Out-Law Analysis | 15 May 2019 | 11:22 am | 4 min. read
This commitment by 60 fund managers and impact investors shows that the principles have industry support, but some concerns remain about some the strength of independent verification; disclosure of the impact of individual investments, and a lack of engagement with the communities affected by impact investment.
The IFC published the draft principles in October 2018. The impact investment principles are designed to create a common market standard for ensuring that impact investment funds achieve alignment with sustainability objectives such as the United Nations’ (UN) Sustainable Development Goals.
The IFC defines impact management as "managing [private] investment funds with the intent to contribute to measurable positive social, economic, or environmental impact, alongside financial returns".
Ultimately, the principles are aimed at ensuring that through project selection, structuring, operation and exit, the investors’ funds are being used in a way that generates real and sustainable impact.
The nine principles are built around the lifecycle of an investment, and fall under the following categories: strategic intent; origination and structuring; portfolio management; impact at exit; and independent verification.
The IFC consulted with asset managers, asset owners, asset allocators, development banks and financial institutions to develop the principles. It also consulted development finance institutions such as the European Bank for Reconstruction and Development (EBRD) and Overseas Private Investment Corporation (OPIC).
The IFC described the adoption as a "day to celebrate", and said it is an excellent first step at curtailing so-called impact washing, whereby projects are billed as having an investment impact in order to raise capital, when in practice there is little or no tangible benefit for the investee, local communities or the environment.
Signatories to the principles include development finance institutions such as EBRD and OPIC, the Development Bank of Latin America (CAF), European Development Finance Institutions (EDFI), European Investment Bank (EIB), FinDev Canada, Finnfund, the Netherlands Development Finance Company (FMO), and IDB Invest which is a member of the InterAmerican Development Bank Group.
A number of hybrid strategy investors, who have an ‘impact offering’ within their larger strategy, also signed up, including KKR, TPG Growth’s Rise Fund, Nuveen, Partners Group, Prudential, UBS and Credit Suisse.
These investors have only undertaken to align the ‘impact’ portion of their funding base with the principles, and it is not clear whether this means that in reality the stated sum of $350bn in managed assets is in fact lower when it comes to assets actually available for impact funding.
Organisation managing assets dedicated solely to impact investment have also signed up, including Acumen Capital Partners, BlueOrchard Finance, Calvert Impact Capital, Capria Ventures, LeapFrog Investments, MicroVest and responsAbility. Some of the signatories are newly formed, and concerns have been expressed that it may be difficult for inexperienced organisations to comply with all nine principles initially.
Some changes have been made to the October 2018 draft of the principles, but none of them is major.
Principle 5, relating to the origination and structuring of investments, was extended. It requires that the manager must "assess, address, monitor, and manage the potential risks of negative effects of each investment".
However, during the consultation process, numerous suggestions were made that Principle 5 does not go far enough in terms of identifying environmental, social and governance (ESG) risks, instead only really dealing with the avoidance and mitigation of risk. The detailed description of the principle now states that the manager must use systematic and documented process to both identify and avoid or mitigate ESG risks.
The protection of indigenous people and human rights is strengthened. One of the criticisms which was noted through the consultation process is that there was no reference to documents such as the UN Global Compact, the UN Guiding Principles on Business and Human Rights, or the OECD Guidelines for Multinational Enterprises.
By neglecting these, there was very little in the principles requiring managers or investors to respect or consider the impact of investments on the local community or human rights. Footnote reference is now made to both the UN Guiding Principles for Business and Human Rights and the OECD Guidelines for Multinational Enterprises.
The application of exit requirements is clarified. Principle 7 requires that a manager must "conduct exits considering the effect on sustained impact". However, a number of responses indicated that the phrasing of the detailed description and the reference to fiduciary concerns implied that the principle is only relevant to equity investments. The IFC clarified, through a footnote to principle 7, that an exit may relate to "debt, equity, or bond sales, and excludes self-liquidating or maturing instruments".
While the IFC has made amendments to address issues raised in the consulation process, some issues remain.
We have previously noted that self-reporting and independent verification, as required under principle 9, did not specify the mechanisms to be used, opening up the possibility of 'least effort' compliance.
Consultation feedback identified this issue. One participant said: "self-evaluation is not credible as part of independent verification as it is too vague a concept". The IFC said that it will be publishing reporting and governance documents that will outline reporting requirements in detail, including time frame, fees, and consequences for non-compliance.
However, the IFC also said in its response to the feedback that "disclosure of individual investments and their impact or financial performance is not required", which appears to leave a lot to be desired in terms of ensuring that individual projects actually achieve impact goals.
We also previously suggested that the principles suffered from a lack of broad-based input, particularly from the target under-developed countries. The list of initial adopters does not dispel this impression, and is heavily focussed on North America, South America and Europe. Notable absences are, for example, the African Development Bank and the Asian Development Bank.
Similarly, although reference to the United Nations Guiding Principles for Business and Human Rights and the OECD Guidelines for Multinational Enterprises is welcomed, there is still no real mechanism inherent in the principles themselves for ensuring input from the investees and people affected by the project. This leaves the distinct possibility that the principles may struggle for traction among the very groups they are designed to benefit.
Although it is currently very early days for the principles, the initial scale of the adoption does appear to bode well. However, in light of recent criticism of the IFC's overall impact investment agenda and concerns over the ability of blended finance to reach the most needy and least developed countries, it remains to be seen whether the principles offer a true improvement within the impact investment community.
Claire Barclay and Reuben Cronjé are project finance experts at Pinsent Masons, the law firm behind Out-Law.com