LexisNexis

The rise of impact investing

Rachael JohnsonWednesday 24 March 2021

Investors looking to align their values with where they’re putting their money have fuelled a significant rise in ‘impact investing’. Global Insight explores how there’s an opportunity for lawyers to influence businesses to move in a more purposeful direction.

‘Climate risk is investment risk’, wrote Larry Fink, Chairman and Chief Executive Officer of BlackRock, in his annual letter to CEOs at the beginning of 2020. As the head of the world’s largest asset management company, Fink has a significant platform to bring certain issues to the attention of the markets. As such, his letters to the CEOs of the companies BlackRock invests in have become highly anticipated.

It’s telling that over the last few years Fink has chosen to underscore the link between climate risk and the ability of companies to create long-term value. His choice demonstrates the extent to which sustainability issues have become mainstream in financial markets, as they are now a matter for consideration by BlackRock.

Fink’s emphasis on climate risk and other environment, social and governance (ESG) themes – for example, stakeholder capitalism and acting with purpose – reflects a broader shift in financial markets.

There’s a growing understanding that ESG risks and opportunities must be managed effectively in order for businesses to create long-term value. Best practice has moved beyond corporate social responsibility (CSR) activities – sometimes seen as a costly add-on to the core business activity – to embedding ESG issues throughout strategy because they have a vital role to play in both generating profit and building resilience.

Much of this change is being driven by consumers, who increasingly want to see their values reflected in their financial products. As the world becomes more aware of the severity of the climate emergency and the magnitude of systemic inequalities highlighted by movements such as Black Lives Matter, the public demands further and more meaningful action.

‘What is changing is people starting to understand that sometimes financial services can be part of the answer to the question, “what can I do?”’ says Tom Tayler, Senior Manager at Aviva Investors’ Sustainable Finance Centre for Excellence.

Impact investing on the up

The increasing emphasis on aligning values with investments, and a greater understanding that the two need not be mutually exclusive, has led to a rise in impact investing.

Impact investing is different from ESG investing, which focusses on managing ESG risks and opportunities of existing investments to maximise financial returns.

Impact investors often choose the outcome they want to achieve first and then pick their investments accordingly, rather than trying to influence the investments they already have. Usually, the chosen organisation has a purpose or activity that directly contributes to the community or the environment. Impact investing can be characterised as seeking to actively do good, whereas ESG investing seeks to do no harm.

For Roberto Randazzo, External Communications Officer of the IBA Business Human Rights Committee and a partner at R&P Legal, an impact investment is ‘something more linked to societal need, a measurable outcome linked to social goals’. He describes such investments as intentional, measurable and conditional.

Deborah Gilshan, founder of The 100% Club and an independent adviser on investment stewardship and ESG, agrees. ‘It’s much clearer from the outset that you are seeking positive impact and that you will manage the asset to get that positive impact’, she says.

REUTERS/Shannon Stapleton

Larry Fink, CEO of BlackRock, at the Bloomberg Global Business forum in New York, US, 26 September 2018. REUTERS/Shannon Stapleton

Aligning purpose and profit

While in some respects impact investing focusses more on social or environmental outcomes, this focus doesn’t need to be at the expense of financial returns. Alex Edmans, Professor of Finance at London Business School, argues there’s ‘increasing evidence that social performance and financial performance are intertwined – that social performance is not at the expense of financial performance, but can actually support it’.


Purpose and profit need not be in conflict

Alex Edmans
Professor of Finance, London Business School


This link between having a positive impact and making a financial return is reflected in the growing understanding by businesses, that embedding social or environmental purpose into strategy will help to build value and resilience over the long term, rather than taking resources away from profit generation. As Edmans argues, ‘purpose and profit need not be in conflict.’

The Covid-19 pandemic has emphasised the relevance of this approach. Organisations that had strong ESG policies in place before the pandemic hit tended to do better at managing its effects.

Pauliina Murphy, Engagement Director at the World Benchmarking Alliance – an organisation that seeks to generate a movement around increasing the private sector’s impact towards a sustainable future – argues that ‘all the flaws in our systems were fully laid bare [by the pandemic] and it’s shown where the gaps are, and some of the gaps are basic, such as human rights’.

By exposing the enormity of the challenges we face in these fundamental areas, the Covid-19 pandemic has accelerated the move towards more purposeful business and more impactful investing. Gilshan says there have been numerous drivers building in the system towards where we are today, but feels there’s a real urgency now.

