How to Finance Your Sustainability Strategy
Impact investing and green bonds can fuel your company’s sustainability action.
Rod Lohin is Executive Director of the Michael Lee-Chin Family Institute for Corporate Citizenship at the Rotman School of Management, University of Toronto.
For years, sustainability professionals (and academics who study their work) have been answering some tough questions. Is there a business case for sustainability? (yes). Can we determine which social and environmental issues are most important to our businesses? (yes). Is it possible to measure and report on sustainability practices credibly? (yes). Can we deliver value to business and society? (yes). Simply put, companies generally perform better if they’re more sustainable.
But despite this progress, many sustainability professionals still struggle to access budgets internally. In particular, it’s hard to get long-term capital for big, multi-year projects.
The fact is that we may know where we want to go, but sometimes we’re short on the capital — the fuel needed to achieve greater social and environmental benefit.
Lack of financing is a common problem
In our research and consulting work at the Lee-Chin Institute and through our networks, we’ve seen major corporations get part way there but run out of fuel. They develop a bold sustainability strategy, map out breakthrough programming to support it, and gain support for the initial costs of the project from annual philanthropy, sponsorship or other expense budgets.
However, when they pitch the longer-term capital requirements to senior management, they get thwarted by otherwise typical features of many socially responsible investments (SRI): complexity, long-term payoff, and modest or moderate financial returns. In other words, they can fail the test for internal capital allocation.
Some company leaders with sufficient influence simply make the investment anyway. Wal-Mart’s leadership invested in a massive sustainable supply-chain management initiative that has had global reach, helped them manage risks and establish a new narrative with consumers. Under Paul Polman, Unilever repositioned as the “sustainable living” company and consistently outperformed its rivals in the public markets for more than 10 years.
But in the absence of such clear executive commitment, how can sustainability professionals get the needed capital? How can we fund projects with long(er) time horizons and lower rates of return but with important long-term payoffs for the company and the world? How can we better leverage the capital markets and the finance capabilities of our companies in support of social and environmental — and business — benefits?
Consider green bonds and impact investments
The answer may be in the booming market for sustainable and responsible investments (SRI). Worldwide, more and more investments have been made with regard for sustainability. In 2015, the market for all types of SRI offerings reached US$22.90 trillion (26.3% of all global capital markets) according to the Global Sustainable Investment Alliance. Two approaches may be the most relevant to sustainability practitioners within companies: green bonds and impact investments.
Fueling action with green bonds
Green bonds (publicly or privately issued) raise funds for environmentally beneficial projects (retrofits, clean energy, pollution mitigation, etc.). They offer a safe and predictable rate of return for investors, often at a rate slightly lower than more traditional bonds. Remarkably, green bond issuance grew more than 100 times between 2012 and 2017 from US$3 billion to US$389 billion (according to the Climate Bond Initiative).
For sustainability professionals (and their companies), there’s an opportunity here. The cost of capital of green bonds can sometimes be lower than that from other sources, even internal sources. In this case, external capital could be more attractive than internal capital. Companies that access funds through green bonds could potentially allocate internal funds to their highest-potential capital projects and at the same time fund more activities with environmental benefits.
Companies can use green bonds in two principal ways: raising their own fundsby issuing a corporate green bond, or by accessing green bonds raised by others.
Best of all, these green bonds appear to be paying both environmental and financial dividends. Researcher Caroline Flammer recently noted that green bonds “yield a positive stock market reaction, improvements in financial and environmental performance, an increase in green innovations, and an increase in stock ownership by long-term and green investors.”
Companies can also access funds raised by governments, municipalities and a range of private players through green bonds. Examples include green bonds worth more than US$4.35 billion by Bank of America and, in Canada, over C$3 billion raised by the Canadian Pension Plan Investment Board.
However, there remains a risks that such funds are not consistently “green:” that is, they use different definitions of what investments are considered environment-friendly. For example, green bonds originating in China can include “clean” coal technologies; most others do not. To ensure consistency, financiers are increasingly making use of the Green Bond Principles or Climate Bond Certification as well as third party verification.
