Accelerating impact investing in Canada (part 1)

The world’s environmental and social crises highlight a problem with the underlying logic of an economic system based only on financial profit. This two-part article suggests ways to accelerate the growth of social finance and specifically impact investing in Canada. This first part argues how a systems change approach would help address restrictions to the flow of capital needed for responding to today’s societal and environmental crises. The second part will explore 7 preliminary ideas to accelerate the flow of capital. 

Context – why focus on impact investing? 

This is a big moment for humanity. The Covid19 Pandemic has not only ended many lives prematurely, it is causing mass suffering and social trauma, damaging education, and inflicting economic damage. It has also highlighted structural flaws that created the conditions for the Pandemic in the first place. It’s a bit of a mess, you might agree.

The pervasiveness and urgency of the world’s environmental and social crises highlight a problem with the underlying organising logic of an economic system based solely on growth and financial profit. This is not a new idea - people have been promoting the ‘triple bottom line’ since the 1970s, arguing that economic activity should benefit the 3P’s: People, Planet and Profit.

What is different now, however, is that the Covid19 Pandemic has created near universal awareness with environmental fragility and societal vulnerability - and therefore a once-in-a-generation opportunity for systemic change.

As a former aid worker, I’ve personally witnessed societal collapse in a time of conflict or calamity, and have devoted most of my professional life to preventing collapse from happening. Collapse can cause multi-generational trauma and damage. You'd rather avoid it. Yet I’ve also seen kindness, resilience and solidarity in humanity in the darkest of times.  I also believe that crisis brings opportunity for change.  This perspective creates urgency: to prevent the worst from happening, to enable the best to emerge, and ultimately to be a good ancestor. This perspective has led me to explore the triple bottom line.   

It would be almost impossible to count the efforts by States and organisations attempting to contribute to the triple bottom line. ESG reporting for example is occurring in all the world’s major corporations, stock markets, ratings agencies, insurance companies and so on. The UN Sustainable Development Goals are a widely referenced reporting tool, and the COP process is driving ever-ambitious government targets. 

System change is the zeitgeist. New fields are emerging and rapidly maturing: social enterprise, social procurement, social innovation, social finance, venture philanthropy, impact investing, mission-aligned investing, innovation labs and accelerators, dialogue processes, green bonds, carbon trading, community-led work and so on. There is a large and growing ecosystem of mission-led co-ops, non-profits, hybrid social enterprises, and mission-led for-profits in Canada. 

A narrative is emerging from this ecosystem about a different way of organising that will leave a sustainable, resilient and just world for the generations that follow. There is a sense of urgency too. But what practical change is happening as a result of this narrative? 

Canadian social finance  

Let’s first take a look at Canadian social finance, as a way to get detailed about impact investing. In theory, if money is flowing into ventures that are focussed on the triple bottom line, then system change is more likely.

Canada consistently is in the top rankings for environments that are supportive of social and environmental entrepreneurship. These could be anything from a social enterprise that is addressing affordable housing in a big city, to a digital technology company that offers a platform that shifts power to indigineous communities, or a new foundation that is experimenting with UBI for disabled people, to a clean tech company that has a new way of sequestering carbon and so on.

In the last decade alone there have been three major reports on social finance: the 2010 Canadian Task Force on Social Finance; the 2013 Federal Government Harnessing the Power of Social Finance; and the 2018 Inclusive Innovation Report.  

Social finance consists of a spectrum of capital – from purely charitable donations at one end to investments that are driven solely by commercial returns. In the middle are hybrids - ‘Venture Philanthropy’ for example, is a hybrid between granting and investing that is fairly well developed in Europe. The European Venture Philanthropy Association (EVPA) illustrates the spectrum in the following diagramme.

‘Impact investment’ is another hybrid term, defined as “investments made into companies, organizations, and funds with the intention to generate a measurable, beneficial social and environmental impact along with a financial return”.

Main sources of capital for impact investment

Here are three commonly available potential sources of capital for impact investment: from philanthropic, governmental and commercial sources.

Philanthropy

Canadian public and private foundations direct capital toward social and environmental impact every day. This could be in the form of increased grant disbursements that can support social ventures, running experiments to stimulate markets, co-investing to leverage other investors, or in ‘mission aligned investments’ where a foundation endowment is invested in ways that further the triple bottom line.  Canadian foundations collectively hold endowments in excess of some $80 Billion, but there are challenges with the rules about disbursements that influence how much of this capital is available and problems with the ways capital can be deployed. 

Government

Government can and is a source of innovation and massive societal change. The ‘Entrepreneurial State’ was a term coined by economist Mariana Mazzucato to describe when the state is the primary risk taker for investing in innovations. One example would be the social finance bank Big Society Capital established by the UK government from funds recovered from dormant bank accounts.

Prior to the pandemic I would have argued that the scale of capital markets dwarf government and philanthropic resources for impact investment. Since the pandemic however we have seen governments taking a much stronger role in providing a societal safety net. We have seen that money can be available at scale. 

