By Laurèn DeMates.
We need to integrate and support new financing models to help society effectively address the social and environmental problems that persist, including the climate change challenge. I would like to discuss two sources of information that I recently came across that motivated me to explore the reality that the current financing models are not reaching the companies and investments that they should. Financing for small and medium-sized enterprises (SMEs) and energy efficiency projects are really two sides of the same coin: the allocation of capital where traditional financial models missed. Large firms don’t seem to have a problem getting the debt and equity they need since they usually have the required collateral to do so and microfinance has been revolutionary in providing access to small loans for individuals and micro-enterprises. I praise organizations such as the Grameen Bank, Kiva, and various community development financial institutions (CDFIs) that provide capital to these individuals that could not access previously. However, in these models, there is a gap in financing for SMEs and for energy efficiency projects.
Not allocating capital in these directions is holding society back because the gap is where extensive work can be done in addressing both global and local social and environmental issues. Impact investing, socially responsible investing, sustainable investing, as well as some private equity firms and development finance institutions (DFIs) recognize the power of capital allocation to address social and environmental issues; however, more support and innovative financing models are still needed to increase the effects and incorporate other potential investment areas. The following two examples illustrate in more detail where capital allocation is vital:
Financing needs to be available for small and medium-sized enterprises, especially in developing countries. I recently read Impact Investing in Latin America: A Deeper Look at the Corporate Role. The study acknowledges the importance of getting capital to SMEs, not only because the gap exists, which is quoted from an IFC and McKinsey study as being between US$330- $410 billion, but also because SMEs make up such a large percentage of the businesses in Latin America. In many countries such as Colombia, Mexico, and El Salvador, SMEs make up more than 90% of all firms, thus need to be supported for economic development. Impact investing aims to support these SMEs, and also organizations and funds, with the capital that current models do not provide. These impact investments are seeking a return, but with the goal of creating and measuring positive social and environmental impacts at the same time. Impact investing continues to overcome barriers and refine analytics to measure the impact of these investments and the SME’s performance in regards to environmental, social, and governance (ESG) issues. However, there is extensive untapped potential for sustainable development by allocating funds in this manner.
Financing needs to be provided for energy efficiency improvements. The other piece that a friend passed along that supported the need for new financing models was a blog posting titled Energy Efficiency Financing: When Being Green Improves Earnings. The post explores the provision of capital for energy efficiency improvements or building retrofits, which traditional financing models or sources ignore as not worth the time or effort. Assistance with up-front capital costs can help companies make the changes to achieve the cost-savings and climate change benefits of reduced energy and water use. Eric Starr of CapX Partners, whose firm has begun to consider these investments, is quoted stating ‘from a portfolio company perspective, energy efficiency financing is a worthwhile investment.’ There is great potential in having this capital accessible, it may tip the scale for companies that are considering making these changes in their buildings towards taking action. Completing energy efficiency improvements and retrofits are key in addressing climate change through the significant reduction in GHG emissions. According to UNEP, buildings contribute 30% of all GHGs and consume 40% of energy globally. Another study by the Rockefeller Foundation puts the benefits for scaling buildings retrofits at mitigating more than 600 million metric tons of CO2, which was 10% of U.S. emissions in 2010. The report also estimates that the retrofits could create more than 3.3 million new direct and indirect cumulative job years in the U.S. economy.
These small and medium-sized enterprises and climate projects can have a multiplying effect in improving social and environmental issues. Using the market for financing is the key to unlocking these possibilities and deserves thorough review to uncover potential areas to invest. Of course, the majority of investments have some level of risk and may not realize as high a rate of return as more traditional investments in the short term, but these go beyond the confines of short-term investing and instead look to the long-term wellbeing of people and the planet. Utilizing the financial market to address problems such as climate change, poverty alleviation, and sustainable development moves away from, but does not act to replace more traditional efforts such as national and international policies, multilateral programs, or NGO initiatives. However, the inclusion of more long-term and sustainability focused financing options to investors can reach companies and projects that these traditional sources have not yet been able to support adequately due to a combination of lack of funding, reach, or just hasn’t fit into the framework yet. There is a valuable role for finance to play in environmental and social issues, the role just needs to be explored, developed, and supported to realize potential.
For more information on impact investing check out the Global Impact Investing Rating System GIIRS. GIIRS was developed by the NGO B Lab and is opening the door to more effective and efficient impact investing. If you are interested in exploring sustainable and socially responsible investing, which some say impact investing actually falls underneath, The Forum for Sustainable and Responsible Investment (USSIF) has great introductory resources as well.