is dominated by European asset managers such as UBS, Amundi, DWS, BNP Paribas, Swisscanto, Natixis, Nordea and Pictet. Two US managers, BlackRock and Vanguard, are in the top 10 due to their size in the ETF market. We also note the presence of two small US managers that have been leaders in responsible investing for 40 years (Parnassus and Calvert). As of December 2023, they managed $46.5 bn and $37.5 bn in total assets, respectively, with 85% and 93% in the Morningstar sustainable fund category. Table 4.12 also shows that the ranking is dominated by asset managers with a large passive management business. However, some purely active managers have also developed a sustainable fund business, such as Nordea, Pictet, Eurizon, Robeco and Vontobel. The big difference between Europe and the US is not only the size of the sustainable market, but also its structure. In Europe, the 20th largest asset manager has more than $27 billion in sustainable funds, compared to less than $3 billion in the US. The cumulative market share of the top 20 asset managers is 86.5% in the US, but only 56% in Europe (Figure 4.7). This means that many other asset managers have more than $10 billion in European sustainable funds, while they manage few assets in US sustainable funds. The US market for sustainable funds is therefore highly concentrated among a few players, whereas in Europe it is more atomistic. In other words, the sustainable fund business is a niche in the US, whereas it is mainstream in Europe.

<figure><img src="image_124.png" /><figcaption>Figure 4.7: Cumulative market share in % of the top 20 asset managers in the sustainable funds market</figcaption></figure>

Source: Morningstar (2024a) & Author's calculations.

The previous analysis can be complemented by another Morningstar analysis dedicated to climate funds (Morningstar, 2023). Again, Morningstar uses several criteria to identify this sub-category of sustainable funds, notably name and investment policy. They group them into five strategies: low carbon, climate transition, green bonds, climate solutions and clean technology. As of June 2023, they found 1407 climate-related open-end funds and ETFs, representing $534 billion or almost 20% of the global sustainable funds market. This market is again dominated by Europe (84% of assets),
<table><caption>Table 4.13: Largest climate funds (As of June 2023)</caption><thead><tr><th>Country</th><th>Name</th><th>Category</th><th>AUM ($ bn)</th></tr></thead><tbody><tr><td rowspan="10">Europe</td><td>ACS Climate Transition World Equity Fund</td><td>Climate Transition</td><td>12.8</td></tr><tr><td>iShares MSCI USA ESG Enhanced ETF</td><td>Climate Transition</td><td>12.2</td></tr><tr><td>Nordea 1 Global Climate and Environment Fund</td><td>Climate Solutions</td><td>10.8</td></tr><tr><td>Blackrock ACS World ESG Equity Tracker Fund</td><td>Low Carbon</td><td>10.2</td></tr><tr><td>Pictet Global Environmental Opportunities</td><td>Climate Solutions</td><td>8.4</td></tr><tr><td>Handelsbanken Global Index Criteria</td><td>Climate Transition</td><td>8.0</td></tr><tr><td>iShares Environment & Low Carbon Tilt Real Estate</td><td>Low Carbon</td><td>7.9</td></tr><tr><td>Blackrock ACS World Low Carbon Equity Tracker Fund</td><td>Low Carbon</td><td>7.5</td></tr><tr><td>BlackRock Sustainable Energy Fund</td><td>Clean Technology</td><td>7.3</td></tr><tr><td>Amundi MSCI USA SRI PAB</td><td>Climate Transition</td><td>6.3</td></tr><tr><td rowspan="11">United States</td><td>iShares Global Clean Energy ETF</td><td>Clean Technology</td><td>4.2</td></tr><tr><td>Impax Global Environmental Markets Fund</td><td>Climate Solutions</td><td>2.4</td></tr><tr><td>iShares Climate Conscious & Transition MSCI USA ETF</td><td>Climate Transition</td><td>2.2</td></tr><tr><td>Xtrackers MSCI USA Climate Action Equity ETF</td><td>Climate Transition</td><td>2.2</td></tr><tr><td>Invesco Solar ETF</td><td>Clean Technology</td><td>2.1</td></tr><tr><td>First Trust NASDAQ Clean Edge Green Energy Index Fund</td><td>Clean Technology</td><td>1.6</td></tr><tr><td>iShares Paris-Aligned Climate MSCI USA ETF</td><td>Climate Transition</td><td>1.5</td></tr><tr><td>BlackRock U.S. Carbon Transition Readiness ETF</td><td>Climate Transition</td><td>1.5</td></tr><tr><td>TIAA-CREF Social Choice Low Carbon Equity Fund</td><td>Low Carbon</td><td>1.2</td></tr><tr><td>GMO Climate Change Fund</td><td>Clean Technology</td><td>1.0</td></tr><tr><td rowspan="10">China</td><td>Orient Secs Green Energy Car Alloc</td><td>Climate Solutions</td><td>2.3</td></tr><tr><td>Huatai-PB CSI Photovoltaic Industry ETF</td><td>Clean Technology</td><td>2.3</td></tr><tr><td>ABC-CA New Energy Theme Hybrid Fund</td><td>Clean Technology</td><td>2.1</td></tr><tr><td>ChinaAMC New Energy Fund</td><td>Clean Technology</td><td>2.0</td></tr><tr><td>TianHong CSI Photovoltaic Industry Idx</td><td>Clean Technology</td><td>1.9</td></tr><tr><td>China Universal New Eneg Car Ind Index LOF</td><td>Climate Solutions</td><td>1.9</td></tr><tr><td>ChinaAMC CSI New En Car Ind ETF</td><td>Climate Solutions</td><td>1.6</td></tr><tr><td>Fullgoal China Secs New Energy Vehicles</td><td>Climate Solutions</td><td>1.5</td></tr><tr><td>Cinda New Energy Ind Stk Fd</td><td>Clean Technology</td><td>1.3</td></tr><tr><td>E Fund Pro-Environment Alloc</td><td>Clean Technology</td><td>1.1</td></tr><tr><td>Japan</td><td>iShares MSCI Japan Climate Action ETF</td><td>Climate Transition</td><td>0.818</td></tr><tr><td>Taiwan</td><td>Cathay Global Autonomous and Electric Vehicles ETF</td><td>Climate Solutions</td><td>0.808</td></tr><tr><td>Australia</td><td>Russell Investments Low Carbon Global Shares Fund</td><td>Low Carbon</td><td>0.611</td></tr><tr><td>Australia</td><td>Russell Invest. Low Carbon Global Shares Fund AUDH</td><td>Low Carbon</td><td>0.559</td></tr><tr><td>Canada</td><td>Fidelity Climate Leadership Fund</td><td>Climate Transition</td><td>0.400</td></tr><tr><td>Canada</td><td>Desjardins SocieTerra Cleantech Fund</td><td>Clean Technology</td><td>0.340</td></tr><tr><td>Australia</td><td>State Street Climate ESG International Equity Fund</td><td>Low Carbon</td><td>0.243</td></tr><tr><td>South Korea</td><td>NH-Amundi Century Enterprise Green Korea Equity</td><td>Climate Solutions</td><td>0.240</td></tr><tr><td>Japan</td><td>NZAM ETF S&amp;P/JPX Carbon Efficient Index</td><td>Low Carbon</td><td>0.236</td></tr><tr><td>Australia</td><td>SPDRÂð S&amp;P World ex Australia Carbon Control Fund</td><td>Low Carbon</td><td>0.217</td></tr></tbody></table>

Source: Morningstar (2023, Exhibits 14, 19, 24 & 30, pages 17, 23, 27 & 32).

followed by China (8.5%), the US (5.9%), Australia (0.5%), Canada (0.5%), South Korea (0.3%), Taiwan (0.3%) and Japan (0.2%). The largest climate funds by region are reported in Table 4.13. It is worth noting that Europe is more focused on low-carbon and climate transition strategies, while China is more focused on climate solutions and clean technology strategies, and the US is more focused on climate transition and clean technology strategies. Morningstar (2023, page 11) found the following asset class breakdown: 82.4% in equity funds, 12% in bond funds and 5.1% in multi-asset funds. Another interesting result is the large share of climate transition ETFs in Europe, which is due to the popularity of CTB/PAB benchmarks (Morningstar, 2023, page 18).
## 4.2 Green and social bonds

Alongside traditional investment vehicles that incorporate ESG criteria, we can find a category of securities that is entirely dedicated to sustainable finance. These are specific sustainable debt instruments. The two best known assets are green bonds and social bonds, but the list of sustainable fixed-income assets is much longer: sustainable bonds, transition bonds, sustainable-linked bonds, green loans, green notes, green ABCP notes, etc. Table 4.14 shows the segmentation of the sustainable bond market. According to CBI (2024c), the cumulative total GSS+ issuance stands at $5.5 tn at the end of 2023, of which $4.4 tn (80%) was found to be aligned. About 99% comes from GSS assets (Figure 4.8). The breakdown is as follows: 65% for green bonds, 18% for social bonds and 17% for sustainability bonds. The market is dominated by DM issuers (about 60%), with the remainder being two-thirds EM and one-third supranational.

<table><caption>Table 4.14: Sustainable fixed-income market</caption><thead><tr><th>Theme</th><th>Label</th><th>Format</th></tr></thead><tbody><tr><td rowspan="3">GSS+</td><td>Green</td><td>Use of proceeds</td></tr><tr><td>Social</td><td>Use of proceeds</td></tr><tr><td>Sustainability</td><td>Use of proceeds</td></tr><tr><td rowspan="2">Transition</td><td>Sustainability-Linked</td><td>Entity KPI-linked</td></tr><tr><td>Transition</td><td>Use of proceeds</td></tr></tbody></table>

Source: CBI (2024c).

<figure><img src="image_125.png" /><figcaption>Figure 4.8: Issuance of GSS securities (in $ bn)</figcaption></figure>

Source: https://www.climatebonds.net/market/data.
4.2.1 Green bonds

Definition

Green bonds are fixed-income securities that finance investments with an environmental objective. They differ from regular bonds in that they are labeled green by the issuer or an external third party, and there is a commitment to use the proceeds to finance green projects. However, there is no legally binding definition of a green bond. Most of market participants<fnref n="23" /> have then adopted the definition of the GBP framework<fnref n="24" />:

"Green bonds are any type of bond instrument where the proceeds or an equivalent amount will be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible green projects and which are aligned with the four core components of the Green Bond Principles (GBP)." (ICMA, 2021a, page 3).

The four core components of the GBP are:

1. Use of proceeds

2. Process for project evaluation and selection

3. Management of proceeds

4. Reporting

The use of proceeds (or funds) should be directed to eligible green projects, e.g., renewable energy, energy efficiency, pollution prevention (greenhouse gas control, soil remediation, waste recycling), sustainable management of living natural resources (sustainable agriculture, sustainable forestry, restoration of natural landscapes), conservation of terrestrial and aquatic biodiversity (protection of coastal, marine and watershed environments), clean transport, sustainable water management, climate change adaptation, circular economy and eco-efficient products, green buildings. With respect to the project evaluation and selection process, the green bond issuer should clearly communicate the environmental sustainability objectives, the eligible projects and the related eligibility criteria. The third component deals with the management of the proceeds and includes the tracking of the "balance sheet" and the allocation of funds<fnref n="25" />. It also recommends an external audit by a third party. Finally, reporting must be based on the following pillars: transparency, description of projects, amounts allocated and expected impacts, qualitative performance indicators and quantitative performance measures<fnref n="26" />.

**Remark 44** The GBP is not the only framework for green bonds. The other popular guidelines are:

* China Green Bond Principles<fnref n="27" /> (PBOC, CBIRC, July 2022)

* Climate Bonds Standard<fnref n="28" /> (CBI, 2019)

* ASEAN Green Bond Standards<fnref n="29" /> (ACMF, 2018)

<footnote n="23">²³According to IFC (2020, page 5), the Green Bond Principles are supported by 95% of issuers.</footnote>

<footnote n="24">²⁴The first version of the Green Bond Principles was published in January 2014.</footnote>

<footnote n="25">²⁵Proceeds should be credited to a sub-account.</footnote>

<footnote n="26">²⁶Here are some examples: energy capacity, electricity generation, GHG emissions reduced/avoided, number of people given access to clean power, decrease in water use, reduction in the number of cars required, etc.</footnote>

<footnote n="27">²⁷They replace China's Green Bond Standards published by PBOC in 2015.</footnote>

<footnote n="28">²⁸The first version is released in November 2011. A new version has been published in February 2024 (CBI, 2024a).</footnote>

<footnote n="29">²⁹The first version is published in 2017.</footnote>
• EU Green Bond Standard<fnref n="30" />

All these guidelines are based on a common framework and are closed to the GBP. The CBI approach, which also uses the GBP, is perhaps more comprehensive and provides more detail on how to issue a green bond<fnref n="31" />.

Green debt instruments can be issued in different formats. They differ in terms of collateral, recourse process in case of default, etc. For instance, the most common instrument is the green regular or “Use of Proceeds” bond (UoP bond), which has the same credit rating as a conventional bond, because bondholders have recourse to all the assets of the bond issuer. In the case of a green revenue bond, the collateral for the debt comes from the cash flows of the revenue streams collected by the issuer. A green project bond is a bond dedicated to a specific green project, meaning that the recourse process only affects the assets associated with the project. Green loans are loans that finance green projects and can be secured or unsecured. These four instruments (regular bond, revenue bond, project bond and green loan) are called asset-linked bond structures because they are linked to a specific asset/project. Asset-backed bond structures consist of securitization and covered bonds. Both involve a group of projects. Securitized bonds can use ABS/MBS/CLO/CDO securitization structures, while covered bonds are German debt instruments (Pfandbriefe) that use a dual recourse process based on the issuer and the cover pool<fnref n="32" />.

The certification process (or external review) is an important step in the issuance of green bonds, as it is related to the issue of greenwashing. We recall that the GBP are voluntary process guidelines. They recommend that issuers engage an external review provider to obtain a pre-issuance assessment of the green project and an external auditor to obtain a post-issuance validation of the funding management. Certainly, the most popular form of external review is the second party opinion or SPO (IFC, 2020, page 19). In this case, the issuer's objective is to obtain a "green bond label" or the approval of its green project by a competent and independent body that is recognized by financial markets and investors. For instance, Ehlers and Packer (2017) and IFC (2020) list the following forms of green bond certification<fnref n="33" />:

* Second party opinion from ESG rating agencies (ISS, Sustainalytics, Vigeo-Eiris);

* Certification by green bond specialists (CBI, CICERO, DNV);

* Green bond assessment by statistical rating agencies (Moody's, S&P).

## Some examples

The climate-related bond market began in 2001 with the issuance of a revenue bond (known as the solar bond) by the City of San Francisco. The goal was to finance 140 acres of solar panels that could power homes and commercial buildings with renewable energy. A second step was reached in 2007 when the European Investment Bank (EIB) issued the world's first Climate Awareness Bond (CAB) to finance renewable energy and energy efficiency projects. Finally, in 2008, the World Bank and the

<footnote n="30">³⁰The proposal for a regulation on European green bonds has been released in 2021. It is based on four key requirements: (1) taxonomy-alignment; (2) transparency on how the bond proceeds are allocated through detailed reporting requirements; (3) all European green bonds must be checked by an external reviewer; (4) external reviewers must be supervised by the ESMA.</footnote>

<footnote n="31">³¹See also the Green Bond Handbook published by IFC (2020).</footnote>

<footnote n="32">³²Investors may have recourse to the issuer, but if the issuer is unable to pay its debt, then bondholders gain recourse to the cover pool.</footnote>

<footnote n="33">³³Ehlers and Packer (2017) added green bond indexes as a fourth form of certification, as inclusion in a green bond index is a market recognition that the bond is green.</footnote>
Swedish bank SEB created the first green bond for a group of Scandinavian institutional investors. Since then, the green bond market has grown rapidly. The amount issued has increased from less than $3 bn in 2013 to more than $700 bn in 2023. According to Baker et al. (2022), 2013 and 2014 marked the development of the green bond market. For instance, the first corporate green bonds were issued by the French utility EDF ($1.8 bn) and the Swedish real estate company Vasakronan ($120 bn). Toyota launched the automobile industry's first asset-backed green bond in 2014 ($1.75 bn), while the Commonwealth of Massachusetts successfully completed the first municipal green bond in 2013 ($100 mn). The development of sovereign green bonds begins with the issuance of Poland in December 2016 ($1 bn) and France^34 in January 2017 ($10 bn).