Fueling action with impact investments
Impact investing is another type of SRI investing that seeks financial returns alongside measurable social and environmental impact (unlike green bonds, which only promise to invest in but not measure environmental impact). Between 2013 and 2017, the global impact investing market grew from US$25.4 billion to US$228 billion (Global Impact Investing Network). As the market grows, major financial institutions like BlackRock and UBS are joining pioneers like Bridges and Calvert.
With all these funds seeking investments, companies may be able to access external funds that align with their environmental and social benefit initiatives. This may be easiest for companies that have an environmental or social purpose (for example, renewable energy or education). However, even more traditional companies could potentially seek investments for specific projects.
The type and the stage of an organization plays a role in determining how to access these markets.
Early-stage businesses or social enterprises (businesses with a specific social or environmental purpose) can look to a range of fast-growing networks of angel or early-stage investors, including Angel.co or F6S.
Social enterprises can also explore social impact bonds (SIBs), increasingly known as pay-for-performance contracts. These are a complex investment vehicle in which a principal (often a government funder) invests in an NGO or program that’s expected to have a social or environmental benefit. A third party is typically engaged to verify achievement of the benefits, which triggers payment to the NGO. One recent example is Activate, the Heart & Stroke Foundation’s SIB to prevent hypertension, which involves Public Health Agency of Canada and the MaRS Centre for Impact Investing (MCII). However, the benefits of SIBs may be outweighed by the complexities.
For more established companies, there are other ways to structure deals to support projects with environmental or social benefit. Companies with advanced finance capabilities might consider more complicated instruments like real options or special purpose vehicles:
Real options give an investor an option to make an investment in a tangible (real) asset. For example, a company could offer an investor greater access to a promising green or social benefit project for a small upfront investment, with the right to choose to expand their involvement later, wait, or abandon the project.
Special purpose vehicles or special purpose entities enable a parent company to place an asset in a subsidiary and securitize it or otherwise offer it to investors. This approach is already used to manage billions or possibly trillions in public private partnerships including governments, multilateral organizations and lenders/investment banks. However, private markets are shy about this approach because it was used — corruptly — by Enron.
Need help to find capital? Seek out the experts
Sustainability professionals have come a long way in understanding how to manage risk – and add value – to their companies. We've had to access new capabilities, including making a stronger business case; understanding materiality, measurement and reporting; and delivering both business and social value.
These are all powerful advances. However, the better sustainability professionals get, the more it becomes apparent that we need more fuel — that is, more financial resources — for our sustainability initiatives than is accessible in internal pools of capital.
To overcome this challenge, we can access new pools of external capital, but we’ll need to learn and engage in another set of capabilities: finance and investment. Newer, smaller enterprises might consider seeking help from specialist advisory firms to find the right investors. Larger, established companies can draw on their internal finance experts.
Happily, the investment market is looking for good work to fund. Perhaps the time is right for sustainability professionals to work with experts and our financial colleagues to connect our work with the capital markets and have a greater positive environmental and social impact than ever before.
About the Lee-Chin Institute
The Michael Lee-Chin Family Institute for Corporate Citizenship at the Rotman School of Management, University of Toronto helps current and future business leaders make sense of options, opportunities and approaches to sustainable business. We conduct research, engage the business community and students through publications, events and teaching. We also consult with pioneering businesses and create public-good resources, such as OpenImpact.ca, an inventory of impact investments in Canada.
About the Author
Rod Lohin is Executive Director of the Lee-Chin Institute.
Rod oversees the Lee-Chin Institute’s research, grants, consulting projects and initiatives to reach business leaders and engage MBA students in corporate sustainability, including teaching courses on sustainability strategy and impact investing. He applies the research and tools created by the Lee-Chin Institute in consulting projects with leading corporations like the RBC Financial Group (Canada’s largest bank), SunLife, Blackberry and others. He was previously a management consultant at pioneering firm Manifest, working with clients like Ericsson, Kellogg’s and the Heart & Stroke Foundation
Rod is a co-founder of OpenImpact, an inventory of impact investing products in Canada. Rod was also a founding member and Treasurer of the board of directors of Rise Asset Development, a micro-finance organization helping people with a history of mental health and addictions issues to explore entrepreneurship and build small businesses.