“Impact Investing is still a small part of the capital markets. But the returns on these investments are good enough to attract vastly larger amounts of capital. And governments, through financial and other incentives, can further encourage the allocation of capital to investments using environmental, social and governance criteria.”
—Robert Glauber, Harvard Kennedy School of Government, former U.S. Under Secretary of the Treasury
The financial crisis called into question business as usual. The notion of safe assets is gone. Many see financial markets as “casinos” instead. There will be an estimated USD 900 trillion in financial assets by 2020, representing claims against about USD 90 trillion/year of global GDP. The figures are so large that even transformational initiatives in relatively large developing countries, such as the total estimated USD 75-79 billion cost of Ethiopia’s Growth and Transformation Plan (GTP) currently underway, can seem like small change.
The challenge, though, has been to orient the world of finance toward consistently adding value to the real economy. Innovation requires investment beyond seed capital.
Over the past decade, a powerful idea has gained more and more traction: the simultaneous and intentional creation of economic and social or environmental value. The assumption is that this can be achieved in all sectors of the economy and society.
Powered by innovative ways to access and allocate capital, incentives to achieve financial and extra-financial performance simultaneously benefit shareholders and stakeholders alike. The quest for holistic value opens the path to use capital much more efficiently to fund solutions to social and environmental challenges.
However, there is still a road to be traveled to grow to a critical mass in terms of market size. Given their current pace of building scale, delivering on this potential will require reaching outside the current networks of self-identified impact investors so that impact investments become a part of standard asset allocations in investor portfolios.
Only with other supporting measures, creativity, and bold action can a functioning large-scale impact capital market emerge. The potential is huge. Seizing it requires clever articulation with three other trends, which advanced more or less quietly.
First, the digital disruption of capital markets powers on. Do-it-yourself and mobile banking as well as the digitization of transactions are the obvious stories. The digital disruption ahead will cut much deeper than this though. In a PwC global financial CEO survey, a majority of respondents stated that market entrants were disrupting their existing business models. They managed to better serve customer needs at distinct points of the financial services value chain by leveraging technology. Stay tuned how fast the Uber of banking will show up and if our kids will have bank accounts at all.
The prospect of much more radical changes already made its first appearance. Consider Bitcoin, a peer-to-peer online payment system invented by a group of cypher punk developers in the middle of the financial crisis. The viability and efficiency of modern payment systems is based on trusted, central third parties for secure processing of payments. The digital revolution now allows for new decentralized systems that could ultimately be cheaper and more secure. The leading technology worth exploring today is the Bitcoin and its blockchain technology. Its many potential applications extend from online payments to property registers in corrupt countries and even the efficient deployment of billions of Internet of Things devices to drive resource efficiency.
The redesign of processes and products and services following from digital technology enabled a second trend: the democratization of access to capital—via crowdfunding. In crowdfunding, some project or venture raises financial contributions online from the public. For the money contributed, the crowdfunder (1) pre-purchases some product or service, thus enabling the launch of a new business concept by building a sales pipeline (so-called “rewards crowdfunding”). Alternatively, (2) the crowdfunder buys shares in an early stage company (so-called “equity crowdfunding”), or (3) makes a loan to a business or person online (“crowdlending”). It is a smaller story for now, but a welcome complement to venture capital.
Next to digitization, regulation, and values, another major theme in capital markets is the rise of emerging markets and especially Asia. For sure, one should not discount major financial hubs such as London and New York. They offer important secondary advantages to public markets, including the depth of legal expertise and the presence of major private equity funds. Yet by 2025, most large companies will consider a secondary listing in emerging markets, where the lion’s share of global economic growth is taking place.
Less clear than such geographical trends though is where massive volumes of innovative investment content will come from. This is where we need to focus our grey matter.
Awareness of the long-term environmental and social sustainability of the global economy is rising. This is not just changing the way people interact, but also how we allocate capital: investing according to environmental, social and governance criteria (ESG) is gaining ground.
For major institutional investors, the potential stranding of their assets is becoming a concern. Just like acting on the dangers of asbestos by banning its use in electric and building insulation disrupted these industries from the 1990s, removing fossil fuels from the energy mix has implications for the value of an energy company’s oil or coal reserves. By the mid-2000s, 40 countries had completely banned asbestos, including most countries in the European Union. The divestment movement is alive and kicking. It now needs alternatives to invest.
Scale has to be our goal if we aim to enlist private and public capital markets in funding the kinds of opportunities discussed in the preceding parts of this Talkback series. Supply chain upgrading and energy are multitrillion-dollar industries and a placeholder for reconciling competitiveness with social and environmental performance at large.
As shown in detail in “Building the Impact Economy,” value with values is the 2.0 of capital markets. Believe it or not, capital markets can help create a better world. It’s high time to make sustainability and impact the main show in town.