According to CBI (2022), the largest corporate issuers in 2021 were China Three Gorges ($7.2 bn), Iberdrola ($3.3 bn), CTP ($3 bn), Ardagh ($2.8 bn), Engie ($2.6 bn), Ford Motor ($2.5 bn), EDP ($2.4 bn), State Grid Corporation of China ($2.4 bn), Mondelez International ($2.4 bn) and Liberty Global ($2.3 bn). In 2022, the largest corporate issuer was again China Three Gorges ($5.1 bn), followed by Orsted ($4 bn), Iberdrola ($3.1 bn), Honda Motor ($2.8 bn), Volkswagen ($2.6 bn), E.ON ($2.6 bn), EDP ($2.4 bn), General Motors ($2.3 bn), RWE ($2.1 bn) and Huaneng Lancang River Hydropower ($2.3 bn). These figures lag far behind those of sovereign issuers and financial corporations. According to CBI (2023), the top three issuers in 2022 were the European Union ($26 bn), the EIB ($14.5 bn) and Germany ($14.3 bn).

**Remark 45** *Post-issuance management of a green bond can be an issue.* For example, the Mexico City Airport Trust issued $6 bn of green bonds in 2016 and 2017 to finance the construction of a new airport. It complied with ICMA GBP and received a second party opinion from Sustainalytics, as well as green bond assessments from rating agencies Moody's and S&P. However, in October 2018, the new Mexican government announced a halt to the construction of the airport and launched a buyback package capped at $1.8 bn.

## The green bond market

**Statistics** From 2007 to the first half of 2022, CBI estimate that a total of 10 800 green bonds have been issued in the world<fnref n="35" />. The geographic repartition is the following: 52% in North America, 23% in Europe, 17% in Asia-Pacific and 8% in the rest of the world (including supranational entities). The distribution of deal size is highly skewed. Indeed, 70% of green bonds have a notional less than $100 mn, whereas 3.2% of them have a deal size greater than $1 bn. If we focus on the number of issuers, we obtain the following top five ranking<fnref n="36" />: 500 in US, 404 in China, 156 in Japan, 104 in Sweden and 63 in Norway. If we analyze the amount issued, the size of the green bond market is roughly equal to $1.9 tn. In Figures 4.9 and 4.10, we have reported the issuance and notional outstanding (or cumulative issuance) by market type and region from 2014 to 2023. The market is lead by Europe (46%), followed by Asia-Pacific<fnref n="37" /> (25%) and North America (20%). The issuance of green bonds mainly concerns four sectors: energy, buildings, transport and water. They represent 88% of the market (Figure 4.11). An analysis by issuer type shows the market is approximately balanced between financials (development banks and financial corporates), government/sovereign issuers (including government-backed entities, local governments and states) and non-financial corporations (Figure 4.12).

<footnote n="34">³⁴Green OAT 1.75% 25 June 2039.</footnote>

<footnote n="35">³⁵This number is skewed because Fannie Mae has been a very frequent issuer of relatively small green MBS deals (less than $100 mn).</footnote>

<footnote n="36">³⁶The number of green bond issuers in France and Germany is respectively equal to 58 and 50.</footnote>

<footnote n="37">³⁷China represents more than 50% of the Asia-Pacific green bond market.</footnote>
<figure><img src="image_126.png" /><figcaption>Figure 4.10: Issuance and notional outstanding of green debt by region</figcaption></figure>

<figure><img src="image_127.png" /></figure>

Source: https://www.climatebonds.net/market/data.
<figure><img src="image_128.png" /><figcaption>Figure 4.12: Issuance and notional outstanding of green debt by issuer type</figcaption></figure>

<figure><img src="image_129.png" /></figure>

Source: https://www.climatebonds.net/market/data.
**How to invest in green bonds** There are several ways to invest in green bonds. We can consider a mutual fund (active management), an ETF (passive management) or a direct investment<fnref n="38" />. Here are some examples of active investment funds: Allianz IG green bond fund, Amundi RI impact green bonds, AXA WF ACT green bonds, BNP Paribas green bond, Calvert green bond fund, Mirova global green bond fund, TIAA-CREF green bond fund. In addition to these investment vehicles, institutional investors can also invest in some closed-end funds: Amundi planet emerging green one, Conservation fund green bonds, Foresight Italian green bond fund, etc. However, the largest investments in green bonds are made through passive management, particularly ETFs: Franklin Liberty green bond, iShares global green bond, Lyxor green bond, VanEck Vectors green bond, Xtrackers corporate green bond, etc. In this case, the ETF uses a green bond index such as:

* Bloomberg MSCI Global Green Bond Index (global green bonds)

* S&P Green Bond Index (global green bonds)

* Solactive Green Bond Index (global green bonds)

* ChinaBond China Climate-Aligned Bond Index (chinese green bonds)

* SSE Green Corporate Bond Index and SSE Green Bond Index (green bonds listed on the Shanghai Stock Exchange)

* ICE BofA Green Index (global green bonds)

**The economics of green bonds**

**Rationale for issuing green bonds** Green bonds are very different from ESG portfolios and funds because the objective is to finance a specific green project. Therefore, the decision to invest in a green bond goes beyond CSR or SRI values (Maltais and Nykvist, 2020). From an issuer's perspective, it is a signal and a visible confirmation of the company's participation in the green economy (Flammer, 2021; Daubanes et al., 2021). From an investor's perspective, it is a relatively easy way to implement an impact investing programme. In addition, green bonds are more climate-related than ESG-related assets. They are heavily involved in financing the climate transition. For example, the issuance of sovereign green bonds is generally presented as a response to climate change. Looking at the NextGenerationEU program of green bonds, the objective of the European Commission is to "achieve the goal of climate neutrality by 2050." Denmark issued its first green bond in January 2022 and the funds will be used to "support the production of renewable energy sources and the green transition of the transport sector." The success of the Republic of the Philippines is explained as the strong recognition and confidence of investors to "achieving sustainable development and mitigating climate change, notably the pledge to reduce our greenhouse gas emissions by 75% by 2030." Therefore, a green bond is a signaling tool to show that governments and companies are responding to climate change<fnref n="39" />. This is the main conclusion of Caroline Flammer's research:

> "I show that investors respond positively to the issuance announcement, a response that is stronger for first-time issuers and bonds certified by third parties. The issuers improve their environmental performance post-issuance (i.e., higher environmental ratings and lower CO2 emissions) and experience an increase in ownership by long-term and

<footnote n="38">³⁸Only the largest institutional investors have access to the primary market for green bonds. Nevertheless, they can trade green bonds in the secondary market.</footnote>

<footnote n="39">³⁹For example, we observe a high issuance activity just before and during the organization of a Conference of Parties (COP) to the UNFCCC.</footnote>
green investors. Overall, the findings are consistent with a signaling argument — by issuing green bonds, companies credibly signal their commitment toward the environment.”
(Flammer, 2021, page 499)

From an economic point of view, green bonds can be seen as a second-best instrument in the absence of a global carbon pricing scheme (carbon tax), which is the Pigovian solution to the carbon externality (Ehlers and Packer, 2017; Daubanes et al., 2021; Baker et al., 2022). From this perspective, green bonds are the answer to the question of net-zero financing:

> “Capital spending on physical assets for energy and land-use systems in the net-zero transition between 2021 and 2050 would amount to about $275 trillion, or $9.2 trillion per year on average, an annual increase of as much as $3.5 trillion from today” (McKinsey, 2022, page viii).

This figure of $3.5 trillion is roughly equal to 1/2 of global corporate profits, 1/4 of total tax revenues, or 4.1% of world GDP. Thus, the gap between current and expected green investment is huge. Of course, green bonds help finance the climate transition, but they are a partial solution representing less than $800 mn of investment. Therefore, the second-best instrument is not currently the solution to climate change.

The last observation raises the question of whether the green bond market is driven by supply or demand. If green bonds are a second-best solution, then we should see more supply. The problem is that there seems to be no economic incentive other than green signaling. In this case, the temptation is to conclude that the green bond market is driven by the demand for green assets. It is true that we observe systematic oversubscription when a green bond is issued. We have already seen that the issuance of the European Commission in October 2021 was oversubscribed 11 times. Such events are not uncommon. For example, the Italian green BTP in December 2020 was oversubscribed 9 times, the German green bond in September 2020 was oversubscribed more than 5 times, and so on. Due to this supply/demand imbalance, we could expect that green and conventional bonds from the same issuer to be priced differently, even if the green and conventional bonds have the same characteristics (same coupon, same maturity, same seniority, same payment schedule). In particular, we expect a large negative premium for the green bond relative to the conventional bond. Below, we will see that the difference is relatively low, which is a market anomaly. In Section 8.3 on page 750, we will learn that a global and fair carbon tax implies a strong distortion of economic profitability across companies and sectors. On the contrary, green bond policies have little impact, which means that green bonds are not really a second-best instrument. They help capture investment flows and finance the climate transition because of the huge demand from investors, but the cost of greening the economy remains relatively high because they have little impact on negative carbon externalities, adverse selection and moral hazard. In this context, the development of green bonds is disappointing if the goal is to fight climate change and drastically reduce carbon emissions. Nevertheless, the development of green bonds is also positive because it contributes to the emergence and diffusion of green sentiment (Brière and Ramelli, 2021).

**Estimation of the greenium** The green bond premium (or greenium) is the difference in pricing between green bonds and regular bonds. Financial theory tells us that the yield of a bond depends on its characteristics (maturity, cash flow schedule, coupon rate, seniority, liquidity), the term structure of interest rates and the default risk of the bond issuer (Roncalli, 2020a, pages 131-136). Therefore, if we compare the yield of a green bond with the yield of a regular bond issued by the same issuer, the difference should be zero if the two bonds have the same characteristics or if they are twin bonds
(Box 4.6). In practice, this is usually not the case. Mathematically, the greenium is defined as:

$$g = y(\text{GB}) - y(\text{CB}) \qquad (4.1)$$

where $y(\text{GB})$ is the yield (or return) of the green bond and $y(\text{CB})$ is the yield (or return) of the conventional twin bond$^{40}$. Let $s = y - y^*$ be the difference between the yield with default risk and the yield without default risk. Another expression for the greenium is:

$$ \begin{align} g &= s(\text{GB}) - s(\text{CB}) + \underbrace{y^*(\text{GB}) - y^*(\text{CB})}_{\approx 0} \nonumber \\ &\approx s(\text{GB}) - s(\text{CB}) \tag{4.2} \end{align} $$

So we can also define the greenium as the spread difference between the green bond and the conventional bond.

### Box 4.6: Green twin bonds

The twin bond concept was introduced by the Federal Republic of Germany in 2020. The idea is that investors in German green bonds can exchange their holdings for a conventional German government bond with the same maturity and coupon at any time, but not vice versa. The aim is to increase the marketability of green bonds and improve the liquidity of the green bond market. The ability to compare two bonds from the same issuer with an equivalent maturity and coupon provides a direct measure of the greenium.

<table><caption>Table 4.A: German twin bonds (as of December 2023)</caption><thead><tr><th>Bond</th><th>Maturity</th><th>Coupon</th><th>Outstanding</th><th>Isin</th></tr></thead><tbody><tr><td>2020 (2030) Bund</td><td>15/08/2030</td><td>0.00%</td><td>€9.50 bn</td><td>DE0001030708</td></tr><tr><td>Bobl</td><td>10/10/2025</td><td>0.00%</td><td>€8.50 bn</td><td>DE0001030716</td></tr><tr><td>2021 (2050) Bund</td><td>15/08/2050</td><td>0.00%</td><td>€11.00 bn</td><td>DE0001030724</td></tr><tr><td>2021 (2031) Bund</td><td>15/08/2031</td><td>0.00%</td><td>€9.00 bn</td><td>DE0001030732</td></tr><tr><td>Bobl</td><td>15/10/2027</td><td>1.30%</td><td>€9.00 bn</td><td>DE0001030740</td></tr><tr><td>2023 (2053) Bund</td><td>15/08/2053</td><td>1.80%</td><td>€6.50 bn</td><td>DE0001030757</td></tr><tr><td>2023 (2033) Bund</td><td>15/02/2033</td><td>2.30%</td><td>€7.25 bn</td><td>DE000BU3Z005</td></tr></tbody></table>

On 3 September 2020, the 10-year German green bond with a coupon of 0.00% was priced 1 basis point below the 10-year conventional German bond. On 19 January 2022, Denmark issued a 10-year green bond with the same maturity, interest payment dates and coupon rate as its 2031 conventional bond. The effective yield of the green bond was 5 basis points below the twin conventional bond. As of December 2023, Germany issued a total of 7 twins for a total amount of €60.75 billion.

**Remark 46** The concept of bond yield (or bond return) is relatively complex because there is no single way to calculate the financial return of a bond. We generally use the yield to maturity, but we can also use the credit spread if we prefer to measure excess return. Another popular measure is the current yield, which is the next coupon value divided by the current market price of the bond.

<footnote>$^{40}$This means that the conventional bond has the same characteristics as the green bond.</footnote>
Box 4.7: Bond pricing

We assume that the bond pays coupons C ( t$_{m}$ ) with fixing dates t$_{m}$ and the notional N (or the par/face value) at maturity date T . The cash flow scheme is reported in Figure 4.A. Knowing the yield curve, the price of the bond without default risk at time t satisfies the following relationship (Roncalli, 2020a, Equation 3.2):

$$
P_t + AC_t = \sum_{t_m \ge t} C(t_m) B_t(t_m) + N B_t(T)
$$

where B$_{t}$ ( t$_{m}$ ) is the discount factor at time t for the maturity date t$_{m}$ and AC$_{t}$ is the accrued coupon. P$_{t}$ + AC$_{t}$ is called the dirty price while P$_{t}$ refers to the clean price . The yield to maturity of the bond is the discount rate that gives its market price:

$$
\sum_{t_m \ge t} C(t_m) e^{-(t_m-t)y} + N e^{-(T-t)y} = P_t + AC_t
$$

<figure><img src="image_130.png" /><figcaption>Figure 4.A: Cash flows of a bond without default risk</figcaption></figure>

By introducing the credit risk of the issuer, the cash flows may be different because the issuer may default at the time τ < T (Figure 4.B). Roncalli (2020a, Equation 3.3) shows that:

$$
P_t + AC_t = \sum_{t_m \ge t} C(t_m) B_t(t_m) \mathbf{S}_t(t_m) + N B_t(T) \mathbf{S}_t(T) + \mathcal{R} N \int_t^T B_t(u) f_t(u) \, du
$$

where R is the recovery rate, S_t (u) is the survival function at time u and f_t (u) the associated density function. The yield to maturity of the defaultable bond is computed in exactly the same way as without default risk. The credit spread s = y − y* is then defined as the difference between the yield to maturity y with default risk and the yield to maturity y* without default risk.

<figure><img src="image_131.png" /><figcaption>Figure 4.B: Cash flows of a bond with default risk</figcaption></figure>
**Example 17** We consider a 10-year green bond $GB_1$ whose current price is 91.35. The corresponding conventional twin bond is a 20-year regular bond whose remaining maturity is exactly ten years and whose price is 90.07. We assume that the two bonds have the same coupon level$^{41}$, which is equal to 4%.

Let us consider Example 17. The computation of the yield to maturity$^{42}$ gives $y(GB) = 5\%$ and $y(CB) = 5.169\%$. We deduce that the greenium is equal to -16.9 bps. If we evaluate the bond return with the current yield, we have $y(GB) = 4/91.35 = 4.379\%$ and $y(CB) = 4/90.07 = 4.441\%$. In this case we get $g = -6.2$ bps. Note that the two measures are different even though the greenium is negative in both cases.

<figure><img src="image_132.png" /><figcaption>Figure 4.13: Greenium in bps of the German green bond (DBR 0% 15/08/2030)</figcaption></figure>

Source: Bloomberg (2024) & Author's calculations.

