This article was originally published in ImpactAlpha and is jointly authored by BlueMark (Christina Leijonhufvud & Sarah Gelfand) and the Global Impact Investing Network (Kelly McCarthy & Dean Hand).
“You can’t manage what you can’t measure” is a now familiar trope in sustainable investing circles, reflecting the belief held by some that the answer to our sustainability challenges is a universal ESG metrics set.
With growing scrutiny over whether sustainable and impact investments are actually contributing to achieving the Sustainable Development Goals, the need for more reliable and verifiable performance reporting on sustainability and impact results is undisputable. A standardized, consistent set of metrics is undoubtedly a helpful tool for achieving comparability across investors against a baseline set of ESG considerations but is distinct from what is needed to achieve accountability for impact outcomes.
Acting on impact data is not about tracking a handful of universal metrics, but rather about evaluating how and which investment decisions can lead to better and longer-lasting outcomes for society and the planet. Investors and other stakeholders need access to information about the intentionality, context and distinct contribution to impact associated with impact investments.
Clarity about the intentionality of an investment is key to understanding and evaluating the relevance of an investor’s goals and KPIs.
Contextual information is key to interpreting the results. The scale of impact at a point in time, versus the pace of change over time, can tell an investor two very different stories of impact. Context also helps account for the qualitative aspects of pursuing impact, such as the scale of the sustainability challenge in a given market.
Further, information about an investor’s engagement with their underlying portfolio is key to understanding their role in enabling impact, including the relative contribution of their capital and expertise.
To put it another way, investors need access to a more complete set of information about impact. They also need tools to be able to interpret and confidently act on the information, especially if they are going to be able to make and manage investments in accordance with sustainability and impact goals and be accountable to the stakeholders they seek to benefit.
Private Markets ESG
Several initiatives are underway to harmonize measurement and reporting of ESG data, efforts that reflect the market’s thirst for more widely available, standardized and comparable information. While these initiatives could help establish a baseline requirement for ESG transparency, understanding progress towards and achievement of sustainability goals requires significant additional effort.
Two recent announcements aimed at improving the use of ESG data in the private markets signal progress, but also how much further we still have to go.
In the first announcement, a group of leading GPs and LPs with more than $4 trillion in combined AUM launched the ESG Data Convergence Project to “advance an initial standardized set of ESG metrics and mechanism for comparative reporting.”
As part of the initiative, several GPs have agreed to track and report to LPs on six metrics across their investment portfolios, including: Scopes 1 and 2 greenhouse gas emissions, renewable energy, board diversity, work-related injuries, net new hires, and employee engagement. These metrics borrow from existing ESG measurement frameworks created by CDP, CDSB, GRI, SASB, TCFD, and others, and broadly align with the ‘Stakeholder Capitalism Metrics’ introduced in September 2020 by the World Economic Forum’s International Business Council (IBC).
As Marcie Frost, CEO of CalPERS, put it: “We have found it challenging to effectively measure impact in our private equity portfolio because of the multitude of frameworks and definitions used by GPs and LPs. This initiative simplifies sustainability reporting by using comparable metrics which allow us to gain insight into the investment risks and opportunities in our private markets portfolio.”
The second announcement (less than a week later) was the launch of Novata, an ESG data hub designed to “enable private companies to collect, analyze, benchmark, and report relevant ESG information,” which was backed by a consortium of non-profit and for-profit leaders including the Ford Foundation, Omidyar Network, S&P Global, and Hamilton Lane. The 10 metrics chosen by Novata include a combination of Environmental issues (e.g., GHG emissions, water and wastewater management), Social issues (e.g., employee safety, data security), and Governance issues (e.g., board diversity, business ethics), all of which align to various established ESG frameworks.
Meanwhile, in the broader financial markets, the IFRS Foundation announced the much-anticipated launch of the International Sustainability Standards Board (ISSB) to develop “a comprehensive global baseline of high-quality sustainability disclosure standards.” The ISSB will build on the work of existing investor-focused reporting initiatives, with the IFRS Foundation committing to consolidate the teams and expertise of the Climate Disclosure Standards Board (CDSB) and Value Reporting Foundation (VRF) under a new board.
