We’re All About that G, ‘Bout that G – Part II

Blind Spots

A very good friend (and investor) likes to say “we all have blind spots.” While the context varies, it usually pops up the deeper we are discussing climate change or sustainable finance. There are many things we don’t know and sometimes, frankly, don’t want to know. And while the phrase is typically used toward the end of a particular thread, it’s about as good a starting point as any, particularly when we talk about Governance and any reporting framework.

As investors, the good news is that there is far more data reporting and requirements across multiple issues around sustainability. Further, more companies are working toward better and more accurate ways to collect and report data. A particularly good example is the impact investing space. There is a great effort to track whether what is intended is indeed what is achieved, and also the principles underpinning these objectives.[1] 

However, it is always more complex: there are usually also unintended consequences of actions that need to be understood and managed. For example, we have learnt that planting a forest without proper engagement with a community or on-the-ground scientists can result in negative outcomes, such as lost income or reduced biodiversity.[2] We would argue that you need expert scientists in any project involving biodiversity given the dynamism in any ecosystem and what can go wrong. Any impact assessment therefore needs to take into consideration the possibility that the project has flaws.[3] There is a case for us to consider regular reassessments of the project for potential unintended consequences (which we need to add may be positive or negative) and not simply report only what impact we are targeting. 

For good Governance, management therefore has to have the desire, skillsets and framework to assess consequences and pivot if necessary. For early-stage companies, this is pretty much always the case in any industry as entrepreneurs try to grow their businesses, adapt as needed and smaller is arguably easier to manage. Venture capital also sometimes favours entrepreneurs and their teams more than other factors in their decision making.[4] From an impact perspective, there is a history of venture investing with a community emphasis (such as in life sciences, medtech) and if we were to formalize and calculate this “impact”, there is a good chance that there is both financial and societal return. Anecdotally, we see more venture investors targeting measurable and verifiable impact.

For larger listed companies, understanding whether the objectives, skillsets and oversight are in place is much harder. Among the many questions would be what are the objectives and trade-offs? How is information gathered, assessed for bias and outcomes on more complex projects where there may be greater risk of unintended consequences? How are incentives set? We shall return to these themes in subsequent blogs but these factors are seldom captured in reporting requirements. And this means that, as investors, the results you want to achieve are not always achieved. For example, even when there are incentives, such as those proposed for sustainability-linked bonds and loans, new studies now show these instruments can lack credibility and have had little material impact.[5] Following a review of the sustainability-linked loans market, the UK Financial Conduct Authority has raised concerns over “greenwashing” and “conflicts of interest” and written to banks.[6]

In sum, despite structured reporting requirements with guidelines, the problems with sustainability-linked instruments provide important learning points. Regulations and requirements for data and strategy disclosure are a key part of the answer, but not the answer themselves. There can always be opportunities to “game the system.”

For investors, the risk is creating blind spots where the data is reported but masks what is, and is not, happening. We are beginning to wonder if we are spending too much time getting comfortable with reporting the data, than understanding what we have really learnt about how companies are acting.

[1] UN PRI and others.

[2] https://www.imperial.ac.uk/news/199473/qa-is-planting-trees-answer-climate/

[3] There is increasing recognition of this and frameworks being put together. See for example, https://www.sei.org/wp-content/uploads/2023/02/luci-tool-sei2023.011.pdf

[4] https://www.gsb.stanford.edu/insights/do-funders-care-more-about-your-team-your-idea-or-your-passion

[5] https://www.econstor.eu/bitstream/10419/268891/1/1837832250.pdf uses sustainability-linked loans data to show that the majority of loans fail to be credible instruments; and, https://documents1.worldbank.org/curated/en/099237410062223046/pdf/IDU0e099a50307f86045a80b33201d0b7057cedf.pdf demonstrate structural loopholes in sustainability-linked bonds.

[6] https://www.fca.org.uk/news/news-stories/fca-outlines-concerns-about-sustainability-linked-loans-market

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