The Importance of Additionality in Impact Investing

Those of us embedded in the world of impact; sustainable; or environmental, social, and governance (ESG) investing know well how prolific it has been in coining terms and concepts to describe the array of principles it encompasses. In our experience, some of these are more useful than others. One that is becoming increasingly focal for impact investors is “additionality.”

Among the range of ESG approaches and strategies, impact purports to be the purest and carries the most ambitious aims, as reflected in its dual mandate—measurable positive environmental and social impact alongside financial return. In our view, such an approach requires a commitment to additionality. 

There are two channels for investors to create additionality: (1) capital, potentially at a lower relative cost to the issuer, and (2) influencing behavior through direct engagement with issuers. 

What is “additionality”?

In its standard sense, “additionality” refers to a positive impact or outcome that would not have otherwise occurred without additional resources or capital investment. For example, the social housing units that would not have been built or the greenhouse gas emission reductions not realized, among other outcomes.

Within credit impact investing, ESG‑labeled bonds often specify the use of proceeds at the outset, with the capital raised designated for a particular environmental or social purpose. This can create additionality, though in our view, the bar should be set high for labeled bonds, and more importantly, impact investing should not stop there.

Impact investing is characterized by its ongoing and evolving nature, and it should go beyond the measured outcome of investing capital and then capturing the economics and activities. This means engaging and working with companies to help guide, strengthen, or accelerate their impact progress or journey, striving toward the best possible impact outcomes. 

It can be particularly useful to provide guidance or views on impact or labeled bond frameworks and standards, on key performance indicators (KPIs), or to push for acceleration toward an existing indicator or target. This can result in better impact outcomes from an individual issuer while also improving collective, market‑wide standards and practices. 

A very good example of this arose in the recent past. Banco Santander Chile approached us for our views on a framework for an inaugural benchmark‑sized social bond. The aim of the bond sale would be to raise money to enable greater social equity in Chile by financing affordable housing mortgages, thereby promoting financial inclusion by providing families with access to credit at a subsidized interest rate. 

In giving our feedback and views on best practices, we highlighted potential to improve the refinancing lookback period, impact reporting disclosures, and views on future social bond issuance. In terms of disclosure recommendations, we recommended that reporting should include core social impact metrics related to affordable housing as defined by the International Capital Markets Association, as well as additional impact metric details on the target population for its mortgages.

Why is additionality important? 

As the example of Banco Santander Chile illustrates, the additionality that we would hope to achieve would be shaping the company’s social bond framework, which will then, in turn, help to foster social mobility, reduce poverty, and increase financial inclusion. Engaging on the refinancing lookback period and emphasizing the need for a more stringent approach could help establish a higher standard and baseline for future social project financing. 

Taking the question more broadly, we can go back to the key principles of impact investing, namely that the environmental and social pressure points facing the world have never been greater, but so, too, is the opportunity to invest in the companies at the forefront of addressing these challenges. 

As investment managers, we aim to promote and progress the global impact agenda through positive feedback loops that additionality through company engagements can help create. Where an engagement leads to some improved behavior and strengthened or enhanced ambition on the part of a company, this should have positive knock‑on effects, such as setting standards for sector or industry peers as well as other investors. Global ESG and impact investor networks are useful here.

 

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