MOVING MONEY TO MEANING

Why is it crucial for the board to include members with expertise in environmental and social issues?

The Board of Directors plays a pivotal role in steering a company and its strategic direction. Board members with expertise in environmental and social issues are better equipped to ask the right questions from management about their sustainability principles and how they are incorporated into a company’s strategy and operations. Moreover, with such expertise, the board is more effective in overseeing measurement of KPIs and reporting of progress.

How do you perceive the role of environmental and social expertise within the governance structure?

I believe that a company’s culture is set by its leadership team. When the board and management see value creation in sustainability and understand its implications on risk as well as on its various stakeholders, the organization takes a more long- term approach in setting strategy and operational standards. This eventually will reflect in the company’s long-term competitive positioning and performance.

Enabling Qapital has very robust governance, sustainability and risk management processes, which I believe are the core reason for its strong and stable returns. Similarly Enabling Qapital sets high governance and sustainability standards for its investees, recognizing the impact of such standards on the underlying value of the investment. Good management frameworks not only reduce risk, but they also generate efficiencies and enhance productivity as well as allow for faster adaptation to change.

How can the board encourage the integration of environmental and social considerations into day-to day business operations?

Our role as board members is to ensure that Enabling Qapital’s management team continues to focus on operational excellence with its robust policies and procedures together with its strong risk management culture. As board members we need to be prepared to initiate and drive sustainability agendas that define clear governance, leadership and accountability on environmental and social issues and incorporate measurement capabilities for relevant KPIs. When we, as a board, understand the implications of such issues to value creation and the resilience of operations, we are best equipped to support management in developing quality investment strategies with sustainable returns.

What is the main difficulty faced with the implementation of SFDR to an impact fund (especially investing in micro finance)?

The introduction of the SFDR represents a significant stride towards equipping stakeholders with standardized and comparable ESG information. However, navigating the complexities of this regulation is not without challenges. The challenges inherent in SFDR9’s reporting mandates are extensive and specific, presenting a formidable task for impact funds due to the granularity of data required. The biggest and most relevant challenge is data availability to meet regulatory requirements.

Securing accurate ESG data in a timely and dependable manner will, especially in the initial stages, pose complexities. This is primarily because such information has not traditionally been as accessible or subject to the stringent checks that financial data undergoes. The difficulties in data accessibility also come from the nature of private credit borrowers themselves.

Given they are often smaller-scale, non-listed companies, there have been some constraints to estimate the scope and the quality of data available to the lenders. In many instances, data providers find it challenging to furnish precise estimates for alternative assets that align with SFDR specifications. Additionally, data collection in emerging countries has its own set of unique challenges.

Microfinance, with its context-centric nature, exemplifies the challenges of numerically representing impact. Crafting a framework for impact investing is essential to navigate these complexities. As a result of these challenges, measurement standards for social and governance indicators need further development. Furthermore, due to the nuanced and intricate nature of some indicators, especially those related to Principle Adverse Impact (PAI), there’s often a need to resort to proxy measures, which might not always capture the full essence of the indicator in question.

How to address the reporting requirement and data collection?

Two years ago, Enabling Qapital (EQ) identified one of the pivotal challenges in private debt: data sourcing. When investing in microfinance institutions, which often resemble small to mid-cap companies, accessing managerial insights can prove more challenging than it is for equity investments. Moreover, many of these institutions might not internally track the kind of data mandated by regulations. To counteract this, we adopted a proactive approach. We dispatched questionnaires to our portfolio companies well in advance – aware that setting up robust reporting mechanisms might take them a year or more. The rationale was simple: it’s always better to start early.

Our initial foray, however, wasn’t without its challenges. The preliminary round revealed that sourcing certain data points was a complex task, and many microfinance institutions (MFIs) faced difficulties in establishing comprehensive reporting. Additionally, there were instances of discrepancies in understanding the regulatory definitions, resulting in data that required meticulous quality checks. This feedback was instrumental in refining our data collection tools. Our revised questionnaires were better tailored to the realities on the ground. Simultaneously, we began exploring data modelling as a complementary approach for cases where direct data remained elusive. For instance, models became instrumental in approximating the carbon footprint of companies based on size, loan portfolio, and sector specifics. Collaborating with the Impact Institute and Joint Impact Model bolstered our efforts in this direction.

Another dimension to this challenge is the stipulation of Article 9 funds. Such funds must evidence their investments in entities driving tangible environmental and/or social impacts. This becomes particularly challenging for microfinance funds, especially with the current ambiguity surrounding the social taxonomy, which, disappointingly, has faced delays without a defined roadmap.

However, proving “impact” is a cornerstone for Article 9 funds. Recognizing this, EQ has meticulously crafted a Theory of Change (TOC) for each product in our portfolio, ensuring our commitment to genuine impact remains transparent and demonstrable. To foster a more standardized approach, collaboration within associations is pivotal. By banding together, industry participants can champion market standards that are harmonized and resonate with the ethos of SFDR. Such collaborative efforts will be crucial in the coming years as we seek to refine and evolve the framework in harmony with the spirit of SFDR.

Do you think that SFDR is suitable for impact funds (especially investing in microfinance) and if not, what should be changed in the SFDR requirements in that respect?

SFDR emerged primarily as an instrument to counter greenwashing and social washing, a phenomenon where investments are misleadingly portrayed as environmentally friendly and socially responsible without genuine sustainable impact. Its foundational intent was not to serve as a definitive stamp of sustainable authenticity. Rather, SFDR aimed to ensure that investment managers marketing ESG-friendly funds were transparent about their offerings. This transparency would equip investors with the requisite information, allowing them to discern genuine sustainable investments from mere marketing facades and thereby make informed decisions.

However, the industry’s response has been intriguingly divergent from the SFDR’s foundational intent. A notable section of institutional investors has co-opted the SFDR as a sort of labelling mechanism. This seems to be driven by the convenience it offers in fund selection. That is definitely one part, that in my mind is not very useful for the industry and also does not do justice to microfinance funds. The definition of “impact” is currently being used in an inflationary way. The differences between the various frameworks the providers use highlight the clear challenges in defining impact investing.

Microfinance funds also face a distinct set of challenges in this evolving ecosystem. The absence of a comprehensive social taxonomy poses significant hurdles, especially when defining and demonstrating their unique focus of impact. And of course, as mentioned above, a recurring concern is the data challenge. Many reporting requirements mandate data that either doesn’t exist or is challenging to obtain, especially from companies in emerging markets. Ensuring the reliability and authenticity of such data further compounds the challenge.

Lastly, it’s prudent to anticipate evolutions in the SFDR9 landscape. Presently, the regulatory emphasis seems to be pivoting towards the tangible demonstration of impact. As I would say the journey is still in its nascent stage, and it underscores the importance of staying agile and responsive to such shifts, ensuring that our approach remains both compliant and effective in reflecting true ESG impacts.