The inspiration behind this effort, according to Erkki Liikanen, Chair of the IFRS Foundation Trustees, is that “to properly assess related opportunities and risks, investors require high-quality, transparent and globally comparable sustainability disclosures that are compatible with the financial statements.”
Impact performance reporting
If only the answer to decision-useful impact performance reporting were as simple as aligning on a universal, standardized set of metrics.
Harmonized metrics, data aggregation platforms, and widely accepted disclosure standards are all foundational elements of a marketplace that supports greater ease of comparison, benchmarking, and investment decision-making. But the question remains: will such data contribute to better understanding of achievement of sustainability and impact outcomes and improved capital allocation towards investments that steward human and natural capital?
It’s one thing for investors to report on a universal set of ESG datapoints, based primarily on their relevance to financial performance. But it’s quite another to provide reliable and balanced information about the contribution of investments to broader social and environmental outcomes.
This higher bar for impact performance reporting is the north star for the impact investing industry, and a prerequisite for unlocking capital at a scale large enough to address today’s urgent climate and social inequity crises.
To address the information gap that limits flows of capital to and contributes to skepticism of sustainable investing, the market needs reporting and disclosure standards that reflect the broader set of factors required to assess impact results (positive and negative) and risks.
Clearly, more work remains to be done to harmonize impact performance reporting, including agreeing on the scope of content to be included, the desired frequency and format of reports, and a market-acceptable mechanism for independently verifying the completeness and quality of these reports. Several organizations are actively working to address this challenge, including the GIIN, B Lab, BlueMark and UNDP’s SDG Impact team, each of which is committed to a stakeholder-centered approach that goes beyond the financial materiality prism still governing much of the sustainable investing market in the U.S. and other jurisdictions.
In May 2021, after a lengthy public comment period, the GIIN released COMPASS: The Methodology for Comparing and Assessing Impact to provide impact investors and service providers with a “methodology to assess and, most critically, compare impact results.” This work builds on the GIIN’s IRIS+ system, and several years of gathering real-world impact performance data at the investment level, to provide guidance on calculations and approaches for interpreting change in impact over time as well as for assessing impact performance relative to the size of specific social and environmental solutions gaps. The COMPASS methodology reflects aspects of several industry-wide efforts designed to bring more rigor and meaning to analysis and comparisons of impact performance data.
In July 2021, BlueMark and the GIIN each received funding from the Tipping Point Fund on Impact Investing to conduct separate yet complementary research, in consultation with market actors, to clarify needs and opportunities related to the verification of impact performance data. These research efforts build on the recognition that independent assurance is key to increasing confidence in the quality and objectivity of reported information as well as to facilitating impact performance benchmarks that are built from a base of relevant and reliable data. For the industry, this work is foundational to evaluating impact performance at scale, and essential to driving the market upward toward ever improved impact yardsticks (disclosure: BlueMark is a sponsor of ImpactAlpha).
Ultimately, the emergence and market adoption of robust impact performance reporting standards and verification services, and the public availability of data about industry performance will contribute to enhanced accountability and confidence in impact investing and its role in helping to achieve our shared sustainability goals. These additional pieces of the puzzle are critically needed for a marketplace to effectively allocate capital for transformative impact.
Christina Leijonhufvud is CEO and Sarah Gelfand is managing director at BlueMark. Kelly McCarthy is director of Iris and impact measurement and management and Dean Hand is research director at the Global Impact Investing Network.
If efficient capital allocation between asset owners and investees is the main function of investment management, then rigorous due diligence is the lifeblood that allows capital to flow.
