Social Impact Investing

An Australian Perspective

Stewart Jones, Helena de Anstiss, Carmen Garcia

• Publisher: Routledge
• Year: 2021
• ISBN:
  9781000530230
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Social impact investing is gaining ground as one of the most important investment trends in the world. While the size of the social impact investing market is still relatively small in global terms, momentum continues to grow unabated. Australia in particular is looking to develop a vibrant and transparent social impact investment market. This book considers a number of innovative strategies and pragmatic policy initiatives that can see the social impact investment market flourish in Australia and internationally.

The book describes how social impact investing can enter the investment mainstream and how a high-quality regulatory framework governing the measurement, reporting and evaluation of social impact will be critical to building investor confidence and ensuring the credibility, effectiveness and transparency of this market. It also examines different approaches to measurement and evaluation that will ultimately be critical to the success of this market. The authors also recognise that governments have a pivotal role to play in growing the social impact investing market, not only in its capacity as a market facilitator and regulator but also as an active purchaser of social outcomes.

This book will be informative for those who wish to learn more about how governments, private investors, investment intermediaries, social enterprises, service providers and other market participants around the world can work together to initiate and grow a vibrant, transparent and well-functioning social impact investing market.

1Introduction

DOI: 10.4324/9781003225591-1

Social impact investing (SII) is a relatively new concept first coined in 2007 at the Rockefeller Foundation conference held at its Bellagio Center in Italy. The Rockefeller Foundation conference had invited leading investors, philanthropists and entrepreneurs to explore how they and others might deploy more capital to work for social and environmental causes (Rodin and Brandenburg, 2014). According to Cohen (2020, p. 11), it was at this conference that the traditional concept of ‘social investment’ was replaced by ‘impact investment’. The Rockefeller Foundation report (2012, p. viii) described impact investing as involving:

investors seeking to generate both financial return and social and/or environmental value – while at a minimum returning capital, and, in many cases, offering market rate returns or better.

SII is now one of the most important investment trends in the world today, and its momentum continues to grow unabated. According to a report by the Global Impact Investing Network (GIIN) (2019), the total global social impact investment market is USD502 billion. While the market is still relatively small in absolute terms (about 0.25% of the outstanding value of global equity and bond issues), it has grown exponentially over the last decade. The Organisation for Economic Co-operation and Development (OECD) report ‘Social Impact Investment 2019: The Impact Imperative for Sustainable Development’ observes that the growth in SII is not confined to developed nations but has extended to many other regions of the world including developing nations. The OECD report stated (2019, p. 33):

The role of impact investment has become increasingly significant across developed and developing countries, with an increase in allocations across every region from 2013 to 2017. Notably, there was substantial growth in allocations to developing countries and particularly in Africa, South East Asia and Latin America.¹

The rapid growth of the SII market in the past decade can be attributed to several interrelated factors. First, the global financial crisis (GFC) (2007–2009) was the most serious economic meltdown since the Great Depression of the 1930s and brought the global financial system to a dangerous precipice (Jones and Hensher, 2008). An unparalleled spate of corporate bankruptcies, which included one of the world’s largest investment banks Lehman Brothers, led to unprecedented government intervention into the economy, as well as several government bailouts of large banks and financial institutions.

The passing of the Emergency Economic Stabilization Act 2008 provided the US Federal Treasury USD700 billion to buy troubled assets and restore liquidity in markets through the Troubled Asset Relief Program (TARP). The American Recovery and Reinvestment Act (2009) (the ‘Recovery Act’) and the economic stimulus packages that followed was targeted at stabilising falling employment levels and providing a range of temporary relief programmes for those most impacted by the economic recession.

While millions of people lost their jobs and homes as a result of the GFC, many notable commentators questioned the Wall Street culture of unfettered greed and excessive risk taking, compounded by poor regulatory oversight and inadequate financial regulation that collectively triggered the chain of events leading to the GFC (Blinder, 2013).² According to Cohen (2020, p. 158):

The financial crisis of 2008, which has been widely attributed to the self-interested excesses of bankers, led to widespread discontent with our whole financial system; in many ways, it opened the door to today’s raging debate about the need to overhaul our system, much like the Wall Street Crash did in 1929.

