| By Elena Johansson
Q: A report by the Climate Policy Initiative has assessed that results-based finance (RBF)*, including environmental impact bonds, is well suited to help financing sectors most affected by Covid-19, such as energy, transportation, water and sanitation and waste management. In your opinion, do environmental impact bonds have the potential to make a difference in the recovery of the US from the pandemic?
A: The potential is certainly there. With green bonds, there aren’t enforceable uniform standards for what technically qualifies as ‘green’, and for sceptics that raises questions about how much impact some of these projects may ultimately have. Environmental impact bonds get around this because, unlike green bonds, they are explicitly designed with sustainable performance targets that are agreed to by all parties. If the impact targets are met, investors receive a bonus or better return. If they aren’t met, investors won’t see those bonuses or may have to pay a penalty.
By effectively tying returns to measurable operational performance on sustainability, environmental impact bonds address how much actual impact is being generated. That said, the universe of environmental impact bonds is a fraction of the overall green bond market, and the green bond market is itself a drop in the bucket of the $119 trillion global fixed income market outstanding. So, there’s a long way to go.
Q: Can you already see evidence/best-in-class cases from the pandemic which underline how US institutional investors with an impact approach can achieve more value and return with their investments in the time after the recovery, compared to more traditional investors who disregard impact? Can you name an example?
A: It’s important to understand that there was plenty of evidence long before the pandemic that impact investing can add value. There has been a good deal of research on this. In fact, one meta study of the effect of ESG policies on market performance found that roughly two-thirds of the 2,200 studies performed on this subject detected a positive relationship between ESG factors and market performance. Just as important, roughly 90% of those studies found there to be no negative relationship between incorporating sustainable factors into your investment strategy and your bottom line.
What the pandemic did show, however, is that we’re all affected by the environment and society. No company or country was immune to Covid. So, in the aftermath of the pandemic, companies have become increasingly aware that not only should they incorporate environmental and social risk factors into their decision making doing so is actually part of their fiduciary obligation.
This is particularly true for any company that has long-term obligations or long-lived assets. If you are an insurer, a pension fund or an infrastructure company and you are not factoring in the long-term risks of climate change, you are at a distinct disadvantage to your competitors who are.
Q: There is some progress on board diversity in the US following the racial justice movements of 2020. Of all newly appointed directors on S&P 500 company boards, 32% were black (a nearly 200% increase), according to a report published by ISS Corporate Solutions in May. The US Securities and Exchange Commission has this month approved rule changes proposed by the Nasdaq stock exchange that seek to increase board diversity and related disclosure. But the Alliance for Board Diversity (ABD) and Deloitte suggested in a 2021 report it could take until 2074 before minorities will reach a 40% board representation rate at Fortune 500 companies.
Do you see the possibility that boardroom diversity rules will accelerate and drive progress at a greater speed than expected by the ABD, given the increasing attention for this topic? What could this mean for the competitiveness of US companies globally if the board representation rate grows in line with ABD expectations?
A: There’s so much research that shows that diversity on boards and in senior management—whether that’s gender or racial diversity—leads to better business decision making and, hence, better performance. Leaders with different backgrounds and different experiences bring different perspectives to organisations, leading to positive outcomes by avoiding ‘group think’. Yes, diversity is a societal issue. We should have more people of colour and more women on boards. But in addition to that, there is so much research saying that by bringing in qualified people of different backgrounds, you get better financial outcomes.
In the US, better corporate governance is starting to happen, albeit slowly. But the pace at which this is happening leaves much to be desired. It’s possible that shareholders will push for accelerated change in this space, just as they have begun doing for other issues. This is particularly true as investors and stakeholders are increasingly demanding that companies walk the talk when it comes to diversity and good governance.
*The common feature of RBF is that payments are made if certain project outcomes are achieved, which are verified by an independent third party.
Vikram S. Gandhi is a senior lecturer at Harvard Business School, where he developed and teaches its first course on impact investing. He brings 23 years of experience in investment banking to influence and inform the ways that impact investing is shaping investors’ responses to global markets. He is the founder of Asha Impact, an impact investing platform set up by socially conscious individuals to leverage combined capital, networks and expertise to address critical development challenges facing India and other emerging economies. He is also a senior advisor to the Canada Pension Plan Investment Board.
During his previous 23-year career in investment banking at Credit Suisse and Morgan Stanley, Vikram focused on advising boards of directors and CEOs around the globe on strategic direction and the implementation of major mergers, acquisitions and capital raising initiatives, and helped to establish Morgan Stanley’s presence in India. He holds an MBA from the Harvard Business School, and a BCom from the University of Mumbai. He is a member of the Young Presidents Organisation since 1997 and is a qualified chartered accountant.
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