In the case of twin bonds, we can easily calculate the greenium since the green and regular bonds have exactly the same characteristics and are issued on the same date. In Figure 4.13, we show the dynamics of the greenium for the German Bund 0% 15/08/2030. This analysis comes from the research study by Pástor et al. (2022). We observe that the greenium is always almost negative since the inception date (08/09/2020). On average, the greenium is equal to -3.12 bps. Its range is between -7 and +1 bps. Another illustration of the greenium is provided by Zerbib (2019), who analyzed the perpetual 5.5 year callable green hybrid bond issued by Iberdrola on 14 November 2017:

<footnote>$^{41}$This assumption is not realistic because the regular bond was issued 10 years before the green bond. In this case, we expect that the coupon of the regular bond was different than the coupon of the green bond.</footnote>

<footnote>$^{42}$We solve the equation $\sum_{t=1}^{10} 4e^{-ty} + 100e^{-10y} = P$ where $P = 91.35$ for the green bond and $P = 90.07$ for the conventional bond.</footnote>
"At the beginning of the day, the coupon price was estimated at 2.2%-2.375%. The issue was quickly oversubscribed to 3.3 billion euros (compared to the initial offering of 1 billion euros), and the final coupon was eventually priced at 1.875%, i.e., 5 bps below the conventional benchmark." (Zerbib, 2019).

In both cases (German and Iberdrola bonds), we must distinguish between the greenium observed in the primary market (when the bonds are issued) and the greenium priced in the secondary market (when the bonds are traded). In the primary market, a negative greenium means that the investor has bought a green bond with a coupon lower than the coupon of the conventional bond. In the secondary market, a negative greenium means that the investor bought a green bond at a higher price than the market price of the conventional bond. Let $c$ be the coupon rate. Mathematically, we have $c(\text{GB}) \le c(\text{CB})$ in the first case and $P_t(\text{GB}) \ge P_t(\text{CB})$ in the second case.

Estimating the greenium is a difficult task. First of all, we have to distinguish between primary and secondary markets. Most academic studies concern the secondary market because there are few observations to calculate the greenium in the primary market. Indeed, in the latter case, we can only have one observation per green bond (the day the green bond is issued). Nevertheless, the different academic studies generally estimate a negative greenium between 5 and 15 bps on the primary market (Ehlers and Packer, 2017; Gianfrate and Peri, 2019; Fatica et al., 2021; Kapraun et al., 2021; Löffler et al., 2021; Baker et al., 2022). These results confirm the professional consensus that the greenium is negative and significant at the issuance date. However, the persistence of the negative greenium in the secondary market is an issue and an open debate. We observe two opposing sides: those who think that the negative greenium persists and remains statistically significant, and those who think that the negative greenium disappears. For instance, Zerbib (2019) found a greenium of -2 bps for EUR and USD global bonds from July 2013 to December 2017. While they measured a greenium of -18 bps in the primary market, the estimates of Gianfrate and Peri (2019) are respectively -11, -13 and -5 bps for three trading dates<sup>43</sup>. In general, when academics estimate the greenium in both the primary and secondary markets, they find that the discount premium is higher at the issuance date. However, some academic studies find that the greenium in the secondary market is zero and statistically insignificant for municipal bonds (Larcker and Watts, 2020) and corporate bonds (Tang and Zhang, 2020; Flammer, 2021).

The second issue in estimating the greenium is the definition of the bond yield spread. For example, we can choose the effective yield, the spread to worst, etc. In general, we observe a small difference. For example, in the case of the German Bund 0% 15/08/2030, the average difference between the spread to worst and the effective yield is equal to 0.5 bps. Also we note that the greenium is different for two green bonds from the same issuer. An example is shown in Figure 4.14 with the German twin bonds. The last issue is the estimation method. According to Ben Slimane et al. (2020), there are two main approaches:

1. The bottom-up matching approach is to calculate the yield differential at the bond level. This means that we compare the green bond of an issuer with a synthetic conventional bond of the same issuer that has the same characteristics in terms of currency, seniority and duration (Zerbib, 2019). This matching method can be relaxed by considering a conventional bond from another issuer in the same country and sector and with the same rating (Flammer, 2021).

2. The top-down replication approach consists of calculating the yield differential at the portfolio level. The idea is to look at a diversified portfolio of green bonds and replicate it with a portfolio of conventional bonds. The aim of the replication process is to avoid biases in terms

<footnote n="43"><sup>43</sup>They are 10 January, 7 July and 14 December 2017.</footnote>
<figure><img src="image_133.png" /><figcaption>Figure 4.14: Greenium for 4 German twin bonds (in bps)</figcaption></figure>

Source: Bloomberg (2024) & Author's calculations.

of currency, sector, credit rating, maturity, etc. Therefore, the greenium is the difference between the yield of the green bond portfolio and the yield of the replication portfolio.

In the bottom-up approach, we first filter all the conventional bonds that have the same issuer, the same currency, and the same seniority as the green bond GB. Then, we select the two closest conventional bonds CB₁ and CB₂ in terms of modified duration:

$$|\text{MD}(\text{GB}) - \text{MD}(\text{CB}_j)|_{j \neq 1,2} \geq \sup_{j=1,2} |\text{MD}(\text{GB}) - \text{MD}(\text{CB}_j)|$$

Finally, we perform the linear interpolation/extrapolation of the two yields y(CB₁) and y(CB₂) such that the modified duration of the synthetic conventional bond CB* is exactly equal to the modified duration of the green bond. For example, assuming that MD(CB₁) ≤ MD(CB₂), the yield of the synthetic conventional bond is:

$$y(CB^*) = y(CB_1) + \frac{\text{MD}(\text{GB}) - \text{MD}(CB_1)}{\text{MD}(CB_2) - \text{MD}(CB_1)} (y(CB_2) - y(CB_1))$$

This calculation is done for each green bond GBᵢ and the greenium is equal to the average of the yield difference:

$$g = \frac{1}{n} \sum_{i=1}^{n} (y(GB_i) - y(CB_i^*))$$
**Example 18** Let us consider a green bond with a modified duration of 8 years. Its yield return is equal to 132 bps. We can surround the green bond with two conventional bonds with modified durations of 7 and 9.5 years. The yields are 125 and 148 bps, respectively. The interpolated yield is equal to:

$$y(\text{CB}) = 125 + \frac{8-7}{9.5-7} (148 - 125) = 134.2 \text{ bps}$$

It follows that the greenium is equal to -2.2 bps:

$$g = 132 - 134.2 = -2.2 \text{ bps}$$

In the top-down approach proposed by Fender et al. (2019), we consider a portfolio $w = (w_1, \dots, w_n)$ of $n$ green bonds. Then, we perform a clustering analysis by considering the 4-uplets (currency × sector × credit quality × maturity). Let $(C_h, S_j, R_k, M_l)$ be an observation for the 4-uplet (e.g., EUR, Financials, AAA, 1Y-3Y). We calculate its weight:

$$\omega_{h,j,k,l} = \sum_{i \in (C_h, S_j, R_k, M_l)} w_i$$

The greenium is then defined as the weighted excess yield:

$$g = \sum_{h,j,k,l} \omega_{h,j,k,l} (y_{h,j,k,l}(\text{GB}) - y_{h,j,k,l}(\text{CB}))$$

where $\omega_{h,j,k,l}$ is the weight of the cluster $(C_h, S_j, R_k, M_l)$ in the green bond portfolio, $y_{h,j,k,l}(\text{GB})$ is the yield of the cluster in the green bond portfolio and $y_{h,j,k,l}(\text{CB})$ is the yield of the cluster in the benchmark portfolio. In general, this approach is applied to a green bond index, implying that the green bond portfolio is the green bond index and the benchmark portfolio is the parent bond index.

<table><caption>Table 4.15: Average greenium (in bps) relative to currency</caption><thead><tr><th>Year</th><th>All currencies</th><th>EUR</th><th>USD</th><th>Non-EUR</th></tr></thead><tbody><tr><td>2019</td><td>-2.2</td><td>-1.3</td><td>-4.5</td><td>-3.3</td></tr><tr><td>2020</td><td>-2.3</td><td>-2.0</td><td>-3.2</td><td>-2.6</td></tr><tr><td>2021</td><td>-2.8</td><td>-2.2</td><td>-4.1</td><td>-3.5</td></tr><tr><td>2022</td><td>-3.7</td><td>-3.5</td><td>-5.5</td><td>-3.9</td></tr><tr><td>2023</td><td>-2.5</td><td>-2.0</td><td>-5.1</td><td>-3.2</td></tr><tr><td>2019-2023</td><td>-2.8</td><td>-2.3</td><td>-4.7</td><td>-3.3</td></tr></tbody></table>

Source: Ben Slimane et al. (2023a, Table 2, page 14).

Figure 4.15 shows the evolution of the greenium (expressed in bps) calculated by Ben Slimane et al. (2023a) using the bottom-up approach. On average, it is negative and equal to -2.8 bps. The 95% confidence interval corresponds to the range -4.3 to -1.3 bps. Note that the greenium highly depends on the currency. On average, the greenium of USD-denominated bond is larger than the greenium of EUR-denominated bond (-4.7 vs -2.3 bps). The probability that the greenium in EUR is below -4.5 bps is less than 1%. On the contrary, this probability is higher than 50% for the greenium in USD. The correlation between EUR and USD premia varies over time and is not very high in absolute terms. For instance, it is equal to 17.2% since 2020. These differences do not only concern currencies, but also sectors, maturities, regions and ratings. For example, the greenium is not statistically significant for many sectors. Ben Slimane et al. (2020) also found that the volatility of green bond portfolios is lower than the volatility of conventional bond portfolios, implying that green and conventional bonds have identical Sharpe ratios over the last five years. In summary, we can assume that the greenium is slightly negative, but the magnitude is relatively small.
<figure><img src="image_134.png" /><figcaption>Figure 4.15: Evolution of the greenium with respect to the currency denomination (in bps)</figcaption></figure>

Source: Ben Slimane et al. (2023a, Figure 11, page 15).

**Remark 47** To illustrate the sensitivity to the different characteristics, we consider the largest common pool of issuer types, i.e., agencies and sovereigns (AS), corporates (CORP), financials (FIN) and supranationals (SN). Table 4.16 shows the evolution of the greenium taking into account these four types of issuers. We notice a more pronounced greenium for corporate issuers. Besides the type of issuer, another important dimension is the currency of the bonds<fnref n="44" />. The case of sovereigns, supranationals and agencies (SSA) is also shown in Table 4.16. Again, the greenium is larger for green bonds denominated in dollars or other currencies than euros.

<table><caption>Table 4.16: Average greenium (in bps) relative to issuer category</caption><thead><tr><th>Issuer</th><th>Currency</th><th>2019</th><th>2020</th><th>2021</th><th>2022</th><th>2023</th><th>2019-2023</th></tr></thead><tbody><tr><td>AS</td><td rowspan="4">AC</td><td>-1.2</td><td>-1.8</td><td>-2.2</td><td>-2.5</td><td>-2.0</td><td>-2.0</td></tr><tr><td>CORP</td><td>-3.9</td><td>-3.9</td><td>-3.8</td><td>-7.2</td><td>-2.9</td><td>-4.5</td></tr><tr><td>FIN</td><td>-0.8</td><td>-1.4</td><td>-2.7</td><td>-1.4</td><td>-2.8</td><td>-2.0</td></tr><tr><td>SN</td><td>-4.9</td><td>-2.5</td><td>-2.2</td><td>-1.6</td><td>-1.2</td><td>-2.2</td></tr><tr><td rowspan="3">SSA</td><td>AC</td><td>-2.4</td><td>-2.0</td><td>-2.2</td><td>-2.3</td><td>-1.8</td><td>-2.1</td></tr><tr><td>EUR</td><td>-1.2</td><td>-1.2</td><td>-1.2</td><td>-2.2</td><td>-0.8</td><td>-1.3</td></tr><tr><td>Non-EUR</td><td>-3.2</td><td>-2.6</td><td>-3.0</td><td>-2.4</td><td>-2.9</td><td>-2.8</td></tr></tbody></table>

Source: Ben Slimane et al. (2023a, Table 4, page 17).

<footnote n="44">⁴⁴The symbol AC stands for all currencies.</footnote>
4.2.2 Social bonds

Definition

In the mid-2010s, the concept of green bonds was expanded to include social objectives. In January 2015, the first social bond was issued by the Spanish Instituto de Credito to support the financing of SMEs in economically depressed regions of Spain. In September 2015, Kutxabank issued the first social covered bond, the proceeds of which were used to finance and subsidize social housing projects in the Basque region. Since 2015, the framework for social bonds has evolved, but it is now a copy/paste version of the framework for green bonds. For example, the definition of a social bond is exactly the same as that of a green bond:

"Social Bonds are any type of bond instrument where the proceeds, or an equivalent amount, will be exclusively applied to finance or re-finance in part or in full new and/or existing eligible social projects and which are aligned with the four core components of the Social Bond Principles (SBP)." (ICMA, 2021b, page 3).

Again, the four core components are the use of proceeds, the process for project evaluation and selection, the management of proceeds, and the reporting. The eligible social project must address or alleviate the specific social problem and, if possible, focus on a target population. Projects are usually part of social milestones such as:

* Basic infrastructure: access to affordable basic infrastructure (clean drinking water, sewerage, sanitation, transportation and energy);

* Basic services: access to basic services (health, health care, vocational training, education, and financial services);

* Affordable housing: access to affordable housing;

* Employment: reducing unemployment and increasing support for microfinance programs and the creation of small and medium-sized enterprises;

* Food security: access to safe, nutritious and sufficient food; resilient agricultural practices; food loss and waste;

* Empowerment: reducing inequalities in income, gender, resources, opportunities and assets.

The use of proceeds also introduces the concept of target population, which means that the goal of a social bond is defined by both a social project category and a target population. Examples of target populations include: (1) those living below the poverty line, (2) excluded and/or marginalized populations and/or communities, (3) persons with disabilities, (4) migrants and/or displaced persons, (5) the undereducated, (6) the underserved due to lack of quality access to essential goods and services, (7) the unemployed, (8) women and/or sexual and gender minorities, (9) the aging population and vulnerable youth, and (10) other vulnerable groups, including as a result of natural disasters. The target population confirms the positive social impact of the investment. To define impact reporting, ICMA provides a set of KPIs closely linked to the SDGs. Some examples are the number of hospital beds, the number of patients benefiting from health care or medical treatment, the percentage of underserved renters, the number of textbooks and educational materials provided, the number of people given access to financial services, and the percentage of people with disabilities employed (ICMA, 2021b). However, social impact reporting often suffers from a large amount of qualitative and intangible information that can be difficult to understand.
Box 4.8: Examples of social project categories and target populations

* Instituto de Crédito Oficial (Spanish state-owned bank, March 2020)

"The Social Bond proceeds under ICO's Second — Floor facilities will be allocated to loans to finance small, medium and micro enterprises with an emphasis on employment creation or employment retention in: (1) specific economically underperforming regions of Spain; (2) specific municipalities of Spain facing depopulation; (3) regions affected by a natural disaster. [...] The target populations are SMEs in line with European Union's standards."

* Pepper Money (non-bank lender in Australia and New Zealand, April 2022)

"The positive social impact of a Pepper Money eligible social project derives from its direct contribution to improving access to financial services and socio-economic empowerment, by using proprietary systems to make flexible loan solutions available to applicants who are not served by traditional banks. [...] Pepper Money is seeking to achieve positive social outcomes for a target population of Australians that lack access to essential financial services and experience inequitable access to and lack of control over assets. Pepper Money directly aims to address the positive social outcome of home ownership for borrowers who may have complexity in their income streams, gaps in their loan documentation or have adverse credit history. Traditionally, this cohort has been underserved by banks that rely on inflexible algorithmic loan application processing."

* Danone (French multinational food-products corporation, March 2018)

"The eligible project categories are: (1) research & innovation for advanced medical nutrition (target populations: infants, pregnant women, patients and elderly people with specific nutritional needs), (2) social inclusiveness (target populations: farmers, excluded and/or marginalised populations and/or communities, people living under the poverty line, rural communities in developing countries), (3) responsible farming and agriculture (target populations: milk producers, farmers), etc."

* Korian (European care group, October 2021)

"The proceeds of any instrument issued under the framework will be used [...] to provide services, solutions, and technologies that will enable Korian to meet at least one of its social objectives: (1) to increase and improve long-term care nursing home capacity for dependent older adults; (2) to increase and improve medical capacity for people in need of medical support; (3) to increase and improve access to alternative, nonmedical services, technologies, and housing solutions that facilitate the retention of older adults' autonomy; and (4) to improve the daily provision of care to and foster a safer living environment for its patients. [...] Furthermore, Korian's target populations are older adults, which Korian defines as being over 65 years of age, and those who are dependent on others for some degree of care, which is defined by the health authorities or insurance system of the respective country."