While governments were busy bailing out many financial institutions with taxpayer dollars, it appeared that many senior executives of large investment banks and financial institutions were not being held accountable for the financial vandalism that led to the GFC. On the contrary, they continued to take generous remuneration packages and ‘golden handshakes’ while their companies struggled or failed. The catchcry of ‘private profits but socialised losses’ took hold and created a deep sense of distrust and dissatisfaction with modern capitalism and free markets. The system had not only failed but was seen to perpetrate the most egregious economic injustices in society where the unsuspecting public not only had to bail out Wall Street excesses but ultimately bear the brunt of the worst economic impacts of the GFC. The climate of distrust, dissatisfaction and uncertainty with the economic system was an unwitting incubator for new investment approaches, such as SII, which provided a compelling alternative to the status quo by engendering a renewed sense of social responsibility and purpose to investment markets. As stated in the G8 Social Impact Investment Taskforce report in September 2014³ (p. 1):

The financial crash of 2008 highlighted the need for a renewed effort to ensure that finance helps build a healthy society. This requires a paradigm shift in capital market thinking, from two-dimensions to three. By bringing a third dimension, impact, to the 20th century capital market dimensions of risk and return, impact investing has the potential to transform our ability to build a better society for all … Doing good and doing well are no longer seen as incompatible. There is a growing desire to reconnect work with meaning and purpose, to make a difference.

Second, as noted by McHugh et al. (2013), the GFC led to greater austerity in government expenditure as the costs of soaring government debt levels and deficits took their toll. While government expenditure was declining, all manner of economic and social disadvantage grew sharply over this period exacerbated by many countries falling into deep recessions. This inevitably led governments to consider more efficient and fiscally sustainable ways to fund costly social programmes, particularly the utilisation of more cost-effective funding models and outsourcing approaches.

Governments and investors started to recognise that harnessing the power of capital markets through SII is a potentially innovative strategy for tackling challenging social and environmental problems. Traditional philanthropy is also important, but its size and scale render it too limited and fragmented to handle the large and very costly social and environmental challenges facing the world, such as lack of adequate education and healthcare, homelessness, refugee crises and climate change.⁴

Even in quite prosperous countries such as Australia, the Australian Taskforce on Social Impact Investing report (2019) contextualised the importance of SII in terms of the enduring social problems of the age including high poverty levels and other forms of social and economic disadvantage. Impact investing was seen as a means by which governments could tackle such problems more cost-effectively and with potentially lower risk for taxpayer dollars. Furthermore, blending private sector investment with social outcome objectives can enhance experimentation, innovation and more rapid learning in targeted social programmes while having social outcomes subjected to more rigorous and transparent performance measurement and evaluation. This can create potentially more efficient and accountable service delivery with improved social outcomes.

Third, concepts such as corporate social responsibility (CSR) and social responsibility investing (SRI) have been increasingly embraced by the business world in recent decades. From the 1990s, it has been commonplace for companies to disclose CSR information and/or prepare separate sustainability reports in their annual reports. Many companies today routinely provide CSR information and/or prepare separate sustainability reports with varying levels of disclosure. Large investment houses and influential business groups have progressively adopted CSR as an important consideration in assessing corporate risk and future profitability. For instance, in August 2019 (para. 2), the Business Roundtable, an association of chief executive officers (CEOs) of the leading corporations in the US, have redefined the purpose of the corporation from the edict of maximising shareholder wealth to a broader focus on stakeholders, implying a renewed sense of CSR and accountability in society:⁵

companies should serve not only their shareholders, but also deliver value to their customers, invest in employees, deal fairly with suppliers and support the communities in which they operate.

Porter and Kramer (2011) took CSR to a whole new level by introducing the concept of creating shared value (CSV), giving a new meaning to the notion that ‘it pays to do good’. According to Porter and Kramer, if corporations can re-align and refocus their business models and strategies to address social and environmental challenges, there is a potential to prosper financially through growth/innovation opportunities in new products, services and markets. Cohen (2020, p. 12) also advocates thinking outside the square of conventional finance and traditional business practices. He argues that impact investing (a closely related concept to CSV) needs to be at the heart of our society and economic system and advocates a fundamental rethinking or reshaping of the traditional risk–return relationship to embrace the new concept of risk–return–impact. Here, businesses should continue making as much profit as possible, but in a manner consistent with achieving the highest social impact within acceptable risk levels.

In summary, SII is gaining momentum because it appears to be meeting a deep-seated investor desire to fulfil a social impact objective which need not be at the expense of making satisfactory or even below market financial returns. Some insight was provided by the GIIN annual impact investor survey (2020a), which included data and perspectives from 294 individual impact investing organisations. In terms of the motivation for impact investing, the top three reasons provided by respondent investors for making SIIs all related to the importance of social impact itself (see GIIN, 2020a, p. xv). According to the survey, most respondents (87%) considered both ‘impact being central to their mission’ and ‘their commitment as responsible investors’ as ‘very important’ motivations. Additionally, the survey indicates that 81% of respondents believed that impact investing was an efficient way to achieve impact goals and 70% found the financial attractiveness of impact investing compared to other investment approaches as ‘at least somewhat important’. Approximately 88% of respondents reported meeting or exceeding their financial expectations, while 67% sought market competitive returns for their assets (see p. xv).