Now with institutional demand for impact investing products on the rise, due diligence requirements have expanded to encompass impact and ESG as well as financial performance considerations. While this is a positive trend, the additional requirements can translate into greater analytical complexity, thus slowing down capital allocation decisions. This is why many investors are now looking towards third-party impact verification as a valuable tool for streamlining due diligence and separating the wheat from the chaff.
How due diligence has evolved
Since 2018, there have been more than 2,000 ESG-committed private funds in the market targeting about $1.42 trillion in aggregate capital, according to data from Preqin’s 2020 Impact Report, “The Rise of ESG in Alternative Assets.” An institutional investor can’t be expected to conduct thorough due diligence on every fund that crosses its desk, let alone every impact fund. A well-designed screening process helps reduce the target list to just those funds that meet a certain set of gating criteria, saving time and energy for both the allocator and the fund manager and allowing financial markets to function more smoothly.
In recent years, questions about ESG and climate change have begun appearing on investor due diligence questionnaires (DDQs) with increasing frequency, including questions on everything from a manager’s commitment to diversity, equity and inclusion (DEI) to a manager’s recycling program. For instance, nearly half of asset owners (46%) said they want fund managers to supply information on the greenhouse gas emissions and carbon intensity of their portfolios, according to a survey by Cerulli Associates. The same survey found that 70% of asset owners either already require or will soon require asset managers to report on thematic metrics to show how their investments make measurable social and environmental impacts.
As investors seek greater visibility into ESG and impact policies and processes, there is a commensurate need for independent assurance that these practices are both accurately characterized and on par with industry standards.
The growing adoption of impact verification
As asset owners look to allocate more capital to impact funds, they are looking for reliable ways to identify best-in-class managers. This is where impact verification comes in.
Independent impact verification can make the lives of asset allocators easier by providing a trusted, third-party evaluation of an investment manager’s impact management practices and/or impact performance. An impact assurance provider looks under the hood to determine if the manager’s claims about its impact practices and performance are backed up with evidence, aligned to industry standards (such as the Operating Principles for Impact Management (OPIM) or the forthcoming SDG Impact Standards), and reported in a consistent and reliable way. Just as an institutional investor would hesitate to allocate capital to a fund that lacked a trustworthy auditor or law firm, the same will soon be true of funds missing a reputable impact verifier.
A statement from a third-party impact verifier can provide confidence that a fund’s representations of its impact practices are accurate while also identifying potential areas of impact risk for future monitoring. Given the many different impact investing standards and the dynamic nature of the impact market, this kind of verification statement could help clarify and spotlight the most relevant and differentiated components of a manager’s approach to impact reporting and impact management.
The list of fund managers that have been independently verified is growing at a rapid pace. As of March 2020, 115 impact investors have signed onto the OPIM, which require public disclosure and independent verification of alignment. Nearly half of these signatories have already published their verifier statements, providing essential information for investors looking to allocate to best-in-class impact funds. The SDG Impact Standards are expected to include external assurance and an SDG “seal of approval” for investors seeking to align their investment activities with the SDGs. Other industry standards like the Social Bond Principles also include a mechanism for independent assurance.
A growing number of institutional investors have signaled that they plan to ask fund managers to complete an independent verification as part of their screening and due diligence processes. For example, we have worked closely with one leading development finance institution to verify that prospective fund managers in their pipeline are aligned with best practices in impact investing.
Within the next year or two, we expect impact verification to become commonplace and eventually represent a de facto best practice for impact fund managers seeking to raise capital. As more impact investors enter the market, the insights and benchmarking they receive via an independent verification by a trusted third-party could be what sets managers apart from the competition, especially as prudent asset allocators rely on insights from impact verifications to reduce impact risks and enhance impact results. This market innovation enables not only the efficient allocation of capital, but also ensures that the impact investing industry scales with integrity.
Christina Leijonhufvud is the CEO of BlueMark, Tideline’s new verification business. She manages all aspects of business strategy, new product development, and external relations, and has directly led 30+ impact verification assignments across investor types and asset classes.
