The Financial Inclusion Centre’s new report evaluates the burgeoning social impact and sustainable finance sector.
The report, titled "Making an impact or making a return?", concludes that as the sector grows opportunities for ‘impact-washing’ – the twin of the higher profile greenwashing – have grown.
If the history of finance tells us anything, it is that ‘harm follows the money’. It is far too easy for conventional return-seeking investment to masquerade as social impact finance.
The standards used to determine whether investments ought to be classified as social impact are far too weak. Indeed, the Financial Conduct Authority's new sustainable investment label could actually facilitate impact washing.
What is the social impact sector?
Financial institutions constantly tells us they want to make a positive social impact along with making returns. The concept incorporates sustainable development goals (SDGs). It is the S in ESG and, along with environmental issues, it is referred to as ‘people and planet’.
Yet, these constructs do not properly convey the extent to which finance is creating new opportunities to generate financial returns while bolstering corporate reputations.
Finance lobbies claim private finance can: tackle social harms such as poverty; promote financial inclusion; invest in regeneration and levelling up; and improve standards of corporate behaviours on social issues such as diversity, human rights, fair wages, ethnicity and gender pay gaps.
A whole new category of monetisable social sector assets has emerged as the state (central and local) restricts its role in funding affordable housing, social care, specialist education, and other public services. Private finance is filling that gap.
Financial sector trade bodies have successfully lobbied for financial deregulation and also want corporate welfare to make social assets even more commercially attractive. Politicians from both major parties champion a greater role for private finance in meeting social and public policy goals.
Impact washing
Social impact-washing includes extracting market returns from social assets and rebranding that as social impact, and seeking reputational reward for just doing what is acceptable on social issues.
Making a market return a prerequisite before financing social assets is no different to investing in, say, utilities, technology, or pharma. These sectors have an impact on our lives. Yet, we would look askance at an asset manager claiming it was ‘investing for good’ by investing in those sectors.
Financial institutions are not charities. They exist to make returns for investors and shareholders. The difference with social impact-washing is that they can obtain a double benefit: extracting value to generate market returns (sometimes underwritten by corporate welfare), and obtaining a marketing advantage for doing so.
The current approach to ESG finance allows financial institutions to gain a reputational advantage for just doing what society expects.
Some might say: 'so what if we use private finance to tackle social harms as long as the finance is provided?' But, return-prioritising private finance expects to generate a return above the risk-free rate (usually taken to mean gilts, the cost of government borrowing).
So, private finance is more costly than government financing. Some of the returns we observed during the research were eye-watering. We found examples of asset managers claiming to generate returns of between 8 per cent to 13 per cent investing in ‘social’ and student housing. The state could fund affordable housing more cheaply.
The same practices are evident in other areas such as the provision of social care and specialist education facilities. Relying more on costly private finance ultimately pushes up the costs for people living in that housing or for local authorities who have to fill huge funding gaps.
Using private finance to keep costs off the state ‘balance sheet’ is a financial conjuring trick to conceal a false economy, a new private finance initiative.
Should finance that extracts market returns due to the state cutting the funding of basic services really be classified as social impact or sustainable? Yet, the FCA’s sustainable investment label would allow exactly that.
FCA guidance references a hypothetical investment fund that makes profits from properties used by local authorities to house homeless people. This fund would be allowed to use the sustainability impact label.
Insurers might claim they are investing for a purpose when they invest in levelling up. But, financialisation does not just push up the cost of tackling public policy goals, it contributes to inequality as insurers, shareholders, and investors obtain returns extracted from deprived communities.
The current approach to ESG finance generally, and the FCA labelling regime, allows financial institutions to gain a reputational advantage for just doing what society expects on social goals.
For example, they may restrict their investments to companies that comply with acceptable standards on human rights, fair wages, and working conditions in supply chains.
These tests would set a new, but not unreasonably high, bar.
That is welcome. But special recognition should be reserved for investing in companies that, for example, have top quartile performance on social issues such as paying fair wages, ethnicity and gender pay gaps, diversity and inclusion in the workplace, supply chain behaviours, and human rights.
By way of analogy, with the honours system, ordinary citizens receive an OBE only if they do something special, not for just doing what society expects. Why should financial institutions be held to lower standards?
The new report proposes tests to distinguish between finance that prioritises positive social impact, sustainable finance that makes an impact while making returns, socially harmful finance, and impact washing.
To qualify as true social impact, we argue that investors should be willing to accept a below market return, and not expect corporate welfare. Investment should follow the do no harm principle and drive the highest standards of corporate behaviour.
The tests can be used to calculate ratings for investment portfolios and pension funds. They can be used by financial advisers, financial institutions, pension trustees, managers of charitable funds, NGOs, and ratings agencies.
The tests can also be used to challenge claims about social impact and sustainability especially when investment funds start to use the FCA’s new sustainability label.
These tests would set a new, but not unreasonably high, bar.
To be clear, we are not saying that private finance that does not meet all the relevant tests is ‘bad’ finance. However, we hope that these tests will provide a much more challenging process for screening financial activities that claim to be social impact or sustainable.
Mick McAteer is founder and co-director at the Financial Inclusion Centre
