Global challenges and opportunities
Rapid urbanisation, demographic, social and climate change, and technological breakthroughs are just some of the current megatrends. All this goes with a palpable degeneration of the rule of profit maximisation, resulting, for instance, in the world’s richest 1 per cent owning more than twice as much wealth as 6.9 billion people.
From the Paris Agreement on Climate Change to the United Nations Agenda 2030 and the G7 leaders’ declaration, these and many other initiatives in addressing global challenges – perceived as potential opportunities for growth – are all demanding a rethinking of capitalism in line with sustainable development. This has been accompanied by an endogenous market reaction, evident in the statements made by BlackRock and Business Roundtable on the purpose of corporations, and in the 2020 Davos Manifesto of the World Economic Forum on the universal purpose of a company in the fourth industrial revolution.
What seems at stake is a paradigm shift in the economic and financial system, already underway. This phenomenon goes by different names, from stakeholder capitalism to impact revolution – to recall with the latter the Global Steering Group for Impact Investment – and has its foundations in key factors such as system failure, climate crisis, sustainable development goals, impact measuring and reporting disclosure, innovative, sustainable and inclusive business models, human rights due diligence, ESG and impact investing.
This ongoing radical change brings with it the shift from a two-step to a one-step economy, namely from CSR and corporate giving to an entrepreneurial and financial vision aiming at matching profit with the pursuit of social or environmental impact (or both), responding to rising market demands – made even more compelling by the covid-19 pandemic.
Drawing from the experience of several jurisdictions, this report intends to support investors, entrepreneurs, policy makers and many other practitioners to understand this landscape, by setting out the latest and upcoming regulatory developments around practices such as ESG and impact investing.
Finance: ESG and impact investing
Private and public investors are increasingly aligning their values and leveraging their investments for the public good. Practices of responsible finance that once were relegated as pioneering are now becoming mainstream, following a constant evolution which brings them into line with new market challenges and demands, as well as regulatory frameworks.
From socially responsible investment based on negative screening, such as not investing in alcohol, tobacco or firearms, the financial sector has also seen the emergence of ESG factors embedded in investment decisions to reduce risk and increase investment performance.
In 2006, the UN-backed Principles for Responsible Investment (PRI) were launched, with currently 3,038 signatories consisting of investment companies (asset owners, asset managers, and service providers) committed to incorporating ESG issues into their investment decisions and representing US$103.4 trillion, according to the March 2020 UNPRI quarterly update.
As stated in the 2019 Fiduciary Duty in the 21st Century Final Report by the United Nations Environment Programme Finance Initiative (UNEP FI), Principles for Responsible Investment and the Generation Foundation, fiduciary duties now require consideration of how ESG issues affect the investment decision – and, in some cases, of how the investment decision itself affects ESG issues. The US SEC Proposal to Enhance Disclosures by Certain Investment Advisers and Investment Companies About ESG Investment Practices, and the EU new sustainable finance strategy and implementation of the action plan on financing sustainable growth, are clear examples of such regulatory development.
More recently, impact investing has taken hold, capable of overtaking traditional forms of philanthropic investment by combining the pursuit of a return on investment with the achievement of a positive social and environmental impact, as first made clear by the G8 Social Impact Investment Taskforce, under the UK government, in June 2013.
Even if there is no legal definition, impact investing, quoting the 2019 Global Impact Investing Network (GIIN), can be understood as ‘investments made into companies or organizations with the intent to contribute to measurable positive social and environmental impact alongside financial returns’. In particular, according to academics and practitioners, impact investing differs from the above-mentioned practices of responsible investing in three key ways:
- Intentionality: impacts should be targeted intentionally, and investment should achieve a positive benefit for society. This requires an explicit before-the-event statement and an investment strategy that proactively pursues economic, social, or environmental goals.
- Measurability: impacts should be measured quantitatively and qualitatively, ideally by independent third parties, to maximise trustworthiness and credibility.
- Additionality: investment must be made in undercapitalised areas, and must consider whether the impact outcome would have occurred without the investment.
The European Securities and Markets Authority (ESMA), in a recent ESMA Supervisory Briefing, has referred to impact investing as investments with the intention to generate positive, measurable social and environmental impact alongside a financial return.
In the scope of impact investing, different tools are available, from impact funds (such as the UK-based Big Society Capital, with more than £600 million of investments) to social impact bonds (SIBs) and outcomes funds. The latter two correspond to the formula defined as ‘pay for success’ or ‘pay for results’, market logics that aim to offer welfare services by lowering public spending through partnerships between public administration, private investors and service providers. These mechanisms provide for the public administration to pay back investors on condition that the set outcomes are achieved. Around the globe, SIB models vary a lot, for example in risk allocation, with some schemes introducing forms of guarantee provided by philanthropic entities to support investors. Nonetheless, the objective is the same: a combination of reduction in public spending, return on private investment and generation of a positive and measured social or environmental impact (or both). The launch of the first SIB in the UK, in 2010, was followed by numerous other initiatives, such as the announcement made by Finland in 2017 for a SIB co-financed by the European Fund for Strategic Investments (EFSI) and Epiqus, the private fund manager, to support migrants’ integration. In 2015 the European Investment Bank (EIB) set up the Social Impact Accelerator, a fund of funds in support of the impact economy and currently managed by the European Investment Fund (EIF).