In 2018 the Canadian Federal Government announced a Social Finance Fund worth some $755 million, supported by precursor two year $50 million ‘Investment Readiness Programme’ (IRP). The recent Canadian Federal budget announced that the IRP will be renewed for another two years, and that the first $200 million (in loans) will be disbursed from the Social Finance Fund. You could argue that progress is slow, particularly given the urgency and scale of the problem, and the decade of process that has led to the budget announcement. There are efforts to move this government support forward. Even if it was all released, the total fund size would not be sufficient to even address housing issues in Toronto or Vancouver. 

Commercial

Given the scale of the problem, philanthropic and government funding is necessary but insufficient. The capital markets must be part of the solution. Canadian institutional investors (like pension funds, mutual and insurance companies) manage more than a Trillion dollars. These institutional investors represent stakeholders who are just as concerned about the environment, social justice and the resilience of Canadian society as anybody. Many institutional investors have made public and explicit claims about their social and environmental values. But there are a number of intermediaries that are influencing the amount and type of capital that can meet demand.  This leads us to explore the ecosystem.

The impact investing ecosystem

On the demand side, people tell me a lot happening in social enterprises that need investment to tackle important problems: indigenous reconciliation; diversity, equity and inclusion; affordable housing; environmental sustainability and so on. There is a lot of attention and activity at all different scales. New ventures are starting every day. Younger investment professionals working in established firms are demanding impact investments too. The pace is changing. People are starting to talk openly about deal flow. 

On the supply side, the Responsible Investing Association’s most recent research reports that 'responsible investing' assets grew from $2.1 trillion at the end of 2017 to $3.2 trillion as at December 31st, 2019.‘Responsible Investing’ is a generic hard-to-define term, but its growth should be celebrated as a sign of transformation in the traditional investment industry toward more sustainable and inclusive outcomes. Globally, investors holding more than $100tn in assets such as BlackRock, Vanguard and Amundi, have signed a commitment called the Principles for Responsible Investment to integrate ESG information into their investment decisions. 

ESG has become the biggest buzzword in investing. Due to the risk of ‘green washing’, regulators (e.g. the EU) are now turning their attention to helping investors decipher sustainable investment products. ESG reporting will result in more transparency about what existing companies are doing.  The short-term value of ESG may be to disincentivise the most egregious violators of environmental and social criteria. ‘Negative screening’ means to intentionally avoid investments that run counter to the investors social and environmental values. This can be known as a ‘do no harm’ approach. Currently I have the impression that ESG is as more about risk management than it is about changing the world. 

‘Positive screening’ is about investing in companies or organisations which are intentionally trying to generate a positive impact. An example of positive screening would be impact investing, which focuses on companies or ventures whose core purpose is generate social and environmental return alongside financial return. 

It is great that ESG has risen to prominence. However ESG reporting won’t deliver the pace or scale of change needed. Some companies will take a leading role in responding to the crises of the moment, like Microsoft’s commitment to be carbon negative by 2030. But the status quo is very powerful, and ESG reporting doesn’t guarantee that a company will play its part in responding to the environmental and societal crises we face.

Is there a bottleneck in the Canadian impact investment ecosystem?

The scale and urgency of our societal and environmental problems requires directing capital towards companies, organisations and ventures whose core purpose is social, environmental and financial impact. In other words, impact investment. This is a view forged from personal experience with societal collapse, and a career trying to prevent it.

Impact investment is growing in Canada. Over the past two years, reported impact investments in Canada have grown from $14.8 billion to $20.3 billion. According to the 2020 Annual Impact Investor Survey from the Global Impact Investing Network (GIIN), the global market for impact Assets Under Management is estimated at $715 billion (USD). But compared to the scale of the global economy, and the scale of societal and environmental problems, this figure is insufficient.

Consider the number of triple bottom line organisations in Canada, which is too little to catalyse change at the scale needed. At the end of 2019 there were over 1.2 million businesses in Canada, but only 230 certified B corporations. There are more mission-led organisations with some 170,000 charities and non-profits, over 5000 cooperatives, and some 1000 social enterprises in the country.

I’m told there is a problem with Canadian impact investing: the speed of change is too slow. People who lead Canadian impact funds report a lot of talk but not enough transaction. The impact investing ecosystem is emerging in the right direction but the transactions are slow and difficult. Not enough money is flowing. There is a lot of demand with everyone talking about ESG and the field is maturing quickly. Will there be the capital to supply it? Here is what they say:

• Foundations are slow in shifting their capital to mission-aligned investments. 
• There have been three major reports into Canadian social finance over the last 10 years, but until the recent budget, the $755 Federal Social Finance Fund had been mired. The budget did commit to releasing some $200 million in loans from the fund, so perhaps this fund will begin to play its part in the ecosystem, but again, the amount is small relative to the scale of the problems that need addressing.
• Funding is difficult to obtain at the critical early innovation stages. New impact funds, for example could play a catalytic role in the ecosysem but they are really struggling to obtain the investment they need to catalyse this at scale. Of the 20 some impact funds in Canada, only a couple are financially sustainable

There seems to be a bottleneck that is preventing the supply of investment capital from meeting demand from triple bottom line ventures. As a result, the potential from impact investing is not yet being realised.

This bottleneck is a systems problem. There isn't one cause, and there wouldn't be one solution. In the second part of this article I will provide a simple systems approach and propose 7 preliminary ideas to accelerate the flow of capital from institutional investors into the emerging Canadian impact investing ecosystem.