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This article has been written by Ashutosh Misra, pursuing the Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

Impact investing is an investment strategy that is not only restricted to generation of financial returns but it also creates constructive outcomes from such returns. The strategy actively seeks to create a positive impact by investing, for instance, in nonprofits that benefit the community or in clean-technology enterprises that benefit the environment. Impact investing attracts individuals and also institutional investors which include hedge funds, private foundations, banks, pension funds, and other fund managers. Impact investing is deeply intertwined with ESG principles which are Environmental, Social and Governance (ESG). 

Environmental criteria looks into the environmental aspects like water consumption, waste management, fuel consumption, etc. A social criterion includes the diversity in the company, the development in the surrounding area where the company is situated. When a company undertakes a Corporate Social Responsibility (CSR) initiative then sometimes they build schools in villages, arrange for clean drinking water for the people, health and sanitation of women and children, etc. The last criteria is governance, this is the most important criteria as without this, no organisation would be efficiently working. If there is good governance in the company then the employees, shareholders, independent directors, all would be working hard to achieve the objectives sought in the financial year. Good governance is sometimes a utopia for companies. 

The researcher has taken this novice topic ‘impact investing’ so as to put this into limelight and to discuss the intricacies involved in impact investing. This new concept will very soon be the most frequent investing mode amongst investors. Impact investing has a lot of advantages like it promotes sustainability, social development, non-profit organisation can get easy funding, private equity investors generally invest in such ventures, etc. 

The researcher would be having a holistic approach with regard to this topic. It would include an emphasis on what is impact investing and the benefits which arise from it. The five major propositions which could uplift a company practicing impact investing, global perspective involved and corporate governance need in it. Recently, the finance ministry has announced the opening up of social stock exchanges. In this regard, Securities Exchange Board of India (SEBI) has set up a joint committee. The researcher would discuss the benefit of this set up and the need for governance under this. Additionally, emphasis would be laid on impact investing in India, with a list of few entities into such practice in India, would be dealt in detail.

What is impact investing?

Impact investing is an investment strategy that is not only restricted to generation of financial returns but it also creates constructive outcomes from such returns. The strategy actively seeks to create a positive impact by investing, for instance, in nonprofits that benefit the community or in clean-technology enterprises that benefit the environment. Impact investing attracts individuals and also institutional investors which include hedge funds, private foundations, banks, pension funds, and other fund managers. 

Impacting investing aims to come up with specific beneficial social or environmental effects additionally to the financial gains. Impact investments may take the shape of various asset classes and should end in many specific outcomes. The purpose of impact investing is to use the money and investment the capital for positive social results. 

The growing impact investment market globally provides capital to deal with the world’s most vital problems in sectors like sustainable agriculture, conservation, microfinance, renewable energy, and affordable and accessible basic services including healthcare, housing and education. A hallmark of impact investing is that the commitment of the investor is to live and report the social and environmental effects or performance and progress of the underlying investments, ensure there is transparency and also accountability while doing the practice of impact investing and constructing the whole field of investing. 

Impact investing involves environmental, social and governance criteria too. Governance is the utmost criteria for any organisation to flourish and prosper. The day to day function of the organization, decision making by the management, nil cases of mismanagement and oppression, etc. is the key of good governance. The perfect balance between impact investing and corporate governance is necessary for the growth of this novice concept. It would give financial gains as well as contribution towards the environment and/or social developments.

Why impact investing?

Impact investing opposes the long-held notion of the people that the environment and social issues can only be addressed by philanthropic donations/charity, and the prime focus of market investments should be exclusively in achieving the financial returns. The impact investing market is clearly an invention from the ‘Pandora box’ which offers both i.e. financial returns on the investment, plus, offers various workable opportunities for the investors towards the benefit of environmental and social advances through such investment. There are many types of entrants in the impact investing market, common investor motivations are: 

  • Pension funds, financial advisors to a person, banking companies and wealth managers can help the client by providing them investment opportunities, both as an individual basis or an institutional basis, by laying emphasis on the environmental and social causes. This in turn will empower them to invest through impact investing in such sectors that can contribute to the environment or support a social cause. 
  • Institutional and family trusts/foundations can have a significant contribution with the help of the assets they possess to advance their core social and/or environmental goals, while properly maintaining the return from their investments.

Investors from the government or the development finance institutions can validate their investments by providing a proof of such monetary investment(s) which in turn would make it viable for the investors from private-sectors while targeting them for social and environmental reforms.