How lawyers fit in

Lawyers from all practice areas should be aware of these changes in financial markets and tailor their advice to clients accordingly. There’s scope for the legal profession to influence businesses to move in a more purposeful direction, for example through including sustainability provisions or clauses when drafting contracts.


Almost any lawyer in any practice area can now see the documents they draft for clients through the prism of sustainability

Jonathan Kitchin
Head of Commercial and Regulatory Disputes, Michelmores


Jonathan Kitchin, Head of Commercial and Regulatory Disputes at Michelmores, argues that almost ‘any lawyer in any practice area can now see the documents they draft for clients through the prism of sustainability’.

For Kitchin, lawyers have a powerful and influential role to play in outlining the available options. ‘It’s all about giving the client the choice’, he says.

Clients may also seek advice on how to attract funding from an impact investor, or the client may be an impact investor wishing to set up a new fund. ‘Impact investing is going to provide a […] niche for lawyers to assist companies in being able to comply with all the requirements [of] these funds’, argues Luis Carlos Rodrigo, Council Member of the IBA Section on Energy, Environment, Natural Resources and Infrastructure Law and Managing Partner at Rodrigo, Elías & Medrano.

Rodrigo is currently part of an IBA Presidential Task Force looking at the rise of impact investing and the role of lawyers. The Task Force is working on a case study that aims to provide practical tools and recommendations for business lawyers to advise either companies looking to attract impact investors or entrepreneurs who want to structure a new company with environmental or social impact goals in order to pursue impact investments.

The study ‘tries to provide lawyers in private practice or lawyers who are in-house counsel with very specific elements that they need to look at, to understand, and to [have] in mind’, so they can enable their clients to qualify for receiving investment from financial entities that take these elements into account, explains Rodrigo.

Lawyers as changemakers

Lawyers can assist clients who want to take a more sustainable approach to their business. In the broadest sense they can bring sustainability or ESG issues into discussions with clients wherever appropriate. ‘It’s not always just meeting the bare minimum regulations’, argues Murphy. ‘Regulations will hit you if you don’t show leadership in this area.’

Some organisations have made model clauses available for the drafting of contracts or other legal documents. For example, the Chancery Lane Project aims to develop new contracts and model laws to help fight the climate emergency. The IBA has also published a Model Statute for Proceedings Challenging Government Failure to Act on Climate Change.

When advising on the best way to structure an entity with a specific purpose in mind, the B Corporation, or B Corp, is a good option. A certified B Corp is legally required to consider the impact of its decisions on its workers, customers, suppliers, community and the environment.

Randazzo describes the B Corp as ‘the corporate face of the impact economy.’ For him, this model perfectly represents the balance many companies strive for, between making an environmental or social impact and being able to generate dividends for their shareholders.

Tayler argues that lawyers should be thinking strategically about how clients can evolve their business to fit with the emerging sustainable economy, asking ‘how is what they’re delivering serving people and planet?’ and considering options such as the B Corp to address these questions.

Randazzo agrees. ‘We could be able to drive [clients] into this new ecosystem represented by B Corps’, he says, ‘or if they are financial operators, into the ESG or impact fund structure.’

‘We could act as changemakers’, he adds.

Unfounded claims

The biggest risk associated with impact investing is referred to as ‘impact washing’, or ‘greenwashing’. This refers to an organisation making unfounded claims about its green credentials. Impact washing, similarly, describes false claims made about a fund or an organisation’s impact credentials.

As impact investing becomes more mainstream, there’s likely to be a stronger appetite for holding organisations to account for impact washing. It is important, therefore, for entities to understand what impact is.


Climate litigation is very much on the rise, and it should be a concern for companies and financial service providers alike

Tom Tayler
Senior Manager, Aviva Investors’ Sustainable Finance Centre for Excellence


There’s also a strong argument here for companies to move away from the more superficial, CSR marketing campaigns we’ve seen in the past. When these activities aren’t underpinned by a thorough understanding of impact, it’s easy for them to stray into the terrain of impact washing. ‘This generation of investors are much more aware of their rights and don’t stand idle when they’ve clearly been mis-sold to’, says Nirav Patel, CSR Lead and Senior Associate at Michelmores. Patel believes it’s only a matter of time before funds engaging in impact washing are held to account.