* JASSO (Japan Student Services Organization, July 2022)

"The social project categories concern the financing of the 'Category 2 Scholarship Loans' (interest-bearing scholarship loans that have to be repaid) while the target population is made up of students with financial difficulties."

Source: Collected from the websites of the organizations.
The social bond market

As of December 2023, 1 030 entities have issued more than 7 800 social bonds in fifty countries (CBI, 2024c). In addition to its smaller size, the social bond market differs from the green bond market in many ways. First, supranational issuers are more prevalent, with a cumulative market share of about 18% (Figure 4.16). Second, Europe and North America are less represented in the social bond market (respectively 33% and 11.9% versus 45.6% and 17.4% in the green bond market), while the share of Asian issuers is close to 35% (Figure 4.17). Third, the majority of social bond issuance is led by governments and sovereign entities, accounting for about 68% of the market (Figure 4.18). The breakdown of this figure is as follows: 58% for government-backed entities, 6.5% for local governments, and 3.1% for central governments. Corporates represent less than 10% of the social bond market, while their market share is more than 30% for green bonds. This market segmentation occurred between 2019 and 2020, when the market share of government and sovereign issuers increased sixfold, mainly due to the launch of the European SURE program. As a result, the social bond market is dominated by developed countries, and the majority of social bonds are denominated in euros (around 39% of the market). Finally, the structure of the bonds differs from that of green bonds, with a shorter maturity and a lower notional amount (CBI, 2024c).

<figure><img src="image_135.png" /><figcaption>Figure 4.16: Issuance and notional outstanding of social bonds by market</figcaption></figure>

Source: https://www.climatebonds.net/market/data.

Ben Slimane et al. (2023a) find that the social bond premium, i.e., the difference between the yield on social bonds and the yield on conventional bonds, is zero and not significant. They also find that there is no correlation between the green premium and the social bond premium. In fact, a large part of the social bond market can be seen as a restructuring of public social debt (unemployment benefits, pensions, etc.) and the financing of social infrastructure (schools, hospitals, etc.) and is not related to social projects to achieve a low-carbon economy.
<figure><img src="image_136.png" /><figcaption>Figure 4.17: Issuance and notional outstanding of social bonds by region</figcaption></figure>

Source: https://www.climatebonds.net/market/data.

<figure><img src="image_137.png" /><figcaption>Figure 4.18: Issuance and notional outstanding of social bonds by type of issuer</figcaption></figure>

Source: https://www.climatebonds.net/market/data.
### 4.2.3 Other sustainability-related instruments

#### Sustainability bonds

Sustainability bonds are debt instruments issued to finance projects or activities that have both positive environmental and social impacts. The idea is that some social projects can have environmental co-benefits and vice versa. Sustainability bonds are aligned with the four core components of both the GBP and SBP. One example is the Series 2021 sustainability bonds issued by the American Museum of Natural History. The environmental objective is to partially finance the Gilder Center (green buildings), while the social objectives are to expand access to critical science education, and promote biocultural diversity and research. The social benefits accrue to target populations that include K-12 STEM education shortage areas and the general public.

According to CBI (2024c), the cumulative issuance of sustainability bonds reaches $870 billion at the end of December 2023. However, we observe a decline in issuance. 2021 was the peak year with $205.4 billion of issuance. In 2022 and 2023 this figure is close to $170 billion. The top 5 countries are the US, France, South Korea, Japan and Germany. Nearly half of sustainability bonds are issued by development banks, 25% by governments or related entities, and the remainder is split evenly between financial institutions and corporates.

#### Sustainability-linked bonds

A sustainability-linked bond (SLB) is a sustainability bond (green/social) plus a step-up coupon if the sustainability KPI is not met. Thus, an SLB belongs to the family of forward-looking performance-based instruments. The financial characteristics of the bond depend on whether the issuer meets pre-defined ESG objectives. These objectives are:

1. measured through predefined Key Performance Indicators (KPIs);

2. assessed against predefined Sustainability Performance Targets (SPTs).

Let us give some examples. In September 2019, ENEL issued a general purpose SDG linked bond based on SDGs 7 (affordable and clean energy), 13 (climate action), 9 (industry, innovation and infrastructure) and 11 (sustainable cities and communities). The KPI is installed renewable energy capacity RIC as of 31 December 2021, while the SPT is equal to 55%. If the SDG 7 target is not achieved<fnref n="45" /> — RIC < 55%, ENEL will have to pay a one-time step-up coupon of 25 bps. On April 2022, the independent report prepared by KPMG certifies that “the percentage of installed renewable capacity as of 31 December 2021 is equal to 57.5%.” Since 2019, Enel has issued other sustainability-linked bonds<fnref n="46" /> and is one of the largest SLB issuers.

On 18 February 2021, H&M issued an 8.5-year sustainability-linked bond<fnref n="47" /> for a notional amount of €500 mn. The annual coupon rate is 25 bps and the objectives to be achieved by 2025 are:

KPI₁ Increase the share of recycled materials used to 30% (SPT₁);

KPI₂ Reduce emissions from the Group's own operations (Scope 1+2) by 20% with 2017 as a baseline (SPT₂);

KPI₃ Reduce Scope 3 emissions from fabric production, garment manufacturing, raw materials and upstream transportation by 10% using 2017 as a baseline (SPT₃).

<footnote n="45">⁴⁵As of 30 June 2019, the KPI was equal to 45.9%</footnote>

<footnote n="46">⁴⁶See https://www.enel.com/investors/investing/sustainable-finance/sustainability-linked-finance.</footnote>

<footnote n="47">⁴⁷See https://hmgroup.com/investors/sustainability-linked-finance.</footnote>
The global step-up rate is equal to:

$$r = 40\% \times 1 \{KPI_1 < SPT_1\} + 20\% \times 1 \{KPI_2 > SPT_2\} + 40\% \times 1 \{KPI_3 > SPT_3\}$$

If the three targets are met, the step-up rate will be zero and no step-up coupon will be paid. Otherwise, H&M will pay a step-up coupon proportional to the step-up rate, which may be 20% (KPI₂ is not achieved), 40% (KPI₁ or KPI₃ is not achieved), 60% (KPI₂ is not achieved, and KPI₁ or KPI₃ is not achieved), 80% (KPI₁ and KPI₃ are not achieved) or 100% (KPI₁, KPI₂ and KPI₃ are not achieved). The H&M sustainability-linked bond attracted a lot of interest as it was 7.6 times oversubscribed.

According to Berrada et al. (2022), “the SLB market has grown strongly since its inception. [...] Bloomberg identifies a total of 434 outstanding bonds flagged as ‘sustainability-linked’ as of February 2022. In contrast, in 2018, there was only a single SLB. The amount raised through the single 2018 SLB issue was $0.22 bn, whereas the total amount raised through all SLBs issued in 2021 was approximately $160 bn.” These authors also found that the vast majority of SLB issues are exclusively E issues (65%) or a combination of E, S and G issues (17%) or E and G issues (3%). The other combinations are marginal (less than 1% each). They also found that the most common KPI is GHG emissions (40%), followed by the issuer’s global ESG score (14%).

A more recent study was conducted by the Climate Bonds Initiative (CBI, 2024b). As of 30 November 2023, the key figures of the SLB market are as follows: $279 bn in issuance, 768 SLB bonds, 469 issuers, average bond size of $364 mn. Enel dominates the top ten issuers with $31.1 bn of issuance, followed by the Republic of Chile ($9.2 bn), Teva Pharmaceutical Industries ($7.5 bn), Eni ($5.2 bn) and Enbridge ($5.1 bn). SLBs have between one and four KPIs, with one being the most common, used by 59% of bonds. 65% of KPIs relate to climate change, 7.5% to product governance, 5% to diversity, equity and inclusion, and 3.5% to circular economy. Step-up coupons are the financial mechanism that dominates the current SLB market, appearing in 58% of SLBs and representing 78% of the amount issued. In this case, they provide a reward to bondholders in the form of a higher coupon if the issuer misses its targets. The average step-up coupon per target is 24.8 bps. Step-down coupons are rare (less than 7% of SLBs and 4% of amount issued). In this case, the coupon is canceled or reduced if the targets are met. In addition to step-up and step-down coupons, another financial tool is the redemption premium. With this mechanism, the issuer compensates by paying an additional amount if it decides to redeem the bond before maturity or at maturity. The redemption premium mechanism is used by 20% of SLBs representing 10% of the issued amount. The Climate Bonds Initiative study is very critical of the KPIs chosen by SLB issuers, their performance and their reporting:

“Three aspects linked to poor reporting are highlighted: failure to explain reasons for changes in performance, lack of clarity around data restatements (especially GHG emissions), and inconsistencies in issuer disclosure. [...] The market shows heterogeneous performance, with a relatively even split of outcomes. Within the sample, 31% of SLBs and 34% of the amount issued have all KPIs off track [...] Of the SLBs sampled, 12% have targets currently met, almost all of which with observation dates up to 2025. Within these, the later the observation date, the less ambitious the targets are likely to be. [...] As well as target ambition, target feasibility varies widely. Some issuers have targets that are only a slight improvement versus the baseline or have even already been met at issuance (i.e., highly feasible). If these targets also lack ambition (below 2°C in the case of GHG targets), they are clear examples of greenwashing.” (CBI, 2024b, page 4).
## Transition bonds

They are financial instruments designed to support the transition of an issuer that currently has significant carbon emissions. These bonds are typically used to finance projects such as renewable energy development, energy efficiency improvements, and other projects aimed at transitioning to a lower carbon economy. The ultimate goal of the bond issuer is always to reduce its carbon emissions. For example, transition bonds can be used to convert diesel-powered ships to natural gas or to implement carbon capture and storage. At the end of 2023, the cumulative issuance of transition bonds is $12.7 billion, or 0.3% of the GSS+ market. The world's first sovereign climate transition bond was issued by the Japanese government on 14 February 2024. The total amount of $11 billion is divided into several tranches and the proceeds will be used to finance the country's Green Transformation Program.

## 4.3 Sustainable alternative assets

Private assets refer to an asset class in which securities, such as stocks and bonds, are traded directly between investors and issuers, without the intermediation of public exchanges. Private assets cover a wide range of investments, including private equity, venture capital and private debt. Real assets refer to an asset class that includes investments in physical assets such as infrastructure, natural resources<fnref n="48" /> and real estate. Therefore, real assets are tangible or physical assets whose value is linked to their physical characteristics rather than their financial characteristics. Investors generally assume that private assets and real assets form a single asset class known as alternative assets or private markets. In fact, the line between private and real assets is not always clearly defined. For example, real estate can be classified as a private asset. The common characteristics are that alternative assets are often illiquid and less regulated, require a longer investment horizon than public market investments, and have fewer disclosure requirements than public markets. Because the alternative investment market is less regulated, it is more difficult to obtain a global view of its size and components. In what follows, we use two data providers, Prequin and PitchBook, to assess the market for sustainable alternative assets<fnref n="49" />.

<table><caption>Table 4.17: Breakdown of private markets AUM (as of June 2023)</caption><thead><tr><th>Asset class</th><th>North America</th><th>Europe</th><th>Asia</th><th>Other regions</th><th>World</th></tr></thead><tbody><tr><td>Buyout</td><td>18.2%</td><td>7.6%</td><td>2.9%</td><td>0.7%</td><td>29.5%</td></tr><tr><td>Venture capital</td><td>8.2%</td><td>1.6%</td><td>9.9%</td><td>0.9%</td><td>20.6%</td></tr><tr><td>Growth</td><td>4.8%</td><td>1.0%</td><td>3.9%</td><td>0.7%</td><td>10.5%</td></tr><tr><td>Other</td><td>1.8%</td><td>0.0%</td><td>0.3%</td><td>0.0%</td><td>2.2%</td></tr><tr><td>Private debt</td><td>8.0%</td><td>3.4%</td><td>0.9%</td><td>0.7%</td><td>12.9%</td></tr><tr><td>Real estate</td><td>7.5%</td><td>2.9%</td><td>1.7%</td><td>0.6%</td><td>12.8%</td></tr><tr><td>Infrastructure & natural resources</td><td>5.5%</td><td>3.7%</td><td>1.2%</td><td>1.1%</td><td>11.5%</td></tr><tr><td>Private equity</td><td>33.1%</td><td>10.3%</td><td>17.0%</td><td>2.4%</td><td>62.8%</td></tr><tr><td>Private assets</td><td>41.0%</td><td>13.7%</td><td>17.9%</td><td>3.1%</td><td>75.7%</td></tr><tr><td>Real assets</td><td>13.1%</td><td>6.6%</td><td>2.9%</td><td>1.7%</td><td>24.3%</td></tr><tr><td>Total</td><td>54.1%</td><td>20.3%</td><td>20.8%</td><td>4.8%</td><td>100.0%</td></tr></tbody></table>

Source: Prequin database, McKinsey (2024a, Exibit 6, page 12) & Author's calculations.

<footnote n="48">⁴⁸Natural resources are materials or substances that occur naturally on Earth. Prequin considers five main categories: (1) Agriculture & Farmland, (2) Energy, (3) Metals & Mining, (4) Timberland, and (5) Water.</footnote>

<footnote n="49">⁴⁹Readers unfamiliar with alternative investments may wish to consult the free Alternatives 101 educational program at www.preqin.com/academy.</footnote>
Box 4.9: Glossary of private equity terms

* The *buyout* strategy focuses on the majority acquisition of established private companies, typically with significant debt financing.

* *Distressed debt* refers to loans and borrowings associated with debtors that are experiencing financial or operational distress, default or bankruptcy.

* *Dry powder* is the available or unused capital that a private equity firm has at its disposal to make new investments. It represents the amount of capital that has been committed by limited partners but not yet committed to investments. It then measures the ability of the fund to make acquisitions or new investments.

* *Exit* refers to the process of divesting or selling the investments made by the private equity firm. It represents the point at which the firm seeks to realize its investment and generate returns for its investors.

* *Final closing* is the end of fundraising and the last time new investors are accepted into closed-end funds. It is then the final stage in which all necessary legal, financial and administrative processes are completed.

* *Fundraising* is the process of raising capital from investors for a newly formed fund. It ends with the final closing.

* The *general partner (GP)* is the partner with unlimited liability in a limited partnership. It is responsible for managing the fund and making investment decisions. It can be thought of as the fund manager.

* The *internal rate of return (IRR)* measures the profitability and performance of an investment over time. It represents the annualized rate of return that an investment is expected to earn based on its cash flows, including both cash inflows and outflows.

* *Leverage* increases the level of investment through borrowing and derivatives.

* A *leveraged buyout* is a technique in which a company is acquired with a significant amount of debt, often using the assets of the acquired company as collateral.

* A *limited partner (LP)* is a partner with limited liability in a partnership. It defines an investor in a private equity fund who provides capital but does not participate in the day-to-day management of the fund.

* The *liquidation phase* refers to the stage in the life of a fund when, at the end of the fund's life, the remaining assets are sold to liquidate the fund and distribute the proceeds to investors.

* *Venture capital (VC)* is a form of private equity investment that focuses on early-stage, high-growth companies with significant growth potential.

* *Vintage* refers to the year in which a fund begins investing its capital. It's an important metric used to evaluate a fund's performance and compare it to its peers.
According to McKinsey (2024a), assets under management in private markets reached $13.1 trillion by June 2023. Table 4.17 shows the breakdown of private markets AUM. The order of magnitude is 7.6% for $1 trillion. The market is dominated by North America with a market share of 54.1%. Europe and Asia have a similar market size, each representing 20% of the market. Buyout strategy is the largest category, followed by venture capital. Private equity (i.e., buyout, venture capital growth and other<sup>50</sup>) represents 62.8% of private markets. If we add private debt, we get a figure of 75.7% for private assets. The remaining 24.3% is real assets, with 12.8% in real estate and 11.5% in infrastructure and natural resources.