Five essential ways in which value creation can be done for ESG

The five ways are an approach to consider ESG in a proper sense with the strategical factors, not an affirmation that each way would be apt in every instance, or apply in a similar way, in each occasion. Some are bound to emerge in specific industries or areas; others will be more continuous in given geographies. In any case, each of the five ways should be viewed as paying little heed to an organization’s plan of action or area. The potential for value creation is too incredible to even think about leaving any of them unexplored. 

The ways include the growth involved in ESG companies, where all the cost can be reduced i.e. the cost reductions, probably less regulatory and the legal interventions to the company into ESG which will act as a catalyst in the growth of the company, another is productivity upliftment and the last being proper allocation of the working capital of the company for better long term gains. 

The below-mentioned illustration has dealt with two propositions where one being the ESG booster or has a strong way of value creation for a company and the other having weak ESG propositions. It lists out the ways which the researcher has mentioned above and which duly have an impact in impact investing. Impact investing is nothing but based on the ESG principles. The more valuable approach a company has, the better results they get based on the same.

Top-line growth

A solid ESG strategy assists organizations with tapping new business sectors and ventures into existing ones. When the administrative authorities trust corporate players, they are more likely to grant them the entrance into the market, approvals, and licenses that offer the companies opportunities to grow. For instance, in an ongoing, public–private infra venture (car manufacturing plant) in Gujarat, India, the capitalist companies that also placed their bids apart from the companies that were working in sectors involving the ESG practices. The capitalist companies had to even prove their stand with respect to prior performance in sustainability where they have worked. 

Proper ESG execution has evidently paid off in mining, also. Think about gold, a costly commodity traded each day, all else being equivalent, gold produces the same return for each company, be it a company into profits or a company based on ESG model. Basis various studies, it was found that the companies practising socio-environmental practices had a leverage over other companies. These organizations accomplished obviously higher valuations than contenders with lower social capital. In these tough times when the pandemic hit the globe, the consumer preferences are switching towards a ‘Go Green’ approach. 

The consumer is willing to spend a more money or rather invest in those companies that are based on the objectives in sustainable development, clean energy, social empowerment based concept, etc. Carbon footprints earlier was a novice concept but now newer generations are taking it seriously and know the impact which it could have on the environment. Taking the example of the newly launched product ‘Nim Wash’ by ITC, which is used to disinfect fruits and vegetables without any added chemicals and is totally organic, the sales of the product reached the zenith. 

This is one example where the parent company i.e. ITC is only a profit driven company. But what if a company is incorporated solely for the purpose of a socio-environment upliftment, then this whole new century having a different approach post-covid will be willing to either invest in that or purchase the commodities produced by it. 

Cost Reductions

ESG can likewise lessen costs generously. Among different focal points, executing ESG viably can help battle rising working costs, (for example, raw-material expenses what’s more, the genuine expense of water or carbon), which McKinsey research has found can have an impact on the company’s profits by 60%. In a similar report by McKinsey, they made a measurement (the measure of energy, water, and waste utilized comparable to income) to investigate the relative asset proficiency of organizations inside different areas and found a critical relationship between’s asset productivity and financial performance. 

The investigation likewise distinguished various organizations across areas that did especially well—majorly those organizations that had taken their maintainability procedures the farthest. Similarly as with every one of the five ways of value creation to ESG, the initial step to acknowledging the value begins by grabbing the opportunity. FedEx, for its part, aims to convert its entire 35,000-vehicle fleet to electric or hybrid engines; to date, 20 percent have been converted, which has already reduced fuel consumption by more than 50 million gallons. Even Microsoft plans to be having zero carbon emissions by 2030. 

Less Regulatory and Legal Interventions

A strong value proposition can empower organizations to accomplish more noteworthy vital opportunities, with less administrative rules and regulations. It is a notable practice that companies with ESG practices have leverage over geographical locations and industry areas. It can likewise get support from the government in the place. The incentive in question might be higher than one might suspect. By McKinsey’s report, regularly 33% of corporate benefits are in danger from state intercession. Regulations definitely hamper an industry growth, depending on the type of work the company is into. 

For pharma and healthcare sectors, the benefits in profits are around 25 to 30 percent. In banking, where arrangements are solely on capital, and customer protection plays a vital role, the incentive in question is commonly 50 to 60 percent. For the automobile, aviation and defence sectors, and tech areas, where government subsidies are common, the incentive in question can arrive at 60% too. The below mentioned illustration demonstrates the benefits an organisation or a company gets from the regulatory and legal factors affecting the various sectors of the industry. 