For Murphy, ‘These are all the practices where, if you don’t have the right accountability in place, then it’s easy for companies to make commitments without really giving the reassurance that they are taking the steps to get there.’

The law can create the kind of accountability Murphy alludes to. ‘Climate litigation is very much on the rise’, says Tayler, ‘and it should be a concern for companies and financial service providers alike.’

According to Jonathan White, a climate accountability lawyer at the environmental organisation ClientEarth, ‘Regulators and courts are increasingly being used to challenge the worst greenwashing offenders, with growing legal action and successes in Europe, the UK and the US.’

Kitchin highlights the potential for litigation risk associated with moving to net zero, with infrastructure projects set to come under a lot of scrutiny. An example could be government investment in projects that may hinder the move to net zero, such as airport expansion or new fossil fuel production.

Randazzo believes there will be new legal categories for lawyers to deal with in the future, centring on ‘social outcome or the social return or measurement’. Where these outcomes are not achieved there will be the potential for litigation. He says the approach companies take to these areas, and how transparent they are, will influence their exposure to impact washing risk.

‘The best way to face this risk today is to develop measurement tools in order to be able to take a picture of [a company’s] activities to be sure that they are ESG-compliant, or impact-complaint, or not’, argues Randazzo.

The metrics challenge

One of the fundamental challenges of impact investing is a lack of suitable, agreed metrics to define what impact means and how to measure progress against agreed targets and create accountability for a failure to meet targets.

Several organisations are developing frameworks to address this gap, but much work remains to create a globally agreed standard for defining and measuring impact.

But since a key facet of an impact investment, compared to an ESG investment, is the ability to measure its impact, the metrics challenge needs to be addressed urgently.

At a European Union level, the European Commission has taken the first significant step towards reporting requirements aimed specifically at impact investing. Its regulation on sustainability-related disclosure in the financial services sector has applied from March. The regulation lays out disclosure obligations for providers of financial products relating to the integration of sustainability risks.

There’s also an obligation to disclose information about the adverse impact that an entity or financial product might have on sustainability matters, regardless of whether the investment strategy pursues a sustainable objective.

The reason for this, explains the Commission, is that ‘Investment decisions and financial advice might cause, contribute to or be directly linked to negative material effects on environment and society.’

According to Tayler, the regulation ‘is asking financial product providers and financial advisers to be much clearer about what they’re setting out to do’. It’s also, he says, mandating regular reporting against it, so customers can see whether the product’s provider is delivering what they’re promising.

The regulation is part of a broader EU initiative to integrate sustainability considerations into its financial policy framework. Another aspect of this initiative is the development of an EU taxonomy for sustainable activities. The EU acknowledges that to direct investment towards sustainable objectives, ‘A common language and a clear definition of what is “sustainable” is needed.’ The EU taxonomy aims to provide this common language and address many of the current gaps in defining and measuring impact.

The EU Taxonomy Regulation came into force in July 2020. The regulation sets out four overarching conditions that an economic activity must meet to qualify as environmentally sustainable. The regulation also requires the Commission to establish a list of environmentally sustainable activities, ‘by defining technical screening criteria for each environmental objective through delegated acts’.

The Commission expects the first of these delegated acts to be adopted in April 2021, with the rest of the taxonomy finalised by the end of the year, to apply by the end of 2022.

Companies and investors will be required to make disclosures using the taxonomy from the beginning of 2022, covering the 2021 financial year. A further delegated act, to be adopted by the Commission by June 2021, will provide more detail on the information required in these disclosures.

Meanwhile, the Task Force on Climate-related Financial Disclosures (TCFD), developed by international body the Financial Stability Board, offers another potential method for measuring and reporting impact. The TCFD aims to develop recommendations for more effective climate-related disclosures to promote informed investment and help stakeholders understand the financial system’s exposure to climate risk.

Some investors, including BlackRock, are beginning to require companies to disclose climate information in line with TCFD recommendations. The UK has also recently announced it will make TCFD-aligned disclosures mandatory across the economy by 2025. Over 1,800 companies have publicly declared their support for the TCFD and its recommendations.

The UN’s 17 Sustainable Development Goals (SDGs) often form the basis of initiatives to measure and define impact and for many working in this area they’re at the core of their ambition. The EU states in its regulation that it ‘links the SDGs to the Union policy framework to ensure that all Union actions and policy initiatives […] take the SDGs on board at the outset’.

