(October 11, 2013) — Large investors who believe in financing projects “for good” should try to energise others to allocate capital by taking on a quasi-guarantor role, a leading association in this field has said.
The Global Impact Investing Network (GIIN) has set out a range of options that these large investors could choose to protect smaller partners who might have less experience in the field.
These catalytic first-loss capital (CFLC) strategies should encourage higher levels of investment to projects, lay groundwork for more money to flow to sectors that have been neglected by investors, and help improve terms at which those receiving funds can access them.
“CFLC is best defined by three identifying features,” GIIN advised in a report published this week. “It identifies the party, (i.e., the provider) that will bear first losses. The amount of loss covered is typically set and agreed upon upfront. It is catalytic. By improving the recipient’s risk-return profile, CFLC catalyses the participation of investors that otherwise would not have participated. It is purpose driven. CFLC aims to channel commercial capital towards the achievement of certain social and/or environmental outcomes. In addition, often—though not always—the purpose can be to demonstrate the commercial viability of investing into a new market.”
The report includes case studies of recent projects by large investors, including one in Australia in which the main investor (named the provider), the national government’s Social Enterprise Development and Investment Fund, created a framework to protect the Christian Super pension (the receiver) in its allocation.
“Both the provider and the recipient believed in the commercial viability of the underlying market. But the recipient is a pension fund—with attendant fiduciary constraints—and so, given the limited track record in the market, the protection was necessary for investment committee approval,” the report said. “Further, both parties hope that, via strong performance, they can demonstrate market viability to other potential investors.”
“Values alignment is critical when using first-loss capital, because you’re locking yourselves together for years,” the report noted in a quote from Christian Super CIO Tim Macready.
There has been a notable shift towards sustainability, with more than 11% of all US assets—$3.74 trillion—now invested in socially-responsible investing and environmental, social and governance strategies, according to the Commonfund Institute.
To download the GIIN paper, click here.
Related content: When ESG Means Alpha & Can Pension Funds Do Without Sin?