Productivity of the employees

A strong ESG proposition definitely assist a company in attracting and retaining the quality employees, it enhances the motivation of the employees by building in them a sense of purpose, and thereby, increases the overall productivity. Employee satisfaction goes simultaneously with the shareholder returns. For example, the London Business School’s Alex Edmans found that the companies that made Fortune’s “100 Best Companies to Work For” list generated 2.3 percent to 3.8 percent higher stock returns per year than their peers over a greater than 25-year horizon.

Investment and the utmost utilisation

A solid ESG recommendation can improve speculation returns by dispensing cash-flow to additional promising and more feasible options (for instance, renewables, waste management cum reduction companies, and air filters or air purifiers). It can likewise assist organizations with keeping away from abandoned ventures that may not result due to longer-term ecological issues, (for example, price down in the oil barrels). Keep in mind, assessing the returns necessitates that you start from the best possible pattern. With regard to ESG, it’s essential to endure as a primary concern that a do-nothing approach is generally not going to work. While the ventures needed to update your activities might be considerable, deciding to endure it tends to be the most costly choice of all. 

Now taking the Indian scenario, did any company or the citizens think that there could be a complete ban on the plastic industry? Plastic bags that used to be the life-support of the market and shopping marts was suddenly banned. This was the administrative action to protect the environment and have a cleaner approach towards the protection of the environment. But what effect would this ban have caused to a company producing jute or cotton bags? In-fact the production of those companies just tripled and the profits surpassed their decade’s overall growth. This proposition, if used wisely, could give returns to any organisation practicing the ESG.

SEBI And Social Stock Exchange

As the securities market involves a large number of retail investors who risk their money in the market, companies may dupe these investors with misinformation. SEBI has set-up a technical committee on the social stock exchange, it will draft a framework for having both the profit and the non-profit organisation on such an exchange. 

It will also include the disclosure requirements for such companies, including their financial statements and the practice of governance. The committee will also prescribe disclosure requirements relating to performance and dwell upon aspects related to social impact and social audit. Esteemed personalities are a part of the expert group, which includes companies into impact investing and those practicing ESG norms.Besides, a direct listing of non-profit organisations through the issuance of bonds and a range of funding mechanisms, which include some of the existing mechanisms such as Social Venture Funds under the Alternative Investment Funds, has been recommended by the working group.

The Social Stock Exchange (SSE) will probably be under the BSE and the NSE. The regulation of it will come under the SEBI. SEBI would be vigil to see any malpractices that could be in place by the companies listed on the SSE. The companies need to maintain their good governance practices. The technical team has been set-up so as to make the regulation without any loopholes and to come up with all the required checks and balances needed. The ideation of SSE is novice and will definitely boost the economy and would bring in large investments from the foreign investors. In a span of few months, the draft of regulations for SSE would be released. It is a much awaited step towards impact investing.

Conclusion And Suggestions

Impact investing’s sole purpose and aim is in providing easy investment along with the required funds for investment to entrepreneurs and companies willing to work on the ESG principles. Impact investors look for companies and such entrepreneurs to work on social and environmental factors and to solve these socio-environmental challenges. Impact Investing acts as a linkage between them i.e. the investors and the companies or entrepreneurs willing to work on such issues which will resolve the social and environmental problems in place. Sustainability is the urgent requirement in the present world crises and needs development in those areas which pose a threat to these challenges. 

The upliftment of the people and the protection of the environment is very necessary, and now some people across the globe are getting to know the urgency of the prevailing situation. Many good impact investors are genuinely worried and want to contribute to these activities by way of their wealth, to cure these problems. Impact Investing is a new and a good mode to practice sustainability and implement those techniques. 

This in turn will create better environment and growth opportunities for one’s country. Indian population is facing issues such as poor sanitation, health care issues, improper waste management by the authorities, quality of education, etc. This novice concept should be widely practised by people and attract impact investors towards their idea of contribution to this society and the environment. In-fact, there would be less regulatory approvals needed for companies into such practices and will get adequate support from the administrative organisations of the government.

The corporate governance practices in any organisation, be it a pro-profit company or a company practising ESG norms, would be the same. The recent move of the government regarding setting up of a social stock exchange. This will in turn bring more and more investment. SMEs and other Indian companies should grab this opportunity. 

These companies who are into ESG practices, should be able to attract investment through impact investment, if they have good governance in place. Though, in the companies working through impact investing, utmost care needs to be given with respect to the management, strategies, employee’s welfare, etc. The company should not forget the purpose of their creation and should abide by all the rules and regulations, by-laws, regulatory compliances for their better functioning. Post-Covid, there would be enormous opportunities for growth as the people are shifting towards sustainability and the company’s should sense this change in the trend and take the opportunity to contribute to society.


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