Data providers typically distinguish between private ESG funds and impact investing funds. For example, Prequin (2023) and PitchBook (2024) separate these two investment universes in their annual reports. Focusing on private ESG funds, Prequin (2023) found that total capital raised grow from $29.4 billion in 2020 to $92.0 billion in 2022. Since 2014, cumulative assets under management in private ESG markets have reached $300 billion. The market is dominated by private equity ESG buyout funds, which account for 50% of assets. Infrastructure is the second category that raises ESG capital, while venture capital, private debt, real estate and natural resources are more marginal ESG strategies (Prequin, 2023, Figure 1.3, page 6). Regionally, Europe leads the market with more than 70% of the market share, followed by North America and Asia. Prequin (2023) estimates that Article 8 funds have dominated the fundraising landscape, but Article 9 funds are gaining momentum. Focusing on impact investing funds, Prequin (2023) suggests that this market is 60% smaller than the market for private ESG funds. Regionally, the market is dominated by North America and Europe, which account for 95% of fundraising:

> "ESG integration and regulations are more developed in Europe than other regions but impact investment strategies are more concentrated in North America. Rather than looking at when capital was secured, examining fund vintages from 2013 shows that European funds have dominated ESG integration fundraising, securing 76% of the global aggregate. However, among impact funds, North America funds of comparable vintages lead, accounting for 53% of capital raised." (Prequin, 2023, page 12).

One of the main reasons for this is that the market for impact investing funds is dominated by venture capital funds, particularly those specializing in renewable energy projects such as wind and solar. As a result, a large amount of assets are being invested in cleantech, a trend that has been stimulated by the 2022 Inflation Reduction Act in the United States (Prequin, 2023, page 12).

PitchBook's annual report on ESG in alternative investments also breaks out the private ESG fund market and the impact fund market. Figure 4.19 shows the evolution of total GP PRI signatories. PitchBook (2024) indicates that the number of new GPs publicly committing to ESG through the Principles for Responsible Investment increases significantly in 2020 and 2021. However, they observe a decline in 2022 and 2023. By December 2023, there are 2503 GP signatories. This represents about 10% of global GPs. PitchBook (2024) questions the momentum of ESG in the private markets and sees a slowdown that may be explained by the ESG backlash in the US and the proliferation of greenhushing. The analysis of Article 8 funds shows a divergence from the global private fund market. Like Prequin (2023), PitchBook (2024) finds that more than 60% of assets are invested in private equity (buyouts) and infrastructure (see Table 4.18). Venture capital funds are underrepresented in Article 8 funds due to their small size and the ESG characteristics of these investments. Indeed, the primary objective of start-up companies is to survive from a financial point of view, which means that sustainability issues are not their main concern.

<footnote n="50"><sup>50</sup>This includes turnaround, private investment in public equity, balanced, hybrid funds, and funds with unspecified strategy (McKinsey, 2024a).</footnote>
<figure><img src="image_138.png" /><figcaption>Figure 4.19: GP PRI signatories</figcaption></figure>

Source: PitchBook (2024, page 2) & https://pitchbook.com.

<table><caption>Table 4.18: Strategy representation among Article 8 funds (as of December 2023)</caption><thead><tr><th rowspan="2">Category</th><th colspan="2">Article 8 funds</th><th colspan="2">Private markets</th></tr><tr><th>Number of funds</th><th>Capital raised</th><th>Number of funds</th><th>Capital raised</th></tr></thead><tbody><tr><td>Private equity (buyout)</td><td>25.80%</td><td>34.50%</td><td>21.92%</td><td>37.62%</td></tr><tr><td>Venture capital</td><td>14.60%</td><td>4.40%</td><td>46.49%</td><td>15.96%</td></tr><tr><td>Private debt</td><td>20.50%</td><td>16.80%</td><td>7.08%</td><td>14.46%</td></tr><tr><td>Real estate</td><td>23.20%</td><td>14.20%</td><td>12.60%</td><td>12.34%</td></tr><tr><td>Real assets*</td><td>12.60%</td><td>29.90%</td><td>4.16%</td><td>9.69%</td></tr></tbody></table>

*Real assets = infrastructure & natural resources.

Source: PitchBook (2024, page 6) & Author's calculations.

<table><caption>Table 4.19: Strategy representation among impact investing funds (as of December 2023)</caption><thead><tr><th rowspan="2">Category</th><th colspan="2">Impact funds</th><th colspan="2">Private markets</th></tr><tr><th>Number of funds</th><th>Capital raised</th><th>Number of funds</th><th>Capital raised</th></tr></thead><tbody><tr><td>Private equity (buyout)</td><td>21.90%</td><td>14.49%</td><td>21.92%</td><td>37.62%</td></tr><tr><td>Venture capital</td><td>40.18%</td><td>7.03%</td><td>46.49%</td><td>15.96%</td></tr><tr><td>Private debt</td><td>7.16%</td><td>6.26%</td><td>7.08%</td><td>14.46%</td></tr><tr><td>Real estate</td><td>5.80%</td><td>3.93%</td><td>12.60%</td><td>12.34%</td></tr><tr><td>Real assets*</td><td>20.55%</td><td>66.96%</td><td>4.16%</td><td>9.69%</td></tr></tbody></table>

*Real assets = infrastructure & natural resources.

Source: PitchBook (2024), https://pitchbook.com & Author's calculations.
<figure><img src="image_139.png" /><figcaption>Figure 4.20: Assets under management of impact investing funds (in $ bn)</figcaption></figure>

Source: PitchBook (2024), https://pitchbook.com & Author's calculations.

<table><caption>Table 4.20: Top 10 impact investing firms by capital raised (as of December 2023)</caption><thead><tr><td>Investor</td><td>Location</td><td>Aggregate capital (in $ bn)</td><td>Number of impact funds</td></tr></thead><tbody><tr><td>Brookfield Corporation</td><td>Ontario, Canada</td><td>61.40</td><td>6</td></tr><tr><td>Global Infrastructure Partners</td><td>New York, US</td><td>55.62</td><td>7</td></tr><tr><td>Macquarie Asset Management</td><td>Australia</td><td>37.78</td><td>13</td></tr><tr><td>Kohlberg Kravis Roberts</td><td>New York, US</td><td>36.48</td><td>7</td></tr><tr><td>EQT</td><td>Stockholm, Sweden</td><td>35.61</td><td>4</td></tr><tr><td>China Development Bank</td><td>Beijing, China</td><td>30.00</td><td>2</td></tr><tr><td>Stonepeak</td><td>New York, US</td><td>29.72</td><td>5</td></tr><tr><td>Actis</td><td>England, UK</td><td>28.63</td><td>37</td></tr><tr><td>Copenhagen Infrastructure Partners</td><td>Denmark</td><td>21.22</td><td>7</td></tr><tr><td>I Squared Capital</td><td>Miami, US</td><td>18.31</td><td>2</td></tr><tr><td>Total</td><td></td><td>354.76</td><td>90</td></tr></tbody></table>

Source: PitchBook (2024, page 11).
Focusing on impact investing funds, PitchBook (2024) finds a decline in assets under management in 2023 (Figure 4.20). This trend is confirmed by fundraising numbers, which peak in 2022 at $150 billion raised by 213 funds. In 2023, fundraising drops dramatically to $44 billion for only 107 funds. We are very far from the 248 funds in 2021 and $111 billion in capital raised. In Table 4.20, we report the top 10 impact investing firms. Some of them are big names in the private markets such as KKR, EQT Partners or Brookfield Corporation. Others are infrastructure-focused GPs such as Global Infrastructure Partners, Macquarie and Copenhagen Infrastructure Partners.

### 4.3.1 ESG private equity and debt funds

According to Eccles et al. (2023), sustainability considerations are less common in private equity firms than in traditional asset management. Of course, PE firms have always been sensitive to governance issues because it is a core element in structuring a private equity firm. Indeed, GPs want to be involved in the management of the company, or at least have influence on the board, in order to deliver performance. By contrast, environmental and social issues have never been a core element of the private equity industry and have come relatively late to this market. However, PE firms have many advantages over traditional asset managers when it comes to implementing ESG and sustainability policies:

> "Private equity's business model gives it clear advantages over investors in public equities when it comes to implementing a sustainability agenda. A PE firm has virtual control of its portfolio companies from an ownership and governance perspective, even when it doesn't own 100% of a company: It has one or more representatives on the board and a strong influence on who else serves. It has access to any information it wants about both financial and sustainability performance — whereas investors in public companies see only what the company reports. Finally, the firm determines executive compensation and can fire a CEO who is not delivering." (Eccles et al., 2023)

The time horizon of GPs and LPs is much longer than that of asset managers and public market investors because most of their investments are illiquid. They are active long-term investors in the sense that they both invest for the long term and must actively manage their portfolios. By active, we do not mean asset trading, dynamic asset allocation, or portfolio rebalancing. In this specific case, active management means that portfolio construction is driven entirely by asset selection and a bottom-up approach. Top-down portfolio construction is secondary and, in most cases, nonexistent. However, since 2020 and the pandemic crisis, we have seen a shift in the private equity industry. More and more private equity firms are adopting ESG criteria and offering ESG funds. In fact, there are some structural reasons to believe that the ESG practices of the private equity industry will follow those of the asset management industry:

> "Three forces are pushing ESG in the industry. First, ESG is becoming more important to limited partners and their beneficiaries. The largest asset owners — among them pension and sovereign wealth funds — are increasingly concerned about the system-level effects of climate change and inequality. [...] The second force pushing ESG in the industry derives from the belief of many LPs and GPs that it will be essential if private equity is to continue delivering its historically high returns. [...] The third force is portfolio companies' increasing recognition of the importance of ESG issues. The reasons are unsurprising: a changing zeitgeist reflected in the preferences of employees and customers; growing awareness of the significance of climate change; social expectations regarding diversity, equity, and inclusion; pressure from large public companies to which
the portfolio companies are suppliers; awareness of the sustainability focus in publicly listed companies; opportunities to boost their own value through sustainability; and increasing regulation.” (Eccles et al., 2023)

These reasons are not specific to PE firms and can apply to any asset owner or manager. Most limited partners are the institutional investors we encounter in the asset management industry. Asset allocation for these investors is not simply a matter of allocating equity and fixed income to public securities. These asset owners also invest heavily in alternative assets. Figure 4.21 shows the evolution of institutional allocations to alternative assets. In 2014, private markets represented 17.3% of the allocation, while in 2023 it is 27%. This represents growth of 56% over nine years, or 5% per year. This increase has been at the expense of equity and fixed-income allocations.

<figure><img src="image_140.png" /><figcaption>Figure 4.21: Allocation of institutional investors to alternative assets (in %)</figcaption></figure>

Source: McKinsey (2024a, Exibit 7, page 13).

This level of ESG progress in private equity is illustrated by the launch of the ESG Data Con-
vergence Initiative (EDCI) in 2021. At the height of the Covid-19 lockdown, CalPERS and Carlyle
hosted a video conference with a small group of GPs and LPs to discuss the challenges they faced
with ESG data. Despite the proliferation of ESG frameworks and rating providers, there was still
no standardized, meaningful, performance-based data from private companies. The conversation
evolved from sharing concerns to creating an action plan. In September 2021, the founding mem-
bers, led by CalPERS and Carlyle as inaugural co-chairs, announced the launch of the initiative.
Membership is now open to private debt firms, investment advisors and ESG data platforms. Since
then, the EDCI has grown significantly, with more than 425 GPs and LPs now participating. The
Steering Committee is currently chaired by Carlyle and CPP Investments. It also includes 7 LPs:
APG, AlpInvest Partners, CalPERS, PGGM, Pictet, PSP Investments and StepStone Group and 7
GPs: Apollo Global Management, Cinven, CVC, EQT AB, PAG, Permira and TowerBrook.
Using data points collected by EDCI from approximately 185 GPs and 4300 PE portfolio companies, BCG (2023b) has produced a report to understand how private markets currently compare to public markets on a variety of topics. One of the key findings is that PE firms have been more successful in driving decarbonization in larger portfolio companies than in smaller ones. A second finding is that private companies lag behind public companies in their use of renewable energy. Overall, the median private company that used at least some renewable energy sources 27% of its energy from renewable sources, compared to 36% for public companies. On social issues, private companies lag behind their public counterparts in some areas, particularly gender and minority diversity on their boards, but they can outperform on other measures, such as job creation. When it comes to work-related injuries, there are no clear differences between private and public companies. Curiously, the proportion of women on management teams in private companies was 5% higher than in public companies.

PRI (2019b, 2023) has produced two guides for incorporating ESG into private equity and private debt. These guides are very similar to those we find for listed equities and bonds. However, there are two key differences. The first is engagement, which is theoretically more efficient in private markets because of the weight of the GP on the board and in management. The second is due diligence, which must be adapted because private companies are not subject to public disclosure requirements. Therefore, they have less experience and less staff to fill out the ESG questionnaire. The due diligence questionnaire must then be adjusted to focus on the most important ESG criteria.

### 4.3.2 Sustainable infrastructure

Infrastructure refers to the long-lived physical structures and networks that are essential to the functioning of a society and its economy. These assets provide critical services that support daily life and economic activity. It can include a wide range of structures and networks, such as:

* Economic infrastructure: industrial parks, manufacturing facilities, shipping terminals, etc.

* Energy: power plants, electricity grids, oil and gas pipelines, refineries, storage facilities, renewable energy facilities, wind farms, etc.

* Other utilities: water and wastewater systems, waste management systems, telecommunications networks, etc.

* Social infrastructure: schools, hospitals, prisons, etc.

* Transportation: roads, bridges, railways, airports, ports, public transit systems, etc.

The European Commission defines green infrastructure as "a strategically planned network of natural and semi-natural areas with other environmental features, designed and managed to deliver a wide range of ecosystem services, while also enhancing biodiversity". Green infrastructure is implemented in a variety of sectors, from the energy sector through energy transmission infrastructure, and the water sector through natural water retention measures or sustainable urban drainage systems, to the urban landscape with street trees to help sequester carbon or green roofs to help regulate the temperature of buildings. In general, sustainable infrastructure falls into three main categories:

1. Net-zero infrastructure refers to the structures needed to achieve a low-carbon economy. It focuses primarily on the development of green electricity, the construction of electricity grids, and the storage of electricity.
2. Climate-resilient infrastructure refers to the construction or renovation of infrastructure, such as transportation and buildings, to withstand and adapt to the impacts of climate change, particularly extreme weather events, sea level rise, temperature increases, changes in precipitation patterns, and other physical risks.

3. Green infrastructure refers to a network of natural and engineered systems that provide environmental and social benefits in urban and rural environments. It's essentially the use of nature-based solutions to address challenges traditionally addressed with concrete and steel. It includes green roofs and walls, rain gardens and bioswales, permeable pavements, urban forests and greenways, and wetlands.

The first category is clearly a response to the transition risk component of climate risk, while the second category is more of a response to the physical risk component. The third category encompasses both dimensions and is also related to resource degradation and biodiversity loss. However, sustainable infrastructure is not limited to Pillar E. According to PRI (2024), it must also mobilize Pillar S. For example, we know that the infrastructure sector has many issues related to safety, working conditions, human rights and health. Therefore, ESG criteria must include labor standards and working conditions, including in the supply chain; land rights and indigenous rights; and diversity, equity and inclusion.

Box 4.10: An example of an ESG agency specializing in real assets: GRESB

GRESB, which stands for Global Real Estate Sustainability Benchmark, is a mission-driven, industry-led organization that provides actionable and transparent environmental, social and governance (ESG) data to the financial markets. They collect, validate, score and independently benchmark ESG data to provide business intelligence, engagement tools and regulatory reporting solutions for investors, asset managers and the broader industry. GRESB was established in the Netherlands in 2009 and consists of an independent foundation and a certified B-Corp. The GRESB Foundation focuses on the development, approval and administration of the GRESB Standards, while GRESB BV conducts ESG assessments and provides related services to GRESB members.

GRESB provides methodologies and frameworks to measure the ESG performance of individual assets and portfolios based on self-reported data to assess their alignment with the Sustainable Development Goals, the Paris Climate Agreement, and key international reporting frameworks. The data and scores are used to create industry ESG benchmarks: (1) real estate benchmark, (2) real estate development benchmark, (3) infrastructure fund benchmark, and (4) infrastructure asset benchmark. In addition, GRESB publishes the global aggregate benchmark data each year, showing the state of ESG in the real assets industry. This consists of two reports, one dedicated to real estate and one dedicated to infrastructure. The results of the 2023 report are available for download at www.gresb.com/nl-en/gresb-public-results.

As of December 2023, the GRESB benchmark database includes 784 real estate funds, 2 084 real estate assets, 172 infrastructure funds and 685 infrastructure assets. For example, it includes 29 airports (e.g., Auckland, Brussels, Gatwick, Glasgow, Sydney), 65 road companies (e.g., A63 Bordeaux Hendaye, APRR, Yongin Seoul Expressway), 27 social infrastructure (e.g., Barts Hospital, Domus Social Housing Ltd, Hospital de Parla), etc.