The impact investing industry has matured over the past couple of years, especially when it comes to aligning investors around common standards for disciplined impact management practices.
The Operating Principles for Impact Management (OPIM) and the forthcoming SDG Impact Standards from UNDP, in particular, have created both clarity around the practices required to authentically integrate impact into each stage of the investment process and accountability for those practices through the encouragement or requirement of independent verification.
Impact performance reports today come in all sizes and flavors, reflecting a lack of clarity and consensus on what constitutes quality impact reporting as well as efforts by individual investors to convey their own “secret sauce.” The state of play makes it difficult for asset owners and allocators to interpret the impact performance of their investments, much less to compare one impact fund to another.
Investors are in search of a better approach to impact reporting that incorporates relevant impact goals and metrics along with the qualitative information needed to communicate a holistic, yet digestible, portrayal of the impact of their portfolios.
While we collectively strive for more consistency and standardization, it’s important to keep in mind that robust reporting—whether on impact or financial performance—is both an art and a science, a balance of both qualitative and quantitative information. Impact reporting will always involve a degree of subjectivity, which makes the role of expert, third-party evaluation and verification critical to ensuring accountability, discipline, and comparability, three core pillars of BlueMark’s approach.
Introducing a way to verify impact reporting
In the absence of a universal or harmonized set of impact reporting standards, BlueMark has stepped up to introduce an impact reporting verification service to respond to market demand. We welcome feedback and comments from market practitioners as we seek to continue to refine our methodology to best meet the market’s needs.
BlueMark’s approach is organized around five key characteristics of high-quality impact reporting. We can think about these elements as divided between two categories: the reporting framework, on the one hand, and the impact performance report, on the other. While an investor’s actual impact report may focus most heavily on the latter, both levels of information are needed for completeness.
Context – Impact reporting should be supported by robust and clearly articulated portfolio-level and investment-level impact theories of change, including an analysis of the evidence base for the linkages between stated impact goals, assumptions, target outputs, and outcomes. The investor’s particular contribution to achieving impact should also be clearly developed.
Relevance – The relevance of impact goals to the SDGs and underlying SDG Targets should be clearly established, drawing on industry frameworks such as the Impact Management Project’s A, B, C classification scheme. In addition, the reporting should take care to identify the stakeholders – including customers, the environment, local communities, and workers – who experience the positive and negative impacts of the investment strategy.
Comparability – An impact report should use objective and transparent impact indicators, drawn wherever possible from industry standards, that allow for the analysis of impact performance over time, relative to expectations, and relative to other organizations. The proportionality of reported impact results to the scale of the investment should also be considered.
Balance – An impact report should feature a discussion of both positive and negative impacts as well as impact and ESG risks. To achieve true balance, the report should also discuss instances of impact underperformance and unintended impacts and what lessons were learned as a result.
Reliability – Impact data, which may come from both primary and secondary sources, should be collected and tracked in a way that drives data quality. Quality control practices should help to ensure that reported impact data is free of manipulation or errors and consistently defined and calculated.
We believe that impact reporting that incorporates these elements is worthy of a high mark, and we look forward to sharing specific examples in future articles.
Given the lack of common standards and dearth of historical impact performance reporting, even the most experienced impact investors are likely to have gaps or shortcomings in their reporting processes. Independent verification of these reports and the underlying systems can help spotlight areas of strength and where there is room for improvement, thereby providing LPs and other stakeholders with the assurance they need while also encouraging investors’ continued advancement towards best practices.
We see the future of impact reporting evolving in much the same way as financial reporting, with third-party verifiers such as BlueMark playing an important role in bringing greater accountability, discipline, and comparability to the market. As impact investors become more comfortable with reporting on a variety of both quantitative and qualitative inputs, the bar of ‘performance’ and best practices will rise across the industry.
Christina Leijonhufvud is the CEO of BlueMark, Tideline’s new verification business. She manages all aspects of business strategy, new product development, and external relations, and has directly led over 20 impact verification assignments across investor types and asset classes.