As part of the Wheeler Institute Climate Initiative, Lucrezia Reichlin, London Business School Professor of Economics and trustee of the International Financial Reporting Standards (IFRS) Foundation, recently hosted a webinar, the second in the Wheeler Institutes Climate Initiative on “The Impact Revolution – it is going to happen sooner than you think” on 17th March 2022. The guest speaker was Sir Ronald Cohen, Chairman of the Global Steering Group for Impact Investing. The webinar covered disclosure, data and infrastructure related to climate risk, focusing beyond climate on impact investment more broadly as well.
From Father of British Venture Investment to the Father of Social Investment
The conversation began with a look back on the personal journey of Sir Ronald Cohen, how he came to join and drive part of the Impact Revolution as he refers to it.
“I decided I wanted to do good and do well,” –Sir Ronald Cohen
Sir Ronald Cohen arrived in the UK as a child, coming from Egypt as a refugee. He studied at Oxford, which he describes as an idealist time, before starting his professional career at McKinsey. Sir Ronald then went on to pursue an MBA at Harvard Business School where his idea of doing good and doing well began to form more concretely, “when I went to Harvard Business School I discovered venture capital, which was just emerging but I loved the idea that technology and young entrepreneurs could disrupt the leadership of big firms and create a lot of wealth in the process.” This led him to go on to found Apax Partner, Britain’s largest venture capital firm. This was a social impact project of sorts for Sir Ronald as he reflected during the webinar, “I went into venture capital in order to create jobs in the UK, there were around 3M unemployed in the UK at that time. I thought I could both create jobs and make a lot of money by becoming a venture capitalist, but my aim was never to make as much money as possible.”
In 2005, as he turned age 60, Sir Ronald’s plan was to leave the firm he had founded, a decision supported by his partners. He wanted to deal with social inequality, because he was once a refugee and he was also troubled by the differences in wealth that venture capital had contributed to, rather than being the leveling process he had once supposed it would be.
This departure from Apax heralded a new era in Sir Ronald’s career, he was asked to become Chairman of the Social Investments Taskforce, who were facing the problem of not being able to attract investment for social entrepreneurs. Attempting to tackle this problem, set Sir Ronald off on a journey to connect social entrepreneurs and the investment market. “I began to apply the lessons I had learned in the investment world to tackling social issues” and he created Bridges Ventures, Social Finance in 2007 which invented the social impact bond in 2010, and Big Society Capital which was originally funded by 400M GBP of unclaimed assets in banks, bank accounts which had been separated from owners for 15 years or more.
By the time he was asked to chair the G8 taskforce in 2013-14, Sir Ronald looked at the world and realized a seismic shift was taking place from risk, return to risk, return, impact.
From Risk Return to Risk Return Impact
The conversation between Professor Reichlin and Sir Ronald moved to the discussion on how do we measure impact and the importance of transparency in furthering the impact revolution.
As Sir Ronald Cohen said, “the world cannot continue to function in the way it is doing, our climate challenges are too big for governments and our social challenges are threatening the cohesion of our society. Capitalism served a fantastic role in lifting billions out of poverty but investing for profit without worrying about the consequences for people and planet is no longer tenable.” Sir Ronald noted that already investors and markets were shifting in the direction of revolution with “change in values [that] has become noticed by investors.” The amount of ESG investment has increased from $13T to $40T with $1T dollars of sustainability linked bonds and loans last year alone (2021). The key to continue to drive to shift towards risk, return and impact is the measurement of the impact, Sir Ronald noted, “through the measurement of impact, through regulations, through taxation we shift to a world where it becomes extremely difficult to just make money.”
