Guest blog: In defining 'impact investment', the IFC helps illuminate the broader responsible finance universe

"This article first appeared in the RFI Foundation's weekly newsletter"
A feature of the responsible finance market for as long as it has existed has been the overlapping and diverse range of what is meant by ‘responsible’ and how it translates (or diverges) between one context and another. A recent report by the International Finance Corporation (IFC) does a remarkable job of providing an overarching framework for how to understand responsible finance, in a way that is highly consistent with how the RFI Foundation defines it.

The consistency between the IFC’s narrow focus on impact vs. no impact and RFI’s umbrella term lies in the perspective applied: from the financial sector rather than what it invests in.  RFI includes as ‘responsible’ all of the following: socially responsible investing (SRI); environmental, social and governance (ESG); Islamic finance; and impact investment. The IFC more narrowly defines ‘impact investing’ as: “Investments made into companies or organizations with the intent to contribute to measurable social or environmental impacts, alongside a financial return.” We would include many more financial services as well (notably the inclusion of bank financing).

What is particularly important to include, which the IFC does in its report, are the following, each of which must be present to be an investment for impact:
  • Intent: There must be explicit intent on the part of the investor (not the investee) to create some positive social or environmental benefit;
  • Contribution: The investment must have a theory of change for how it creates additional benefit that would not occur with only an investor solely focused on commercial returns in its place;
  • Measurable: There must be a system in place to measure the degree to which the investment created a positive social or environmental impact.
The standard that the IFC uses is at the same time very demanding and very flexible. A key overlap between the IFC’s approach and RFI's is the ‘intent’ and ‘theory of change’, each of which is a key part of the RFI-member Statements of Intent. Measurement is also viewed as an important output in responsible finance, although we diverge in having a wider focus beyond impact investment.

Rather than viewing measurement as solely a quantitative output, we view it as a fulfillment of intent. The CDIT Initiative which we initiated with European Partners for the Environment follows through on our particular understanding of ‘measurement’ with a focus on consistency and traceability across time between commitments and actions.
With this background, it should be seen that there is a clear picture developing of a new way to categorize different degrees of responsible finance more clearly based on how the financial institutions and investors are doing “something”, however small and unsystematic. By doing “something”, they demonstrate an awareness that responsible finance is either necessary or in demand.

The next level of responsible finance consists of those that have the level of commitment to it. They have expressed an ‘intent’, whether to support the SDGs or the Paris Agreement or to meet the stipulations that define Shariah compliance. They may only aspire and not understand how to operationalize their intention but the intention differentiates from just following the trend.

Going deeper still, are those who have defined their intent. They will have answered the question of “What is important to our firm besides the financial returns that we will naturally seek as a financial intermediary or owner of financial assets?” They will also be able to define how their investments contribute to and detract from their objective. A narrow understanding of this question defines ‘impact investment’, while a wider understanding is a ‘values-aligned’ investment.

Finally, institutions that can show they “walk the talk” can show their intent and how it connects to their actions. This is broader than just impact investments, which demand a showing that intent traced through actions created a specific degree of additionality in environmental and social impact. The broader vision outlined by the CDIT Initiative, for example, just offers proof for how intention was operationalized. It may be accompanied by a showing of specific environmental or social benefit but, coming from the umbrella ‘responsible finance’ mindset, it is not required.

The difficulty with defining responsible finance to date is that there is so much attention paid to ‘how’ it is undertaken and less on the question of ‘why?’ This mirrors discussions in Islamic finance, which has its own version of the how vs. why debate wrapped up as a form vs substance question.

By rephrasing the categorization of responsible finance into the intent/contribution/ measurement matrix, it is much easier to compare the intentionality across different types of responsible finance. When the measurement becomes consistently tracked across time by developing transparent and traceable baselines, as the CDIT Initiative aspires to do, the matrix becomes fully formed in 3D across intent, consistency and impact.

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