Sustainable investing – can impact be feasibly measured?

Nick: Welcome to ‘The Angle” from T. Rowe Price. ─ shaper insights on the forces shaping financial markets begin here. In this inaugural season of ‘the angle’ we're diving into the world of the blue economy. I'm Nick Truman and I'm your host as we learn more about this intriguing and rapidly evolving area of the economy and financial markets.

In other episodes in the series, we focused on the importance of the world's water resources for economic development and the threats they're facing. We've also discussed how innovations in finance are working to support sustainable development efforts in the blue economy. Today, we're going to build on the discussion around sustainable investing. In particular, we're asking how feasible is it to measure impact in sustainable investing and how can we tell if the targets of sustainable investing are meeting their sustainability objectives over time?

Joining us for this discussion are two experts in impact investing and sustainability, Matt Lawton and Tongai Kunorubwe. Matt is an Impact Fixed income portfolio manager and Tongai leads on sustainability in Fixed Income at T Rowe Price Associates.

Welcome Matt and Tongai.

Matt: Thanks, Nick. Happy to be here.

Tongai: Looking forward to the discussion.

Nick: Well, gentlemen, perhaps we should start with some definitions of key terms for our listeners. Matt, what is impact investing? And once we've got our definition, we can then move on to how impact can be measured.

Matt: Sure. Thanks, Nick. So just to provide a level setting definition. Impact investing refers to investments that are undertaken with the intentionality that they will generate both financial return and measurable environmental or social impact, and that those two objectives sit in equal priority to each other.

Nick: Okay. Tell me more about the financial and the non-financial. It's interesting to see that you've split those two.

Matt: If I just double click on that impact objective, there are two things to keep in mind. One is the focus on external impact or the real-world outcomes that an issuer or project are helping to deliver. And second is measurability. So, investments would typically carry a non-financial key performance indicator or KPI, such as greenhouse gas emissions avoided from renewable energy generation or number of jobs created from microfinance lending, for example.

When measuring impact of an investment, the objective is to ascertain whether that impact is authentic, and also the project can deliver the positive outcome that it is striving to achieve. One channel for pursuing potential impact in public fixed income are ESG labeled bonds. So, these could be green, social, or sustainability bonds, which are debt instruments where an issuer can raise capital to finance discrete environmental and/or social projects that in turn can hopefully help yield positive, measurable impact outcomes. It's important to evaluate before investing if the project is credible and seeks to achieve additionality. For those not familiar with the concept of additionality, this refers to efforts that help generate positive impact or a positive outcome that otherwise would not have occurred without additional resources or capital investment

So, an example here could be the number of social housing units that would not have been financed or cubic meters of water that would not have been saved, among other examples. Aside from all of these issues that are considered upfront, it's also critical throughout the lifecycle of a bond transaction to continue monitoring and measuring impact in order to identify whether the issuer or company is indeed delivering on their intended sustainable objectives.

Nick: Okay. So, a bond with a label is linked to a particular sustainability project or goal. For example, a green bond is linked to the green economy and a blue bond is linked to the blue economy. Does having a sustainable bond label ensure that a bond is authentic and seeks to achieve a positive impact Tongai?

Tongai: So, Nick, thank you. It's a very good question. A label gives no guarantee about the quality and authenticity of a bond. It is worth noting that in instances sustainable labeled debt can be self-labeled by the issuer itself, of course, having taken advice from underwriting banks and advisors.

Now it's also important to remember there is no global compulsory standards for issuing debt with the label. Although most companies typically follow the International Capital Market Association or ICMA for short ─ guidelines for issuing, such as the Green Bond, or the Social Bond Principles.

There is certainly room for different interpretations by companies. Just to be clear, ICMA, is a self- regulatory organization which represents financial institutions globally.

Now, explicitly, whilst green, social, or sustainable bond frameworks typically list target allocation categories, these are non-exhaustive Nick. And these frameworks, to be clear, are not legally binding in the strictest sense of the word. Hence the need arguably for more detailed diligence. That's why it's important to evaluate the credentials and measure the impact of bonds which carry a label, such as Blue, which are used exclusively for funding, refinancing, ocean friendly and other clean water projects.

The key to unlocking the potential for the blue economy is a credible and functioning blue bond market. Measuring impact is arguably paramount to that.

Nick: Tongai, can you provide more detail on what is involved in measuring the impact of a blue bond?

Tongai: Yeah, absolutely. So just building on the previous question you asked. Blue bonds do require additional rigor and analysis. There are four key areas that are important to consider when measuring the authenticity and impact of a blue bond. And I'll go through these. First, the issuer’s sustainable investing profile. It is important here to examine the company or issuers overall sustainability profile, whilst assessing future ESG targets and their credibility.

Nick: Just to jump in there, Tongai. Tell us a little more about the sustainable investing profile.

Tongai: Okay. Nick. So that's a very important intervention on your part. If you step back and think about it, we have to have compatibility with the issuer's overall strategy and sustainability position and the actual bond they are looking to bring to market. Now, oversimplifying to make the case, it would be very strange to have an issuer where the water intensity metrics or some of the controversies that are tracked by the industry, for example, around ocean health, are at quite material or are coming out quite materially different to what they are claiming to be doing within the bond itself.

And that's the point we are making with this first point around the harmony of the issuer evaluation, its strategy, and the actual bond that they are bringing to market. I hope that helps.

Nick: That certainly does. Thanks, Tongai. Back to the four areas, I think you were about to tell us about the second area.

Tongai: Yeah. Second, alignment with industry standards. It is important to examine the alignment with industry standards and current best practice Nick, including recent guidance provided quite helpfully, again by ICMA on issuing blue themed bonds.