Sir Ronald posed the question, “if you don’t measure impact how can you manage it? How do we standardize the measurement of impact?” These questions are being answered by the Impact Weighted Accounts Project at Harvard where Sir Ronald along with Professor George Serafeim and others, have shown through big data and AI that we can measure and translate into monetary terms the impacts of companies. They break this down into four categories of impact: operations, employment, products, and impact in the supply chain that is not controlled directly. Sir Ronald Cohen gave staggering statistics examples on operating impact from the work done by the project. After measuring 3,000 companies’ impact, 450 companies create more damage environmentally in a year in monetary terms than they make in profit, 1,000 create damage of 25% or more of their profit, and two-thirds create damage that is less than 25%. This last group can transition to net zero more easily, an important point to understand given that laser focus is required to ensure the transition to net zero is as swift and efficient as possible.
This transparency has highlighted $4T dollars of damage in a year from operations and helped to highlight a correlation already between higher levels of pollution and lower stock market valuations for these high polluting companies. Measurement and reporting of impact, the definitions of what is required has to be determined by investors at the end of the day, and if investors are reducing the value of companies that pollute the environment even if profits grow at the same rate these issues go beyond the profitability of the company in the near and medium term and investors will demand impact related information in order to determine company valuations. As Sir Ronald pointed out, since we already see additional information that is not relevant to immediate profitability affecting company value, a natural evolution will be for investors to ask for all disclosures of interest and then investors will decide what companies they want to invest in based on all relevant disclosures; financial, strategic, as well as ESG-related disclosure.
From Environmental to Social and beyond
The discussion went beyond the environmental impact and the impact measurement required to transition to net zero to discuss the complexity and emerging investor attention on social impacts too which has become a further focus of the Impact Weighted Accounts Project. This further data availability, Sir Ronald asserts, will continue to push investors and the broader impact revolution forward. He says, “we are going to be measuring impact, the next step is to value these impacts,” which will become a step to an impact accounting system, a system that may take more time.
During the discussion Sir Ronald pointed to historical parallels of the 1930s financial crisis as support that regulators will mandate in the coming 2 to 3 years the publication of impact statements by companies. “Investors woke up to the fact they had been investing without transparency with each company picking its own accounting standards.” He continues explaining that just as in the 1930s when this awakening to the need for transparency drove a financial disclosure revolution so similarly will investors waking up to the need for impact transparency drive an impact revolution. He pointed out that, “standardized physical measures that the ISSB is establishing can come together with the Harvard project standardized valuation coefficients and enable regulators to provide investors with the data they need to make decisions.”
“Need to guide the invisible hand of markets with the invisible heart, impact”
The measurement of impact however is not the only instrument that must be utilized to spur the revolution onwards. Sir Ronald Cohen and Professor Reichlin’s conversation continued onwards to discuss the financial instruments that are revolutionizing the market landscape for social investment, and the need to adapt what Sir Ronald calls the broken model of philanthropy.
They discussed the invention of the social impact bond, a financial security where the return depends on achieving a social or environmental objective. Noting examples in the early stages of the instrument such as the UK government paying for the outcomes achieved for reducing the re-offending rate at Peterborough prison. This financial instrument has now grown to over 200 social impact bonds in 35 countries tackling 15 different social issues but it had not gone further because as Sir Ronald stated, “neither philanthropists nor governments have gotten their head around paying for outcomes but the mainstream financial markets grabbed at the idea. Last year alone you had $1T of sustainability linked bonds and loans where the rate of interest that the borrower pays is lower because they have achieved an environmental or social objective. We are beginning to see the financial markets adopting these concepts of outcomes-based securities that optimize risk return impact.”
The social impact bonds and other similar financial instruments will help with the evolving landscape of philanthropy – “it has been a broken model for a long time” where charitable service providers are small and low on funds and historically outcomes have not been measures, rather only the inputs and activities. But Sir Ronald discussed how philanthropy is not immune to the effects of the impact revolution and “things are shifting in the direction of measuring outcomes.” This will enable philanthropists to allocate money that goes to outcome-based grants so they can pay for an outcome, in education for example. It will also help to resolve the contradiction of philanthropy where endowments grow based on investments in non-ESG which then fund social projects by allocating money from its endowment to ESG.