Recent estimates confirm the steady growth of impact investing, despite market figures varying widely due to the lack of a uniformly established impact investing definition. According to EUROSIF, impact investing assets under management equalled €108 billion (US$128 billion) in 2017, yielding a positive compound annual growth rate of 5 per cent, which suggests that the current value of impact investing in Europe might exceed €130 billion. Considering, more generally, ‘sustainable finance’, Morningstar reported that the total value of investments in 3,432 sustainable funds exceeded US$1 trillion worldwide at the end of June 2020, with Europe one of the leading players in this market, with a total stock of US$870 billion and 2,703 funds (82 per cent of the total). A Eurosif Report of June 2022, recalling data from Morningstar, highlighted that as of 31 March 2022, 31.5 per cent of funds available for sale in the EU, representing 45.6 per cent of total assets and an amount of €4.18 trillion, were classified as sustainable under the EU new regulatory framework (see below).
There is a transition also among entrepreneurs towards business models capable of balancing the pursuit of profit with the achievement of social and environmental impact objectives. It is still a very fragmented ecosystem, as each jurisdiction follows its own legal traditions in regulating the way in which an entity can pursue purposes other than profit. In this sense, this report might be a useful tool for comparison, by outlining what seem to be the common characteristics of this particular cluster of entities, for which there is no unique term, but which are generally defined as purpose-driven companies.
Typically, these legal forms of business are hybrids; in other words, they stand between traditional non-profit and for-profit entities, but due to their balance between lucrative and non-financial interests, they represent a separate and unique cluster.
Primary among the models expressly recognised and regulated by law are those characterised by a primary social mission and partial or full restrictions on the use of assets or profits. This set includes, for instance, the Impresa Sociale in Italy, the Social Purpose Company in Belgium, the Enterprise Solidaire d’Utilitè Sociale in France, the Sociétè d’Impact Sociétal in Luxemburg, the Community Interest Company in the UK and the Low Profit Limited Liability Corporation in the United States.
There are also models that have neither an asset nor a profit lock, representing a perfect junction between the pursuit of impact and investibility. This category includes, for example, the benefit corporations and the B Corps, with the difference being that the latter are not expressly provided for by law, but rather are linked to the certification system of the non-profit organisation B Lab.
Cooperatives can also be part of the hybrid cluster, as they do not pursue a lucrative, but rather a mutualistic, purpose and, in some cases, they envisage in the by-laws not only democratic forms of governance, but also the exercise of social utility and public interest activities. This is the case, for example, for the Italian social cooperatives devoted to the integration of disadvantaged people in the labour market or the implementation of specific activities in a subsidiary form with respect to the public sector.
Finally, there is an increasing number of companies that pursue social or environmental outcomes (or both), without locking them in their mission. They generate profits as well as a positive impact on a pure voluntary basis, with no legal imposition.
Globally, not every jurisdiction allows and regulates each of the above-mentioned categories. Even when this happens there are huge differences in how jurisdictions regulate typical issues such as profit-sharing, mandatory measurement and disclosure, compensation of workers and directors, the supply chain, participation in public tenders, entity dissolution, and the existence of benefits, fiscal or other, for example in favour of investors.
Legislation and taxonomy
With a focus on regulatory and policy profiles, this report intends, first of all, to examine if and how jurisdictions legally address ESG, impact investing and purpose-driven companies. In doing so, the report also aims to create the basis for understanding what is common to each jurisdiction in these fields, and what are the regulatory trends and upcoming developments.
Although there are, as yet, no joint and global legal definitions of practices such as impact or ESG investing, or regarding purpose-driven companies, there are certainly common factors that are useful in setting a taxonomy, which might facilitate and boost these kinds of investments as well as the dissemination and growth of such businesses. Most importantly, a taxonomy represents a great tool to safeguard sector integrity and prevent ‘impact washing’ (sometimes called ‘greenwashing’), which consists of inappropriate use of terms to serve self-interested reasons for market expansion and growth, instead of real impact achievements.
In this sense, great examples of and attempts at proper classification in support of the impact economy are both EU Regulation 2019/2088 on sustainability‐related disclosures in the financial services sector and EU Regulation 2020/852 on the establishment of a framework to facilitate sustainable investment.
Another area the report intends to explore is which non-governmental organisations and networks exist in each jurisdiction in support of – and promoting the transition to – responsible investing and purpose-driven companies. This is the case, for example, of the Global Steering Group on Impact Investment, the Social Enterprise World Forum, the Global Alliance of Impact Lawyers (GAIL), the European Venture Philanthropy Association (EVPA), the Asian Venture Philanthropy Network (AVPN), and the Impact Investing Legal Working Group in the United States.