Third, bond credibility, and here it's important to step back and examine the credibility and ambition of the issuers financed project, as well as evaluate how proceeds will be managed throughout the life of the bond.

And fourth. But certainly, by no means last or least ─ post issuance reporting is quite important, Nick. It's important to examine the issuers post issuance reporting, for example, is the issuer providing sufficient allocation and impact reporting in its reporting?

Nick: Matt, Tongai has outlined these four areas, which are important to the evaluation process of a blue bond. Can you really demonstrate additionality and/or impact through these investments? Maybe just to dive in, give us some examples.

Matt: Sure, Nick. It's a good and important question because it is really important to be able to substantiate potential impact. For investments that focus on the blue economy one could argue there is both an opportunity to capture that real world impact and also be able to evidence it through robust measurement.

Within credit impact investing, labeled bonds, such as blue bonds, may specify the use of proceeds at the outset. So, what that means is the capital that’s being raised, how it’s being designated to particular environmental or blue projects. Measuring the impact outcomes are of course important as we've discussed, but analysis need not stop there.

Engaging and working with companies is also important and this process can help guide, strengthen, or accelerate their impact progress or their impact journey. It can be particularly useful for investors and capital market participants to provide guidance or views on impact or labeled bond frameworks and standards or key performance indicators, in an effort to push for acceleration toward an existing indicator or target. Although, of course, it's never guaranteed, one could argue that seeking alignment between investor and issuer can offer a higher probability of success. In this case, success defined as outcomes that are material, measurable, and additional.

At the same time, issuers and investors can work together to improve collective market wide standards and practices. And I think, this this last point on standards and practices, is particularly important for blue bonds, given the market is still in its infancy.

Nick: Just to go a bit deeper there, I mean, blue bonds are very new Matt. And I often hear about the challenges of data availability when seeking to measure impact. So, what's the data availability like? How much is qualitative versus quantitative? Perhaps, let's go into a bit more detail there, please.

Matt: Sure. Although, data to measure impact today certainly remains challenging and incomplete in some instances. We are seeing coalescence around what the market would consider to be best practices. One useful tool for measurement is ICMA's harmonized framework for impact reporting that details core impact indicators to specific projects. For example, a project that's focused on sustainable water and wastewater management, a core indicator here would be cubic meters of water saved. If it's a project like living natural resources and land use projects, an indicator could be increased percentage in certified sustainable fisheries. Or, if it's a project focused on biodiversity, square kilometers of safeguarded coastline could be a useful indicator.

Also, IFC or International Finance Corporation recently published guidelines for Blue Finance, and that provides a comprehensive list of eligible blue project categories that could fit within in the description of a blue bond.

And lastly, we recently saw a document which was the practitioners guide on bonds to finance the sustainable Blue Economy. This was a piece that was collaboratively written by IFC, Asian Development Bank., ICMA, and the U.N. to guide prospective issuers, investors, and underwriters on blue bond transactions. Even as these standards are increasingly understood and digested by capital market participants, we still expect engagement to play a role. Again, directly engaging with issuers to help verify the blue projects, whether they meet the standards for materiality, measurability and additionality should also be considered.

Nick: So Matt, does this demonstration of impact really address some of the skepticism that we hear around sustainable investing?

Matt: Sure, Nick. We certainly appreciate and are aware that there is some skepticism around ESG. Issues like corporate behavior, financial product labeling, and greenwashing are just some of those issues driving that skepticism. It's important to remember that impact is distinct from the more generic description that is ESG. Such that impact is uniquely focused on outcomes and not just outcomes, but measurable outcomes.

So, in that sense, some might consider impact to be really the purest expression of investing within the broadly defined sustainability space.

Nick: As you think about where the market is today from an impact measurement perspective and how new it is, but how far we've come in a short period of time, what excites you as you look forward? Tongai, let's start with you.

Tongai: Yeah, absolutely, Nick. So, I think a couple of things are quite exciting here. I think it's important to recognize the increased level of enthusiasm from both investors and issuers to help solve for some of the critical environmental issues that we're facing together. You take that enthusiasm and accompany it with a much better understanding and clarity on what a quote unquote, “credible impact bond” looks like and I'm very hopeful we'll see standards continue to elevate. And that's very encouraging for the wider group of stakeholders, whether it's asset owners, investors, issuers, and importantly, the environment. So, to summarize, the excitement really has a lot to do with the potential to positively influence real world outcomes in these arguably mission critical areas for us all around clean healthy oceans and drinking water respectively.

Nick: Matt, perhaps I can bring you in here.

Matt: Certainly, we all understand and appreciate that the blue bond market is still very much in its infancy, but there's also a lot of things to be excited about; standards, data availability, data accuracy, all improving as well as overall capital market awareness of the blue economy. And I think you couple that with the need for scaled investments into the blue economy in helping to solve for some of these critical environmental issues.

Nick: That brings an end to today's discussion. Thank you, Tongai, and Matt for your time today.

Tongai: Thanks, Nick, and thank you to your listeners as well. It's been a pleasure to be here.

Matt: A great discussion everyone, thanks for having us on today.

Nick: Tongai and Matt helped us understand the importance of measuring impact and how to do it for blue bonds. Whilst there are many challenges ahead and a huge amount to do, there are some reasons for optimism. The key takeaways for me are that measuring impact is challenging complex, and time consuming but essential. For the blue economy to really develop it's critical to have a credible and functioning blue bond market.

And thank you for listening to the angle. You can find out more information on the blue economy on our website.

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