Source: www.gresb.com/nl-en.
### 4.3.3 Sustainable real estate

The real estate sector emits significant amounts of CO₂ through building operations, building materials, and construction. Action is needed to be taken in the construction of new buildings, but also in the renovation of existing buildings. For existing buildings, it is very important to reduce energy consumption, eliminate emissions from energy and refrigerants, and reduce or eliminate the use of fossil fuels. This is done by improving equipment such as insulation, ventilation, and the use of renewable energy, as well as optimizing operations by installing GHG monitors or adjusting temperature settings. New construction must be energy and carbon efficient, taking into account new and clean technologies. In both cases (renovation and new construction), certification is an important indicator of what constitutes a green building (PRI, 2022c). It is widely used in the real estate industry and real estate funds. This is particularly true for new buildings, especially in Europe, where regulations require them to be in line with the European Commission's decarbonization policy and comply with the Energy Performance of Buildings Directive (EPBD).

This explains the strong momentum of sustainable real estate funds, which typically target multiple sectors and countries with a specific allocation to reach net zero by 2050. Unlike infrastructure, which is more difficult to monitor and evaluate, the carbon footprint of real estate is easier to assess. Below is a list of some of the tools used by real estate funds:

* *Accounting and Reporting of GHG Emissions from Real Estate Operations* developed by PCAF, CRREM and GRESB, www.crrem.eu/accounting-and-reporting-of-ghg-emissions

* *CRREM Risk Assessment Reference Guide* prepared by the Institute for Real Estate Economics (Austria) in collaboration with the University of Ulster, GRESB BV, University of Alicante and Tilburg University, www.crrem.eu/tool/reference-guide

* *CRREM Risk Assessment Tool* with updated CRREM-SBTi Aligned Decarbonization Pathways, www.crrem.eu/tool

* *EU Building Stock Observatory (BSO)* under the umbrella of the EU Commission to monitor the implementation of the Energy Performance of Buildings Directive (EPBD), https://energy.ec.europa.eu/topics/energy-efficiency/energy-efficient-buildings_en

* *PCAF European Building Emission Factor Database*, https://building-db.carbonaccountingfinancials.com/login.php

* *SBTi Buildings Guidance and Tool* developed by the Science Based Targets initiative, www.sciencebasedtargets.org/sectors/buildings

* *US Commercial Buildings Energy Consumption Survey (CBECS) database* developed by the US Energy Information Administration (EIA), https://www.eia.gov/consumption/commercial

* *US Residential Energy Consumption Survey (RECS) database* developed by the US Energy Information Administration (EIA), https://www.eia.gov/consumption/residential

In Europe, sustainable real estate funds mostly follow the CRREM (Carbon Risk Real Estate Monitor) path, targeting 1.5°C/2°C using a Paris-aligned decarbonization pathway per country and building type, ranging from office buildings to retail stores and hotels.
Chapter 5

Impact Investing

Impact investing is not ESG investing. That is, the two investment approaches are different. Perhaps it is more accurate to say that ESG investing is not impact investing. This is certainly the consensus of asset owners and managers who believe that impact investing is part of ESG investing. In fact, we saw in Chapter 1 that impact investing is one of the seven categories of ESG strategies. However, many investors believe that impact investing is a special animal in the sustainable finance ecosystem and should not be compared to ESG selection, ESG integration and other ESG strategies, with the possible exception of the second category dedicated to norms-based screening (Figure 1.15 on page 43). This second category is also known as the values strategy, and it is no coincidence that we can associate impact investing and values. In her Presidential Address at the American Finance Association (AFA) Annual Meeting in New Orleans on January 7, 2023, Lara Starks discussed the differences between investors’ and managers’ motivations for considering sustainable finance. Her presentation was titled *Value versus Values* and focused on the preferences of sustainable investors:

> "For some investors, ESG decision making is driven by values, that is by preferences — in particular non-pecuniary preferences [...] For other investors and managers, ESG decision making is driven by financial value, that is, by a firm's risk and return opportunities. [...] Clear identification may be complicated by the fact that ESG investing can also be motivated by a combination of values and value." (Starks, 2023, pages 1838-1839).

In Figure 5.1 we reproduce the Venn diagram created by Laura Starks on the range of ESG ap-
proaches. Impact investing is unique in that it is driven primarily by values, not value. One could
argue that norms-based screening is a similar strategy, but it is not. In fact, it is an exclusion strat-
egy and is widely used by ESG investors because it has become mandatory if investors want to put
an ESG stamp on their investments. In contrast, impact investing is a niche strategy. To understand
the difference, we need to distinguish between investing WITH impact and investing FOR impact.
Investing WITH impact means that impact considerations in the investment process come after
financial return considerations (values after value), while investing FOR impact means that impact
considerations in the investment process come before financial return considerations (values before
value). This is why impact investing was first developed by philanthropic foundations. Investing
FOR impact is a narrow segment of sustainable finance. In contrast, investing WITH impact can be
claimed by virtually all ESG strategies. Using an ESG score, managing with a climate risk measure,
applying an exclusion list, or engaging and voting have an impact on companies and the world, but
they are not impact investing. Precisely, the first section of this chapter is devoted to the definition
and scope of impact investing, to be clear about what it is and what it is not. This is followed by
two sections on the SDGs and the impact investing market. Finally, we look at the biodiversity in
a final section to illustrate the differences between investing WITH and FOR impact.
<figure><img src="image_141.png" /><figcaption>Panel A. *Values* versus *Value* in Investment Approaches</figcaption></figure>

<figure><img src="image_142.png" /><figcaption>Panel B. *Values* versus *Value* in Investment Approaches: Investor Preferences</figcaption></figure>

<figure><img src="image_143.png" /><figcaption>Panel C *Values* versus *Value* in Investment Approaches: Expected Returns</figcaption></figure>

This figure illustrates a Venn diagram for the spectrum of investment approaches. Panel A shows the overlap between SRI, ESG, and traditional investing; Panel B shows the typical investor preferences related to the approaches; and Panel C shows the typical expected returns across the approaches.

Source: Starks (2023, Figure 1, page 1840).
## 5.1 Definition

Impact investing refers to "investments with the intention to generate positive, measurable social and environmental impact alongside a financial return" (GIIN, 2021, page 4). This is the definition of the Global Impact Investing Network. But the GIIN adds that the impact investing market must provide capital to address the world's most pressing challenges in areas such as sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services such as housing, health care, and education. The GIIN argues that the practice of impact investing is further defined by four core characteristics: "(1) Intentionality: an investor's intention to have a positive social or environmental impact through investments is essential to impact investing; (2) Range of return expectations and asset classes: impact investments target financial returns that range from below market (sometimes called concessionary) to risk-adjusted market rate, and can be made across asset classes, including but not limited to cash equivalents, fixed income, venture capital, and private equity; (3) Investment with return expectations: impact investments are expected to generate a financial return on capital or, at minimum, a return of capital; (4) Impact measurement and management: a hallmark of impact investing is the commitment of the investor to measure and report the social and environmental performance and progress of underlying investments, ensuring transparency and accountability while informing the practice of impact investing and building the field."

These various elements provided by the GIIN to define impact investing call for several comments. First, the definition clearly indicates that the primary goal of impact investing is to generate a non-pecuniary return, and that financial performance is secondary. Therefore, the investor's preferences are not to maximize a risk-adjusted performance measure that is biased toward some sustainable non-pecuniary benefits. The optimization problems defined in Chapter 2 (the Pástor-Stambaugh-Taylor model and the Pedersen-Fitzgibbons-Pomorski model) are not valid in the case of impact investing. Investor preferences are more likely to maximize non-pecuniary benefits, subject to a minimum acceptable rate of return. Utility functions are different in the two cases, and a mean-variance framework is not valid when considering impact investing. We generally assume that the impact investor has no financial benchmark and that his expected return is below the market. Second, the investment universe of the impact investor is small compared to the investment universe of a traditional or ESG investor. In the eighties and nineties, impact investing was primarily focused on health care, education and microfinance for minorities and communities. At that time, the concept of social impact investing (or social investing) was very close to philanthropy: philanthropy involved giving money to charitable causes without expecting a financial return, while social impact investing involved giving money to social causes with the expectation of a minimal financial return. Since the 2000s, social impact investing has included other motivations beyond purely social issues, particularly environmental issues. It has become simply impact investing, which embraces both social and environmental considerations. The third comment relates to the second core feature devoted to asset classes. The GIIN identifies four asset classes: cash equivalents, fixed income, venture capital, and private equity. Cash equivalents and fixed income refer to short- and long-term debt instruments in both public and private markets. Venture capital and private equity are two forms of investment in unlisted companies. Private assets are then largely targeted by impact investors, while public assets are mainly represented by debt and fixed income instruments. This excludes public equity and the market for listed companies. Why can't buying shares in a public company be considered an impact investment? Certainly because buying public shares has no social or environmental impact from the investor's perspective. To better understand this lack of impact, we need to develop the last comment related to the fourth core characteristic: the measurement of impact. In fact, an investment can only be considered an impact investment if we can measure the
impact. This may seem trivial, but it is not. Consider the case of buying public stock. By definition, the investor has bought these shares from another investor. This new investor cannot measure social or environmental impact just because some shares have changed hands. Or he must buy enough shares to take control of the public company and change the way it does business. In contrast, the investor who funds a new hospital or a new school can measure the impact of that investment directly in terms of the number of additional hospital beds in the country or the number of children who benefit from that school. In both of these examples, the impact is measured as the difference between a KPI before and after the investment. This implies that the KPI has increased with this investment. The concept of additionality (supplementary benefit) is then essential when talking about impact investing. Consider an investor who has the choice of buying a forest or planting a new one. In the first case, the forest area does not change. Strictly speaking, this is not an impact investment. In the second case, the forest area has increased. This can be an impact investment.

5.1.1 Impact investing frameworks

The intentionality-additionality-measurability framework

From a practitioner’s perspective, the four core characteristics are generally not obvious to apply and
are replaced by other frameworks. For example, France Invest & FIR (2021) propose a framework
based on three dimensions:

1. Intentionality

The intention of the investment to contribute to the generation of a measurable social or
environmental benefit

2. Additionality

The positive impact that would not have occurred without this specific investment

3. Measurability

The process of measuring the social and/or environmental impact of investments

Intentionality is the critical element of an impact investing framework because it often determines whether an investment is an impact investment or not. The investor's primary intention is to create social or environmental impact from an ex ante perspective. It cannot be an investment for other purposes<fnref n="1" />. For example, replacing an investment in the MSCI World Index with an investment in the MSCI World PAB Index is not an impact investment. This is also the case with many investment vehicles that are built using a top-down approach. In other words, the investor starts with the intention of funding or participating in a social or environmental project. For institutional investors whose investments are driven by strategic asset allocation, this can be an issue. They need to clearly separate which investments are impact and which are not. The fact that they are making assumptions about expected returns, volatilities and correlations, even for impact investments, can be challenging. This is easier for charities, philanthropic foundations or endowments that do not have liabilities to manage. By construction, impact intention precedes the investment decision. If it's the other way around, it's not impact investing, for example, claiming positive impacts after they have been generated. Impact could not be a by-product of the investment. To better assess intentionality<fnref n="2" />, France Invest & FIR (2021) then suggest to define three characteristics: the impact thesis (and the link to the SDGs), the impact strategy and its implementation and the appropriate governance (Table 5.1).

<footnote n="1">¹Of course, performance and returns remain important, but they are not the defining factor of an impact investment.</footnote>

<footnote n="2">²In Table 5.2, we have listed some questions to answer that help assess the three dimensions.</footnote>
<table><caption>Table 5.1: The 9 core characteristics of the intentionality-additionality-measurability framework</caption><thead><tr><th>Intentionality</th><th>Additionality</th><th>Measurability</th></tr></thead><tbody><tr><td><ul><li>Thesis</li><li>Strategy</li><li>Governance</li></ul></td><td><ul><li>Coverage</li><li>Time horizon</li><li>Commitment</li></ul></td><td><ul><li>Metrics</li><li>Transparency</li><li>Remuneration</li></ul></td></tr></tbody></table>

The second dimension is additionality. It is sometimes referred to as contribution, but the latter concept is less demanding. In fact, we can think of all ESG strategies as contributing to society and participating in a better world. For example, some authors argue that they create market signals and encourage the adoption of better sustainable practices. However, the concept of additionality requires a distinction between individual and collective contributions, tangible and hypothetical outcomes, and realized and expected benefits. In Table 5.2 we list some questions that can help assess the additionality of an investment. One question in particular is important:

What would happen if the investment were not made?

If the answer is nothing or very little, then the investment is not an impact investment. A typical example is investing in publicly traded stocks that have no problem accessing capital, even if the company has a social or environmental impact, such as pharmaceutical companies or renewable energy companies. In this case, there are two main reasons: (1) if we don't fund the company, someone else will; (2) shares and capital are two different things in a public market. In contrast, most microfinance investments are considered impact investments because the borrowers have limited access to the debt market. Similarly, many impact investments are directed to private equity and private debt markets because companies in these sectors are typically young and in need of capital. It is also easier to claim additionality when investing in projects related to the labor market, education, food security, personal care services, and poor countries. In addition, additionality needs to be evaluated and defined in terms of two key characteristics: coverage and time horizon. Indeed, the negative and positive externalities of an investment may be different in the short and long term. For example, investments in R&D projects may have low additionality in the short term but high potential additionality in the long term, e.g., funding a new vaccine R&D project. Portfolio coverage is also important. Ideally, additionality should cover 100% of the impact portfolio assets. Finally, engagement is the third factor to consider when assessing additionality. Impact investors need to be active, not passive, in their engagement with investee company managers to ensure alignment on maximizing impact and additionality.

The last dimension is more traditional in the ESG investment framework, as it relates to measurability and reporting. For example, the SFDR and CSRD regulations can help define impact metrics, but generally impact investors use specific and recognized reporting tools<fnref n="3" /> designed for impact investing reporting, such as the IRIS+ system. A typical example of impact metrics is the number of MWh of electricity produced annually by a new wind farm and the equivalent of CO₂ emissions avoided. These metrics and KPIs should be transparent, can be quantitative or qualitative, and must be used for reporting as well as for managing the project or company. They are therefore both reporting outputs and management inputs. In the latter case, they are used for decision making and

<footnote n="3">³These are discussed in Section 5.1.4 on page 320.</footnote>
<table><caption>Table 5.2: Questions to assess intentionality, additionality and measurability</caption><thead><tr><th></th><th></th></tr></thead><tbody><tr><td>Intentionality</td><td><strong>What specific impact goal(s) does the investment seek to achieve?</strong><ul><li>What are the ex-ante impact goals?</li><li>How do the impact goals contribute to the UN SDGs?</li><li>How does the investment policy support the impact goals?</li><li>Does the impact cover the entire investment?</li><li>What governance supports the achievement of the impact goals (impact committee, scientific committee, etc.)?</li></ul></td></tr><tr><td>Additionality</td><td><strong>What would happen if this investment were not made?</strong><ul><li>Do the recipients of the funding typically have difficulty obtaining funding?</li><li>Does the investment horizon allow for the long-term viability of the enterprise/project?</li><li>What is the commitment to working with investee managers to achieve impact, and if so, how is it implemented?</li><li>What initiatives are in place to support the impact of the investment beyond direct engagement with investees?</li></ul></td></tr><tr><td>Measurability</td><td><strong>How will impact and progress towards the goal(s) be measured?</strong><ul><li>What is the impact reporting methodology?</li><li>What are the impact KPIs?</li><li>How are these impact KPIs used to inform decision-making?</li><li>How are these impact indicators used to engage companies in the portfolio?</li><li>What is the frequency of impact reporting?</li></ul></td></tr></tbody></table>
compensation. Indeed, it is important that both investor performance and investee remuneration are linked to the metrics used for impact reporting. We see that this last dimension is related to the first two and cannot be defined once intentionality and additionality are established. In fact, the three dimensions are not independent and it is important to ensure coherence between them (Figure 5.2).

<figure><img src="image_144.png" /><figcaption>Figure 5.2: Links between intentionality, additionality and impact measurement</figcaption></figure>

Source: France Invest & FIR (2021, Chart 1, page 4).