For Randazzo, ‘SDGs have the power to align globally attention on the needs coming from communities, so this is the perfect starting point.’ He says the SDGs have made the conversation about impact and sustainability a global one, meaning he’s able to have the same discussions with clients based across many different jurisdictions.

The World Benchmarking Alliance takes the SDGs as its guide in measuring the progress of business against sustainability standards and governance goals. Pauliina Murphy describes the SDGs as a political agreement that doesn’t immediately speak to business.

‘Part of the work that we do in our measurement is try to give a roadmap for those companies on the things that they need to do’, she says. This involves producing benchmarks to be used by a range of stakeholders to assess progress towards achieving the SDGs. This information could also be used to hold organisations to account where it’s felt they’re not doing enough.

Tayler agrees the SDGs are crucial and need to be better understood by consumers and by businesses. ‘Ultimately each of those sustainable development goals represents a market failure’, he says. ‘If markets delivered sustainable outcomes on all those 17 things, they wouldn’t exist, and we’d have a much fairer and more just society.’

Defining social impact

A significant amount of focus to date has been on developing metrics for environmental impact, perhaps because this area lends itself more readily to definition. For example, carbon emissions are relatively straightforward to measure. Social impact is much harder, particularly because the action required by each company will vary depending on the specific needs of the community which it’s operating in.


The SDGs are all about leaving no-one behind; that’s the agenda it sets, so we need to think about the impact of companies on people as well as on the planet

Pauliina Murphy
Engagement Director, World Benchmarking Alliance


Despite this, it’s important that social impact is measured so it’s not overlooked. Randazzo suggests key performance indicators as the best option for measuring an organisation’s social impact.

Murphy stresses the importance of making a just transition to a more sustainable economy. For example, by protecting employees when a company changes its core business activity to ensure they have the appropriate skills and experience to adapt.

‘We need to put social at the heart of everything that we do’, says Murphy. ‘The SDGs are all about leaving no-one behind; that’s the agenda it sets, so we need to think about the impact of companies on people as well as on the planet.’

Walking the walk

It’s important that law firms practise what they preach when advising on sustainability issues. ‘Law firms really need to be having a look at themselves to see [if] they are doing the right things’, argues Patel.

According to Kitchin, sustainability credentials are becoming an important part of the tender process, with many prospective clients making ‘your sustainability credentials a percentage of the marks that you’re awarded’.

‘It’s not just a surface, tick-box exercise’, adds Patel. ‘Clients really are looking at your responses and verifying what you’re backing them up with.’

This theory can be applied to investors too. Asset managers should outline the steps they are taking to manage their own ESG risks and opportunities.

‘If finance companies are going to take this agenda forward, they also need to have a culture change’, argues Murphy, as well as ‘a mindset shift from the incentives they give their fund managers or executives based on short-term financial returns […] and move to a mentality where you look at non-financial rewards as well’.

Build back better

There is hope that impact investing will play an important role in the broader effort to ‘build back better’ from the effects of the Covid-19 pandemic. ‘Personally, I am convinced about that’, says Randazzo.

Patel argues that businesses can learn from impact funds in terms of how they approach ESG, how they draft provisions for these issues and how they monitor them strictly.

The same can be said of mainstream investing. ‘Where we need to get to is mainstream finance thinking like an impact investor’, says Murphy, ‘but we need the scale of the mainstream.’

Edmans adds that ‘it should not be every company’s responsibility to solve all of the world’s problems’. For him, ‘a company should focus on solving the issues that it’s best placed to solve’, to have the most meaningful impact.

Rodrigo agrees, arguing it won’t be possible to make having an impact mandatory for all companies because not all business activity fits that remit. However, it’s still possible to hold those companies to very high ESG standards.

‘I hope that as we recover from the pandemic the sustainable development goals are the guiding principles [of] that recovery’, says Tayler. ‘We hear the rhetoric of building back better, and now we’re looking for action and policy to back that up’, he adds.

The IBA Presidential Task Force on the rise of impact and the role of lawyers presented a session at the IBA 2020 – Virtually Together conference, entitled IBA Showcase: the rise of impact – a lawyers’ perspective from a business outlook. The session can be watched here.

Rachael Johnson is a freelance journalist and can be contacted at rachael.editorial@gmail.com

Header pic: Shutterstock.com/Black Jack