Impact financing: Finding the sweet spots

Ambitious rhetoric → credible action → real-world impact

The events of the past year have drawn attention to the fact that many of the world's major challenges – whether social, environmental, ecological or economic – are in urgent need of funding and focus if they are to be addressed at the scale and pace required during this Decade of Action.

There was no shortage of ambitious net-zero climate targets pledged in the latter stages of 2021. During the COP26 climate conference, over 450 financial sector signatories (GFANZ), who collectively represent US$130 trillion of assets under management (AUM), committed to delivering net zero across their portfolios by 2050 as well as to providing the estimated $100 trillion of finance necessary to create a net zero economy over the next three decades¹.

“Each different part of the private debt market creates investment opportunities in a different way.” 
 

As calls to turn rhetoric into meaningful and credible action intensify, private and public sectors must work together to drive immediate action and finance many of the innovative investment solutions needed to achieve key climate and sustainability goals. The opportunities to invest in market-based solutions and assets that can deliver tangible, real-world environmental and social impact will only stand to grow, in our view. Further, we believe investors that are considering the environmental and social impact of their portfolios should look to private markets to potentially drive and deliver impact in 2022.

Sourcing impact financing opportunities

Together with having a robust proprietary impact criteria and framework with which to analyse and select the most impactful opportunities for private debt impact portfolios, having sufficient origination capabilities is also integral to asset sourcing and creation in private markets. 

Each different part of the private debt market creates investment opportunities in a different way. We source impact assets across a wide opportunity set to ensure we are investing in those areas of the market that are offering good value, while seeking to maintain fundamental credit quality. Through our global original channels and relationship networks, we have been finding a number of potential opportunities to finance impact assets in ‘non-core’ markets. These assets are higher credit quality, and are often backed by significant equity capital commitments in the capital structure, including from reputed government and quasi-government counterparties in some cases – thereby potentially providing additional security and credit enhancement for senior lenders or noteholders. 

Key focus areas for impact financing

In view of the impact investments we have already made over the past 12 months or so, and the nature and focus of the impact opportunities in the early-stage pipeline, we have identified some areas and themes where we are seeing particularly interesting opportunities proliferate. 

Social inclusion: A good mix of social impact opportunities continue to come through the pipeline, focusing on primary impact themes of economic (financial) inclusion, health and social services and social and affordable housing. One recent example included a transaction involving senior debt financing to an Indian-based financing platform which provides financing to non-bank financial companies (NBFCs) which on-lend to underserved consumers, corporates and SMEs. 

The economic imbalances triggered by the pandemic and uneven economic recovery that has followed have bolstered the need for, and supply of, these assets, with many social issues amplified and their importance brought to the fore. We believe impact investors are well placed to provide the necessary capital at the scale required to finance investments seeking to address myriad of social inequalities, reduce poverty, and break down barriers to economic opportunities.

Climate solutions: As the need to start delivering on climate change and wider sustainability goals – with credible (and increasingly, science-based) interim targets drawn up along the way – grows, we believe this could lead to a proliferation of environmental impact assets requiring financing over the medium term. In the UK alone, it is estimated by the Climate Change Committee that £1.4 trillion of green investments will be needed between 2020 and 2050 to meet the 2050 net zero target. Undeniably, the transition to low carbon, and ultimately net zero, economies will require significant investment in renewable energy generation capacity and energy efficiency technologies – given the vast majority of global CO2 emissions come from the energy sector. 

• Renewables and alternative energy sources: We are looking at several potential investments financing renewable energy projects, including an opportunity to provide financing for the construction and aggregation of a portfolio of small-to-medium-scale solar assets in Latin America. The financing would help to support the transition of the energy supply sector into renewables and, at the same time, support the phase-out of coal-derived energy.

The range of investable impact solutions that seek to address climate change (mitigation, adaptation, resilience) is nevertheless varied and evolving, spanning multiple sectors and industries.

Circular economy: As noted in the recently-published M&G SDG Reckoning Report, wastefulness has become increasingly problematic in the wake of the pandemic, with a shocking spike in single-use plastic – emphasising an urgent need to shift to a circular global economy, moving away from the current wasteful and linear model. 

• Waste-to-energy (WtE): The generation and management of waste are rapidly growing global challenges that are closely linked to other environmental concerns including resource depletion and climate change – and we have seen a number of impact assets coming through focusing on these themes. There is recognition that modern WtE facilities, which power and heat homes from waste generated by society, can help the transition to a more resource-efficient and circular economy, and support broader net-zero ambitions. 

Biodiversity: We were recently presented with a potentially interesting financing opportunity under the primary impact theme of ‘Sustainable food, agriculture and forestry’, according to our thematic impact eligibility criteria – providing senior debt financing to a large New Zealand-based agricultural business committed to producing food using sustainable and environmentally-friendly practices. 

Awareness around biodiversity loss has moved up the agenda in the past 18 months or so – with the world waking up to the stark reality of nature and habitat loss, and the repercussions this has on the ecosystems that provide the foundations for human wellbeing and a stable climate. According to research, nature-based solutions can provide over one-third of the cost-effective climate mitigation needed between now and 2030². Momentum also looks set to ramp up this year and new global targets for nature are expected to be set at the second leg of the UN biodiversity summit, COP15, hosted in China in May 2022. 

Diverse portfolios of impact opportunities

Looking ahead, we believe private markets, in particular, could hold the key to many of the investment opportunities needed to drive tangible, real-world impact – and potentially offer higher risk-adjusted returns to investors. The opportunity in the asset class alongside the ‘pure play’ and targeted nature of private debt could help investors achieve their impact goals, as many investors increasingly consider the environmental and social impact of their portfolios.

¹ Glasgow Financial Alliance for Net Zero (GFANZ), “Amount of finance committed to achieving 1.5°C now at scale needed to deliver the transition.”, 3 November 2021.

² UN Global Compact, “Nature-Based Solutions to Address Climate Change”. 

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.