The distinction between impact investing and other ESG strategies needs to be clear, because too often impact investing is a repackaging of the latter. Negative screening and norms-based screening cannot be considered as impact investing, because the intention and the motivation of these strategies is not to generate positive impact. Investors do not want to invest in these companies because of moral values or because they want to avoid sustainability and financial risks. Similarly, best-in-class selection and ESG integration are not impact investing strategies because they are incompatible with the additionality property. In fact, they do not satisfy the coverage and commitment properties. By definition, voting is far from impact investing because materiality and measurability are difficult to assess. Moreover, the principle of individual attribution of additionality is not established. Finally, there may be some confusion between impact investing and sustainability themed investing. Indeed, some impact investing products or funds are also thematic products or funds. Therefore, in some cases, there is overlap between these two strategies.

## Other frameworks

The intentionality-additionality-measurement framework is not the only approach. Investors also use other methodologies, which can be divided into two main categories: (1) non-specialized and general frameworks, and (2) dedicated impact investing frameworks. For example, they may use the PRI reporting standards and the UN SDGs, which were not designed for this specific purpose. In 2018, the PRI supplemented its standards with a dedicated framework, the Impact Investing Market Map,
to identify mainstream impact investing companies and investments (PRI, 2018b). The following is a non-exhaustive list of dedicated impact investing frameworks<fnref n="4" />:

* The 5 dimensions of impact were developed by the Impact Management Principle (IMP) and incorporated into Impact Frontiers<fnref n="5" />;

* The Operating Principles for Impact Management (OPIM) were launched in 2019, led by the International Finance Corporation (IFC) in partnership with a group of peer institutions. It is now a division of the GIIN<fnref n="6" />;

* The Compass was developed by the GIIN and is a methodology for comparing and assessing impact;

* The B Impact Assessment is a system for B-Corp certification. It is a tool developed by B Lab to assess a company's impact on its employees, community, environment, and customers. After completing the assessment, companies go through a review process and companies that score a minimum of 80 out of 200 points are certified as B-Corps<fnref n="7" />;

* The Theory of Change (ToC) in impact investing is a framework that explains how and why a desired change is expected to occur in a particular context (Jackson, 2013). It describes the path from initial inputs and activities to expected long-term outcomes and impacts, and articulates the assumptions and mechanisms that link investments to social or environmental benefits<fnref n="8" />.

According to the French National Advisory Board (NAB), the most common frameworks used by French impact investors are<fnref n="9" /> the Principles for Responsible Investment (61%), followed by the SDG Impact Standards (33%), the French Sustainable Finance Institute's rating grid (26%), the 5 dimensions of impact (26%), the Theory of Change (24%), and the B Impact Assessment (18%). In Germany<fnref n="10" />, impact investors use their own framework (52%), the EU Taxonomy (41%), the Sustainable Development Goals (40%), the Principles for Responsible Investment (38%), GIIN's IRIS+ (36%), the 5 dimensions of impact (33%), OPIM (26%), the GIIN Compass (19%) and the B Impact Assessment (7%). Below, we describe two approaches that complement the intentionality-additionality-measurement framework.

**Impact management project (IMP)** From 2016 to 2018, the Impact Management Project (IMP) convened a community of 3000 practitioners (companies and investors) and a network of 13 organizations, including PRI, OECD, and UNEP, to build a global consensus on how to measure,

<footnote n="4">⁴We exclude regional and country initiatives such as IMP+ACT and the Impact Investing Institute in the UK (www.impactinvest.org.uk) or the Sustainable Finance Institute's rating grid in France (www.institutdelafinancedurable.com).</footnote>

<footnote n="5">⁵The norms can be found at https://impactfrontiers.org/norms/five-dimensions-of-impact.</footnote>

<footnote n="6">⁶The dedicated website is www.impactprinciples.org.</footnote>

<footnote n="7">⁷A Benefit Corporation, or B-Corp, is a type of for-profit company that includes a positive impact on society, employees, the community and the environment as one of its legally defined goals, in addition to profit. Benefit corporations are legally recognized in several countries (e.g., Belgium and the Netherlands) and several states in the United States. The French and Italian equivalents of benefit corporations are ‘entreprises à mission’ and ‘Società Benefit’ respectively.</footnote>

<footnote n="8">⁸There is not one framework, but several approaches proposed by GIIN, IMP, GSG Impact, etc.</footnote>

<footnote n="9">⁹Source: NAB France (2023), Overview of the French Impact Investment Market 2023, Report, December, 20 pages, www.franceinvest.eu.</footnote>

<footnote n="10">¹⁰Source: Bundesinitiative Impact Investing (2022), Impact Investing in Germany 2022 Marktstudie, Report, October, 48 pages, www.bundesinitiative-impact-investing.org.</footnote>
<table><caption>Table 5.3: The five dimensions of impact (Impact Management Project)</caption><thead><tr><th>Impact dimension</th><th>Impact questions</th></tr></thead><tbody><tr><td>What</td><td>What tells us what outcome the enterprise is contributing to, whether it is positive or negative, and how important the outcome is to stakeholders</td></tr><tr><td>Who</td><td>Who tells us which stakeholders are experiencing the outcome and how underserved they are in relation to the outcome</td></tr><tr><td>How much</td><td>How Much tells us how many stakeholders experienced the outcome, what degree of change they experienced, and how long they experienced the outcome</td></tr><tr><td>Contribute</td><td>Contribution tells us whether an enterprise's and/or investor's efforts resulted in outcomes that were likely better than what would have occurred otherwise</td></tr><tr><td>Risk</td><td>Risk tells us the likelihood that impact will be different than expected</td></tr></tbody></table>

Source: www.impactfrontiers.org/norms/five-dimensions-of-impact.

improve, and disclose positive and negative impacts. The resulting consensus (or 'norms') provide a framework for understanding how companies and investors impact people and the planet. These resources migrated to Impact Frontiers in 2021. The five dimensions of the framework are shown in Table 5.3. These dimensions are What, Who, How Much, Enterprise Contribution and Impact Risk. Each dimension is then defined by a set of characteristics and data categories. For example, the How Much dimension has 3 data categories:

1. Scale: the number of individuals experiencing the outcome, e.g., 1 450 individuals;

2. Depth: the degree of change experienced by the stakeholder. Depth is calculated by analyzing the change that has occured between the 'outcome level at baseline' (Who) and the 'outcome level in period' (What), e.g., 20% increase in outcome relative to baseline;

3. Duration: the time period for which the stakeholder experiences the outcome, e.g., 24 months.

The mapping to the previous framework is not obvious. It is tempting to align intentionality with what and who, additionality with how much and contribution, and measurability with risk. However, the reporting dimension is missing or less present, probably because it is a framework for assessing positive and negative impacts and not fully dedicated to impact investing. Furthermore, impact is considered from the perspective of the company, not the investor. This also explains why intentionality is not at the heart of this framework.
**Operating principles for impact management (OPIM)** The Operating Principles for Impact Management outline an end-to-end process consisting of five main elements: strategy, origination and structuring, portfolio management, exit, and independent verification. Each element has its own set of principles. In total, there are nine principles that serve as the foundational components of an effective impact management system. These Principles are based on two core concepts: (1) core elements of a robust impact management system; and (2) transparency of signatories' alignment with the Principles. The nine principles are described in Figure 5.3 and more details on each principle can be found at www.impactprinciples.org.

<figure><img src="image_145.png" /><figcaption>Figure 5.3: The nine operating principles for impact management (OPIM)</figcaption></figure>

Source: www.impactprinciples.org.

The process for adopting the Principles is similar to the PRI. In fact, an investor wishing to use the OPIM must become a signatory and meet certain obligations. To do so, the investor must submit a letter of commitment, disclose total and covered assets under management, pay registration and filing fees, and publish an annual disclosure statement. The disclosure statement details compliance with the Principles and includes independent verification reports. As of the end of June 2024, there are 181 signatories in 40 countries representing $539 billion in covered assets. Signatories managing more than $10 billion under the Principles are the International Finance Corporation (Multilateral, $92.1 bn), the European Bank for Reconstruction and Development (Multilateral, $61.9 bn), the European Investment Bank (Multilateral, $43.3 bn), the US International Development Finance Corporation (US, $35.1 bn), the Multilateral Investment Guarantee Agency (Multilateral, $31.3), IDB Invest (Multilateral, $21.0), Brookfield Global Transition Fund (US, $15 bn), The Rise Fund (US, $15.0 bn), FMO (Netherlands, $14.1 bn), DEG (Germany, $11.4), BlackRock (US, $10.4) and BentallGreenOak (Canada, $10.1 bn).
5.1.2 Historical perspectives

The practitioner’s corner

Contrary to what we can read on the Internet (e.g., Wikipedia), the term ‘impact investing’ did not appear for the first time in 2005 or 2007. It was used in the 1990s and perhaps earlier, and was associated with ethical investing, community investing, or philanthropic investing:

> "Portfolio screening is by far the most prevalent approach [...] The second SRI approach, targeted investing, may hold greater promise for minority media, particularly for small local firms. Also known as community investing or high-impact investing, this method seeks out opportunities where relatively small capital investment can generate substantial social returns. Unlike portfolio screening, there is usually no demand that returns match or beat a specific benchmark." (Kurtz, 1999, page 685).

However, it is true that the term impact investing was popularized by the Rockefeller Foundation in the late 2000s. According to Höchstädter and Scheck (2015), the term impact investing was exten- sively discussed and largely adopted in October 2007 when investors and philanthropic organizations were invited to a Bellagio meeting organized by the Rockefeller Foundation<fnref n="11" />. In addition, Antony Bugg-Levine, who was a managing director at the Rockefeller Foundation from 2007 to 2011, has been instrumental in popularizing the term impact investing. In November 2010, he participated in the first comprehensive research study conducted by J.P. Morgan and the Rockefeller Foundation (O’Donohoe et al., 2010). In June 2011, he also co-authored with Jed Emerson<fnref n="12" />, Executive Vice President of ImpactAssets<fnref n="13" />, the book *Impact Investing: Transforming How We Make Money While Making a Difference* (Bugg-Levine and Emerson, 2011). In September 2009, the Rockefeller Founda- tion, the United States Agency for International Development and other participants also launched the Global Impact Investing Network (“the GIIN”) to accelerate the development of a more effective impact investing industry.

<figure><img src="image_146.png" /><figcaption>Figure 5.4: The Rockefeller Foundation</figcaption></figure>

The philanthropic sector has been instrumental in developing and structuring the impact invest-
ing market. This is because the philanthropic sector has long experience in this area, as venture
philanthropy has been developed since the 1970s. Venture philanthropy can be seen as the appli-
cation of concepts and techniques from venture capital to the management of philanthropic goals
(Letts et al., 1997). In 2012, the OECD launched the Network of Foundations Working for Devel-
opment (netFWD), a group of foundations and philanthropic leaders committed to optimizing the

<footnote n="11">¹¹The Bellagio Center, located in Bellagio, Italy, is a prestigious retreat operated by the Rockefeller Foundation.</footnote>

<footnote n="12">¹²Jed Emerson is known as the creator of the blended value proposition, which is another name for impact investing (Emerson, 2003).</footnote>

<footnote n="13">¹³ImpactAssets was founded in 2010 as a spin-off of Calvert Impact Capital.</footnote>
impact of philanthropy in development with three main axes: education, gender, and health. All of these initiatives have given rise to the term philanthropic capitalism. Another group of investors that has been key to the development of the impact investing market are Development Finance Institutions (DFIs). According to OECD, “DFIs are specialised development banks or subsidiaries set up to support private sector development in developing countries. They are usually majority-owned by national governments and source their capital from national or international development funds or benefit from government guarantees. This ensures their creditworthiness, which enables them to raise large amounts of money on international capital markets and provide financing on very competitive terms.” We generally distinguish two types of DFIs:

* Bilateral DFIs are typically owned and primarily funded by a single national government and focus on development projects in developing countries that align with the foreign policy and economic interests of the owning country<fnref n="14" />;

* Multilateral DFIs are owned and funded by a consortium of national governments and operate on a broader international scale, supporting development projects that promote global or regional development goals<fnref n="15" />.

The weight of DFIs in impact investing is significant. For example, if we look at the signatories of the Operating Principles for Impact Management (OPIM), the breakdown as of June 2024 is as follows:

<table><thead><tr><th></th><th>Bilateral DFIs</th><th>Multilateral DFIs</th><th>Other signatories</th><th>Total</th></tr></thead><tbody><tr><td>Number of investors</td><td>17</td><td>8</td><td>142</td><td>167</td></tr><tr><td>Covered assets (in $ bn)</td><td>100.5</td><td>252.3</td><td>187.0</td><td>539.9</td></tr><tr><td>Covered assets (in %)</td><td>18.6%</td><td>46.7%</td><td>34.6%</td><td>100%</td></tr></tbody></table>

The 25 DFIs represent approximately 65% of the $539 billion in covered assets, while the 142 other signatories, including some major investors such as Brookfield Asset Management, BlackRock, UBS Group, Zurich Insurance Group and Amundi, represent less than 35%. The International Finance Corporation is arguably the most influential and active DFI in impact investing. It is one of the five institutions of the World Bank. The other four are the International Bank for Reconstruction and Development (IBRD), the International Development Association (IDA), the Multilateral Investment Guarantee Agency (MIGA), and the International Centre for Settlement of Investment Disputes (ICSID). While the IBRD lends to governments of middle-income and creditworthy low-income countries and the IDA provides highly concessional financing to governments of the poorest countries, the IFC provides loans, guarantees, equity, advisory and project development services, and mobilizes capital from other sources to increase private sector investment in developing countries. As such, IFC is responsible for supporting and financing private companies in the developing world with two overarching goals: reducing extreme poverty (SDG 1) and promoting shared prosperity (SDG 10). This positioning explains IFC's important role in impact investing. In addition to its massive direct investments, IFC has established OPIM and promoted blended finance with several innovations in deal structuring.

<footnote n="14">¹⁴The main bilateral DFIs include OeEB (Austria), BIO (Belgium), BMI-SBI (Belgium), FinDev Canada (Canada), IFU (Denmark), Finnfund (Finland), AFD/Proparco (France), KfW/DEG (Germany), CDP/SIMEST (Italy), FMO (Netherlands), Norfund (Norway), SOFID (Portugal), COFIDES (Spain), Swedfund (Sweden), SIFEM (Switzerland), CDC Group (United Kingdom) and the US International Development Finance Corporation (United States).</footnote>

<footnote n="15">¹⁵The main multilateral DFIs include AFDB (African Development Bank), ADB (Asian Development Bank), EBRD (European Bank for Reconstruction and Development), EIB (European Investment Bank), IDB (Inter-American Development Bank), IFC (International Finance Corporation) and ISDB (Islamic Development Bank).</footnote>
Box 5.1: Blended finance and impact investing

In simple terms, blended finance is the combination of public and private capital to finance projects in developing countries with social/environmental impacts. There are many variations on this definitionª:

* "Blended finance is the use of catalytic capital from public or philanthropic sources to increase private sector investment in sustainable development." (Convergence).

* "Blended finance is the strategic use of public finance for the mobilization of additional private finance towards sustainable development in developing countries. The most significant value of blended finance transactions is the ability to unlock funding for investments in areas that are not well funded. These investment segments are typically seen as 'too risky' for low-risk-seeking investors, or returns are not commensurate with risk for risk-seeking investors." (World Economic Forum).

* "Blending involves the strategic use of a limited amount of grant resources to catalyse additional financing for development projects. Grants are often combined with loans, equity, beneficiary resources or other forms of financing, with the aim of de-risking projects and making them bankable. Blending allows partners to get the most out of their grant resources and enhance their overall development impact." (European Investment Bank).