In the Australian context, governments at the federal and state levels have shown considerable interest in the growth of the SII market. The Australian Taskforce on Social Impact Investing released an interim report in 2019 which provides a blueprint for the future development of this market in Australia. While federal and state governments in Australia have made varying levels of commitment to SII, the Australian market is still in its infancy, even being referred to as a ‘cottage industry’ by the Australian Taskforce. Echoing the G8 Taskforce report (2014) recommendations on SII, the Australian Taskforce envisages a critical role for government in growing the SII market, not only as a market facilitator and market regulator but also as an active market participant in the purchase of social outcomes (such as through social impact bonds [SIBs]).

This book assesses the state of play of the SII market internationally and in Australia. We consider several initiatives and proposals that have the potential to enhance the viability, credibility and transparency of the SII market and ultimately stimulate its growth in Australia. We also consider the many challenges and headwinds ahead which include⁶ the following:

1. Limited SII investment opportunities available for investors and the lack of expert intermediaries who can structure, coordinate and manage risk for SII funding options;
2. Lack of secondary markets, such as a social stock exchange or social investment wholesaler, to facilitate social impact investment;
3. Small and illiquid impact investment markets with no clear exit strategies for investments;
4. Cost and complexity of SII funding options (such as SIBs) and the time it can take to set up these arrangements;
5. Lack of robust metrics for measuring and evaluating social outcomes; including diverse views from market participants on how to measure and report social impact;
6. Lack of good quality social impact data that can support SII investments and their subsequent evaluation;
7. Limited information and evidence on the track record and performance of social impact investments which is needed to attract investment and build investor confidence.

Creating more SII opportunities in Australia and fostering a more liquid and transparent market to attract investors will require some innovative strategies, forward thinking and strong commitment from all market participants, including government, private investors, social entrepreneurs, service providers, investment intermediaries and other parties. The establishment and development of secondary markets (such as an Australian social stock exchange) or a financial institution dedicated to facilitating social impact investment (such as Big Society Capital in the UK)⁷ may be important initial steps to facilitate a vibrant SII market with sufficient liquidity, appropriate regulatory oversight and diverse impact investment opportunities at scale sufficient to attract investors.

Mainstream capital markets generally enjoy a high level of investor confidence which can be attributed, at least in part, to extensive regulation with its focus on investor protection. For instance, the Australian Stock Exchange (ASX) has extensive listing rules which cover detailed financial disclosure and auditing requirements, continuous disclosure requirements, regulation over significant transactions, extensive corporate governance guidance and requirements for the application of accounting and auditing standards. There is also extensive corporate regulation and oversight stemming from the Corporations Act 2001.

For an Australian social stock exchange to operate on an equal footing with mainstream stock markets and with the same level of investor confidence, it will require comprehensive regulation covering issues such as corporate governance, generally agreed-upon concepts of social impact measurement and reporting, requirements for rigorous impact evaluation frameworks and more rigorous risk assessment tools for service providers (particularly for not-for-profit [NFP] entities), just to mention a few considerations.

Public companies in Australia are also required to follow generally accepted accounting principles (GAAPs) and international financial reporting standards (IFRSs). A key measure of financial impact is corporate profitability – this is determined by the application of these principles and standards which are, for the most part, generally accepted across the world. Capital markets have disciplinary mechanisms for companies that depart from these principles. For instance, if a company deliberately manages or manipulates its reported earnings numbers (leading to misleading earnings disclosures), this could result in a negative stock market reaction, a shareholder class action or possibly an intervention from a regulator such as the Australian Securities and Investments Commission (ASIC).

If SII is to enter the investment mainstream, a similar regulatory framework will inevitably be needed to build investor confidence and ensure the credibility, effectiveness and transparency of the SII market. As there are standardised approaches for the measurement and reporting of corporate profits, there needs to be similar standardised approaches to measure and report social impact. Corporate performance is assessed by widely agreed-upon metrics, such as rate of return on equity (ROE), profit margin, working capital, leverage, price earnings, operating cash flow and so on (see Jones and Belkaoui, 2010). Similarly, in the social impact sphere, there needs to be greater consensus on the metrics which best capture impact performance and the standards of evidence required to evaluate the achievement of social outcomes.

Another factor to consider is how the costs of so...