 

The biggest challenge now is having investors agree on what these big challenges are.

To a certain extent, regulation can help as well, but that's sort of hope in the next few years and where I think a lot of the trends will be, as innovation around very big challenges, for example, carbon capture, but also generally continuing to deploy renewable energies into the grids and energy storage.

 



The main actors in sustainable investment

 

Impact investing is linked to innovation at its core because some of these challenges we are investing in are manifesting now, and we haven't found the solution yet. So, innovation needs trying to solve these issues and it can be technological innovation, it can be social enterprise innovation. And clearly, the more challenges are recognised as important, the more actors are interested in investing in this innovation. Some actors have been doing it for longer than others, which are starting to build a sort of ecosystem and some of these ecosystems are very much at the earlier stage. There's a lack of investment support at a late stage capital growth equity capital, for example, that is specifically focused on impact.

But it's starting to become also of interest to venture capital as well, that are moving into this space and certainly will continue to do so going forward at the later stage. 

Who is investing? In an earlier stage, we've certainly seen very active accelerators that are starting to focus on this, specifically the sustainability accelerator programs. Recently I even saw Techstars, which is one of the most prominent ecosystems of acceleration, that launched an acceleration program for sustainability. 

The other participants are family offices so it's typically someone that's investing the wealth of their own family. Specifically, the second generation individuals that are particularly interested in, through this work of investing, being very close to the innovation that's happening around some of these themes. And the reason why family offices play an important role is that they are typically a bit more risk-tolerant relative to institutional pools of capital that are very much risk-averse towards innovation and early-stage investors. 

And then there's also a series of seed investors that are part of a sort of venture fund that is also interested in looking at investing in this field. But I would say, there are certainly very few players relative to the amount of innovation that it's out there.

This has led to very sort of competitive processes, as well as he looked for funding at the earlier stage. 

One thing I haven't mentioned is the foundations: they have been some of the most active players in impact investing historically. They started this field when they recognized that through the national program you weren't building sustainable businesses in the sense of like durable businesses - because funding was there one day and it wouldn't be there the other day - but they've professionalized. So some foundations are starting to be more active and begin to build programs of investing around specific themes that the foundation is interested in. There are some environmental foundations backing innovation at an even earlier stage than this sort of early-stage investing.


 

Tips for environmental or sustainable innovators

 

For the innovators and founders out there, I would just give them advice: try to find what is the biggest issue the world is struggling with right now. That in itself seems daunting, but it's an easy exercise when you start to analyze what are some of the pinpoints these corporations or even these CEOs are struggling with.

Sometimes the perception is that if you're thinking about a large corporation, they would want to solve this issue because they have to scale the money, et cetera. But the reality is that some of the CEOs are really distracted by their day to day jobs, and they're not necessarily flexible enough or agile enough to change the business to want to start pursuing some of these challenges and solving them, for example.

This is where the role of founders and innovators is really important especially around ecosystems that exist out there, that allow them to get access to what are the challenges of these corporates and perhaps, work in tandem with them as customers potentially or even running some pilots where the corporate could be just being a customer of them, but also sharing idea, technical expertise, et cetera.
This is why I also focus on being part of an ecosystem.
Make sure you're not alone in trying to solve this issue. Try to capitalize what are the stakeholders in the field and work in tandem with them.


 

The different understanding of profit in traditional and impact investments
 

In terms of the vision for sustainable investing the idea that you're building sustainable businesses, not just focused on themes that are growing - and they're growing just because the world is changing, and these are suddenly starting to grow sectors, thinking about renewables relative to conventional energy - you position yourself towards growth also because when you're thinking about sustainable investing, you're thinking about the duration of a business. 

You want to make sure that the businesses you're investing in are profitable and can stand on their own. And this is very much in line with how traditional investing has worked today: trying to find profitable businesses. 

Now there's this concept that the traditional investing community has been somewhat alienated by profit maximization and what that's meant is that you've been focused on short term profits. There's been a concept of even quarterly reporting that wasn't a thing in the fifties, but it has become because there has been such big scrutiny around economic metrics needing to be met.

The industry will probably continue to evaluate business performance with a mindset towards profit. But I think with profit - that can be around long-term incentives - and profits - that can be tied to potentially also some impact metrics as well - are core to growing the business.
How are you assessing a business towards impact? There'll be very much a focus on trying to find some core metrics around business performance that are both tied to profit and the achieving impact.

To give you an example, as you look at a business by just profit, you could be also looking at it from the perspective of several people reached, for example, this leads to more profit because the more customers you have the more sales you have, but also more impact because if you're reaching more people than the delivery of the product and service you're providing can lead to an impactful outcome.


 

About the author

Maria Eugenia Filmanovic

Expert in Sustainable Finance and Impact Investing.


 

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