What more must be done
The conversation then shifted to an open Q&A prompting a discussion around the importance of boosting impact capital flows to emerging countries. Sir Ronald noted a need to harness powers like sustainability-linked bonds to specific social issues and a need to move beyond a theoretical discussion. He touched on the example of using outcomes funds to reskill miners who would lose their jobs in the green transition in South Africa. Providing grant money to go into an outcomes fund for re-skilling, instead of providing loans only, would provide the necessary money to fund the delivery organizations that are going to re-skill workers to work in infrastructure, clean energy, and other affected industries. “By focusing on specific social issues and specific funding mechanisms,” the Wheeler Institute and others like them can help to further the impact revolution.
The Q&A also touched on managing the complexities of local requirements and standardization to which Sir Ronald responded that each country requires a degree of adaptation. Corporates are being deluged with demands for impact measurement, and are in need of clarity, Sir Ronald mentioned, given the level of pressure and the time-consuming nature of all of the disclosures, companies will settle for standardization. Professor Reichlin added that during the ISSB creation process a public consultation highlighted the need for global standards, with the current landscape of too many requirements, an “alphabet soup” of disclosure. She acknowledged now the IFRS need notes on the kind of local flexibility required since “different countries have different objectives due to the different public process.” However, the answer remains that there must be a global baseline and a coherent framework with a governance structure at the global level.
As the discussion concluded, Sir Ronald touched on what hurdles still need to be cleared. Regulators need to act now and satisfy the needs of investors. The more the data flows further the methodology of impact measurement, and the more companies publish transition plans, showing how they calculate tradeoff between investment now and profit, this will coalesce to put pressure on regulators to act and drive the mandatory publication of impact statements, but it must be universal.
As with all revolution though, Professor Reichlin touched on “we need all parts of society involved.” Noting that what began as bottoms up involving consumer groups, investors, NGOs, still needs the intervention of governments and regulators, “without [them] it is very difficult to give legs and keep orders on things, so we need the bottom up and the top-down process as well. Similar to other areas of social policy progress, this needs both and it is a collective responsibility.” The objective, to get a single set of generally accepted impact principles across the world, will require bringing together the SEC efforts, focused on companies, and the EU efforts, which has been focused on investment organizations. Although a politicized issue, Sir Ronald concluded “that is where we need to focus.”
About Sir Ronald Cohen – Sir Ronald Cohen is a pioneering philanthropist, venture capitalist, private equity investor, and social innovator, who is driving forward the global Impact Revolution. He serves as Chairman of the Global Steering Group for Impact Investment, the Impact-Weighted Accounts Initiative at Harvard Business School, and The Portland Trust. He is a co-founder and former Executive Chairman of Apax Partners Worldwide, a global private equity firm. He is also a co-founder of Social Finance UK, USA, and Israel, co-founder Chair of Bridges Fund Management and former co-founding Chair of Big Society Capital. He is the author of IMPACT: Reshaping capitalism to drive real change, which was published in 2020.
About the Impact Weighted Accounting Project – The mission of the Impact-Weighted Accounts Project is to drive the creation of financial accounts that reflect a company’s financial, social, and environmental performance. Our ambition is to create accounting statements that transparently capture external impacts in a way that drives investor and managerial decision making.
The Wheeler Institute Climate Initiative seeks to understand, illuminate, and support the business community – individuals and systems – in understanding, responding and adapting to the challenges and opportunities that climate change presents. We have a particular interest on implications and actions for those in developing countries.
Professor Reichlin’s conversation with Sir Ronald Cohen is the second event in a five-part webinar series with high-profile corporate leaders that aims to explore how public and private institutional investors can restructure capital offerings and risk management processes to reflect climate forces.
Margaret Wieland (MBA 2022) has a background in corporate finance, with 6+ years of experience in audit, controllership and financial analysis roles. Prior to London Business School she was based in Shanghai, China leading revenue accounting teams in the region for a large multinational. Margaret is an intern for the Wheeler Institute, contributing to the creation of content that amplifies the role of business in improving lives.