Each definition complements the simple one by highlighting some aspects of blending finance. For example, blending finance acts as a catalyst, helping to initiate or increase the scale of private investment that might not otherwise have taken place. In effect, this approach aims to fill financing gaps for projects or sectors in developing countries that private and traditional investors consider too risky or not profitable enough. In addition, these projects must contribute to the achievement of a number of sustainable development goals. In fact, blended finance differs from a traditional investment partnership or co-investment approach. In these cases, all investors take the same risk and receive the same financial return, but blended finance is not based on a mutual fund or club deal structure. Public investors take more risk than private investors or improve their risk/return profile to attract the private sector to finance the project. According to Flammer et al. (2024), blending can take the form of a concessional loan (with a below-market interest rate), a junior equity tranche, a risk management provision (including credit enhancement), or performance-based incentives. In order to achieve this type of blending, the deal must adopt a structuring approach. A typical example is a pay-through structure where the junior tranche is held by the public investors and the senior tranche is held by the private investors (Roncalli, 2020a, page 139). In this context, blending finance acts as a leverage of the funds provided by the public investors. For example, if the junior tranche corresponds to 20% of the first losses and $1 billion of capital, the leverage ratio is equal to 5, meaning that this structure has mobilized $5 billion of capital, of which $4 billion comes from the private sector. By definition, blended finance is part of impact investing, as the objective of the investment is to finance projects with social or environmental benefits. For public investors, blended finance ticks all the boxes: intentionality, additionality and measurability. This is not the case for private investors, who bear only part of the risk.

<footnote>ªThese definitions can be found at www.convergence.finance, www.weforum.org and www.eib.org.</footnote>
Alongside philanthropic investors and development finance institutions, private equity investors have historically been the third category that has driven impact investing. This is expected given that impact investing began in the private equity and debt markets. This makes this market very different from the traditional ESG investment market. In fact, traditional asset managers have only recently embraced the concept of impact investing, whereas they have been implementing ESG investing for a long time. Not surprisingly, impact investing has its roots in the United States, the largest market and a pioneer in private equity and private debt. In 2011, ImpactAssets began compiling an annual list of the top 50 fund managers engaged in impact investing. Since then, the list has been revised annually through 2024. Below we reproduce the list from 2011. We note that most of the fund managers are active in private equity (34 fund managers) and private debt (25 fund managers). The first appearance of the public equity asset class in the Impact Assets 50 was in 2012, with 5 fund managers. This asset class peaked in 2018 with 7 fund managers. However, public assets (cash, public debt and public equity) remain far behind private assets (private debt, private equity and real estate), which represent at least 80% of the fund managers in the Impact Assets 50 list. This confirms the importance of real assets and their fund managers.

<table><caption>Table 5.4: Impact Assets 50 list in 2011</caption><thead><tr><th>Fund</th><th>Cash</th><th>Commodities</th><th>Private Debt</th><th>Private Equity</th><th>Public Debt</th><th>Public Equity</th><th>Real Estate</th></tr></thead><tbody><tr><td>Absolute Portfolio Management</td><td></td><td></td><td></td><td></td><td>✓</td><td></td><td></td></tr><tr><td>Accion</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Acumen Capital Partners LLC</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Bamboo Finance</td><td></td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td></tr><tr><td>BAML Capital Access Funds Management, LLC</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Beartooth Capital</td><td></td><td></td><td></td><td></td><td></td><td>✓</td><td></td></tr><tr><td>BlueOrchard Finance Ltd</td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Bridges Fund Management Ltd</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Calvert Impact</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>City Light Capital</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Community Investment Partners</td><td></td><td></td><td></td><td></td><td>✓</td><td></td><td></td></tr><tr><td>Core Innovation Capital</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Creation Investments Capital Management, LLC</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Developing World Markets</td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>E+Co</td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>EcoEnterprises Fund</td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>EKO Asset Management Partners, LLC</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Elevar Equity</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>EnerTech Capital</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Equator Capital Partners</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Global Partnerships</td><td></td><td>✓</td><td></td><td></td><td></td><td></td><td></td></tr><tr><td>Good Capital</td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Grassroots Capital Management Corp, PBC</td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Habitat for Humanity International</td><td></td><td>✓</td><td></td><td></td><td></td><td></td><td></td></tr></tbody></table>

*Continued on next page*
<table><caption>Table 5.4: Impact Assets 50 list in 2011</caption><thead><tr><th rowspan="2">Fund</th><th colspan="6">Continued from previous page</th></tr><tr><th>Cash</th><th>Commodities</th><th>Private Debt</th><th>Private Equity</th><th>Public Debt</th><th>Public Equity</th><th>Real Estate</th></tr></thead><tbody><tr><td>IGNIA</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Incofin Investment Management</td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>LeapFrog Investments</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Living Cities Inc.</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Lumni</td><td></td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td></tr><tr><td>The Lyme Timber Company LLC</td><td></td><td></td><td></td><td></td><td></td><td>✓</td><td></td></tr><tr><td>Media Development Investment Fund, Inc.</td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>MicroVest Capital Management, LLC</td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Mindful Investors</td><td></td><td></td><td></td><td>✓</td><td></td><td></td><td></td></tr><tr><td>Minlam Asset Management</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Murex Investments</td><td></td><td></td><td></td><td>✓</td><td></td><td></td><td></td></tr><tr><td>Nonprofit Finance Fund</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Pacific Community Ventures</td><td></td><td></td><td></td><td>✓</td><td></td><td></td><td></td></tr><tr><td>Partners for the Common Good</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Public Radio Capital</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Renewal2</td><td></td><td></td><td></td><td></td><td>✓</td><td></td><td></td></tr><tr><td>Root Capital</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>RSF Social Finance</td><td>✓</td><td>✓</td><td></td><td></td><td></td><td></td><td></td></tr><tr><td>Sarona Asset Management</td><td></td><td></td><td></td><td>✓</td><td></td><td></td><td></td></tr><tr><td>Satori Capital</td><td></td><td></td><td></td><td>✓</td><td></td><td></td><td></td></tr><tr><td>Shared Interest</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>SJF Ventures</td><td></td><td></td><td></td><td>✓</td><td></td><td></td><td></td></tr><tr><td>Small Enterprise Assistance Funds</td><td></td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td></tr><tr><td>SustainVC</td><td></td><td></td><td></td><td>✓</td><td></td><td></td><td></td></tr><tr><td>Symbiotics SA</td><td></td><td></td><td>✓</td><td></td><td></td><td></td><td></td></tr><tr><td>Triodos Investment Management</td><td></td><td></td><td>✓</td><td>✓</td><td></td><td></td><td></td></tr><tr><td>Total</td><td>1</td><td>0</td><td>25</td><td>34</td><td>2</td><td>0</td><td>2</td></tr></tbody></table>

Source: https://impactassets.org/ia50.

The role of institutional investors has been fundamental to the development of ESG investing. However, with the exception of non-profits and foundations that see impact investing as an effective way to align their investments with their values, impact investing remains a niche sector for other institutional investors, particularly pension funds and insurance companies (Wood, 2013). For example, in 2022, impact investing accounted for less than 0.3% of ESG strategies (Table 1.11 on page 48). However, this is the figure calculated by the Global Sustainable Investment Alliance, which is primarily an institutional investor platform. There are several reasons for this lack of mobilization around impact investing. Impact investing requires more resources and knowledge than ESG investing, which can be quickly implemented by purchasing external ESG ratings. Impact investing is a specialized market by nature, with no mainstream investment vehicles. Another reason is the perception by institutional investors that the risk behind impact investing is higher than the risk
behind other traditional investments<fnref n="16" /> (e.g., liquidity risk, credit risk). There is one segment of the impact investing market where institutional investors have a massive presence. This is blended finance. But this is understandable because it is strongly supported by public investors such as DFIs and MDBs and the asset managers who structure the investment project. They do not invest directly in the projects.

<figure><img src="image_147.png" /><figcaption>Figure 5.5: Global Impact Investing Network</figcaption></figure>

The impact investing ecosystem is complex, with many organizations dedicated to this market. The most prominent is the GIIN, a non-profit organization. Since its inception and under the leadership of its charismatic CEO, Amit Bouri, the GIIN has played a leading role in advancing the field of impact investing. In particular, the organization has developed and hosts a number of tools and resources to help investors navigate the impact investing landscape:

* Impact Reporting and Investment Standards (IRIS), which provides a common language and framework for measuring and reporting on the social and environmental impact of investments;

* GIIN Benchmarks, which allow investors to measure the impact performance of their investments relative to the market, peer groups and against the scale of the social and/or environmental challenge;

* GIIN COMPASS is a methodology for comparing and assessing impact that aims to standardize the components and process of impact performance analysis at the aggregate investment, fund or portfolio level;

* Operating Principles for Impact Management (OPIM) is a framework for investors to implement their impact management systems, ensuring that impact considerations are integrated throughout the investment lifecycle.

Today, the GIIN has more than 400 members in 50 countries<fnref n="17" />. The GIIN also publishes a number of reports and surveys on impact investing. In addition to the GIIN, many other organizations are involved in impact investing, such as ImpactAssets or Impact Europe.

## The academic's corner

Academics have also been involved in studying impact investing. However, they have been less prolific in this area compared to other aspects of sustainable finance, perhaps because this market is not easily accessible and data is not readily available. Moreover, they may use the term 'impact

<footnote n="16">¹⁶See the blog of Laure Wessemius-Chibrac published in November 2023 at www.impacteurope.net/insights/unlocking-institutional-resources.</footnote>

<footnote n="17">¹⁷We can find them at https://thegiin.org/members.</footnote>
investing' in a broader sense that does not fit the framework of intentionality, additionality, and measurability<fnref n="18" />. Höchstädter and Scheck (2015) provides a first survey of academics' and practitioners' understanding of impact investing<fnref n="19" /> and concludes that the heterogeneity of definitions is less pronounced than expected. However, this conclusion is not shared by Agrawal and Hockerts (2021). For these authors, the terminology has changed over time to be more accurate today. They also note that some academic articles make a distinction between impact investing, socially responsible investing, social impact bonds, microfinance and venture philanthropy, while others do not. The paper by Chiappini et al. (2023) analyzes 196 academic papers published over the years 2011–2021 on impact investing and seeks to answer the following research questions: (1) What are the research trends in impact investing? (2) What are the most relevant and emerging topics? (3) What are the directions for future research? They first note that 75% of the articles have been published since 2018, while the years 2011–2015 show less than 6 publications per year. The most common keyword in these 196 articles is social impact bond (99 articles), far ahead of social enterprise (17 articles). According to Chiappini et al. (2023), the most cited article in 2021 was Private Finance for Public Goods: Social Impact Bonds by Warner (2013). Since then, it has been largely surpassed by Impact Investing by Barber et al. (2021), which is the most influential paper on impact investing in the last 5 years. The articles published by academics prior to 2021 are organized around three basic themes:

1. Impact investing as a source of funding for high-impact social enterprises

2. Theoretical drivers and issues related to the marketization/financialization of public services

3. The practice of social impact bonds

It is only recently that the issue of performance and risk in impact investing has attracted the attention of academics, particularly since the publication of Barber et al. (2021) and Geczy et al. (2021). Before 2021, it was common to say that the financial return of impact investments was below the market<fnref n="20" />, but without knowing exactly the magnitude between impact investments and traditional investments. Hand et al. (2021) collect seven published studies on the financial performance of impact investing for the GIIN: one academic study (Barber et al., 2021) and six industry reports<fnref n="21" /> (one from the IFC, two from Cambridge Associates and three from Symbiotics). Results are highly dependent on the market, methodology and data used. For example, IFC's private equity portfolio achieved a public market equivalent (PME) of 1.15, indicating that the portfolio outperformed a comparable public index by 15% over its lifetime. Similarly, the portfolio achieved a PME of 1.30 relative to the MSCI Emerging Market Index. Conversely, Barber et al. (2021) found that impact funds had an average internal rate of return (IRR) of 3.7% (with a median of 6.4%), compared to an average IRR of 11.6% (with a median of 7.4%) for impact-agnostic funds. Using random utility/willingness to pay (WTP) models, the authors estimated that investors accept 2.5 to 3.7 percentage points lower IRRs for impact funds. Heeb et al. (2023) conduct an experiment to assess the willingness to pay for CO₂ emission reductions with a panel of 527 experienced private investors and 125 high-net-worth impact investors. They show that investors have a significant

<footnote n="18">¹⁸An example of this is the famous paper *The Impact of Impact Investing* (Berk and van Binsbergen, 2024). The authors study the impact of divestment on the cost of capital and conclude that “our results suggest that to have impact, instead of divesting, socially conscious investors should invest and exercise their rights of control to change corporate policy.” Based on our definition, this paper focuses more on exclusion policy and ESG strategies than on impact investing. The next section, Investing WITH Impact vs. Investing FOR Impact, will clarify this.</footnote>

<footnote n="19">¹⁹The comprehensive survey on socially responsible investments written by Renneboog et al. (2008) makes no mention of impact investing.</footnote>

<footnote n="20">²⁰Kurtz (1999) already mentioned on page 686 that the expected return of impact funds must be below market.</footnote>

<footnote n="21">²¹We can find them at www.ifc.org/en/insights-reports, www.cambridgeassociates.com/insights/sustainable-impact-investing and www.symbioticsgroup.com/publications.</footnote>
WTP for sustainable investments, but do not pay significantly more for more impact, for example when emission reductions are multiplied by a factor of 10. They also find that there is no significant difference between private investors and impact investors. Of course, these results relate to carbon reduction impacts and cannot be generalized to social and other environmental impacts, but they are still of interest to financial professionals.

Box 5.2: Willingness to pay (WTP)

Willingness to pay (WTP) is a measure of the maximum amount an individual is willing to pay for a good or service. It reflects the value an individual places on that good or service. The calculation of WTP depends on the context and can involve different methods (Breidert, 2006). The most common approaches are survey methods (e.g., contingent valuation, conjoint analysis), experimental methods (e.g., simulated experiment, auction), market data analysis (e.g., hedonic price), or econometric models (e.g., demand estimation, discrete choice model). The hedonic price technique assumes that the price P of a good is a function of its attributes $X_1, X_2, \dots, X_m$:

$$P = \beta_0 + \sum_{j=1}^{m} \beta_j X_j + \varepsilon$$

The WTP for the attribute $X_j$ can be calculated as:

$$WTP = \frac{\partial P}{\partial X_j} = \beta_j$$

In discrete choice models, willingness to pay can be derived from the (random) utility function of good i:

$$\mathbf{u}_i = \alpha + \beta P_i + \sum_{j=1}^{m} \gamma_j X_{i,j} + \varepsilon_i$$

We have:

$$WTP = \frac{\partial P_i}{\partial X_{i,j}} = \frac{\partial \mathbf{u}_i / \partial X_{i,j}}{\partial \mathbf{u}_i / \partial P_i} = \frac{\gamma_j}{\beta}$$

Barber et al. (2021) assume that the utility function of investor i, facing a binary choice of whether to invest in fund j, is given by:

$$\mathbf{u}_{i,j} = \alpha_i + \beta \mathbb{E}[R_j] + \sum_{j=1}^{m} \gamma_j X_j + \sum_{j=1}^{m'} \gamma'_j X_{i,j} + \delta_i \mathbb{I}_j + \varepsilon_i$$

where $\mathbb{E}[R_j]$ is the expected return for fund j, $X_j$ is a set of fund characteristics (e.g., region, sector, fund size), $X_{i,j}$ is a set of investor characteristics and $\mathbb{I}_j$ is a dummy variable equal to one if fund j is an impact fund and zero otherwise. Therefore, the WTP for impact for investor i is:

$$WTP = \frac{\partial \mathbb{E}[R_j]}{\partial \mathbb{I}_j} = \frac{\partial \mathbf{u}_{i,j} / \partial \mathbb{I}_j}{\partial \mathbf{u}_{i,j} / \partial \mathbb{E}[R_j]} = \frac{\delta_i}{\beta}$$
### 5.1.3 Investing FOR impact vs. investing WITH impact

For a long time, there was no distinction between investing for impact and investing with impact. By the 2010s, the two terms were interchangeable and had the same meaning. For example, in 2013, the Swiss impact investing firm Obviam AG and the bank Morgan Stanley published two reports *Investing For Impact* and *Investing With Impact*, but the content and themes were the same (Martin, 2013). In 2018, the European Venture Philanthropy Association<fnref n="22" /> clarifies “*the distinction between investing with impact, where impact is a secondary dimension of investing alongside financial return, and investing for impact, a segment where impact is the key dimension driving investment decisions.*” (Gianoncelli et al., 2019, page 3). Investing for and with impact lies between the two extremes of the ESG spectrum: traditional philanthropy and SRI. On the one hand, investing for impact puts the social purpose organization (SPO) or social project and its beneficiaries at the center. On the other hand, investing with impact must guarantee a financial return that is competitive with the market. The degree of intentionality and the active risk taken by investors help to differentiate between *for* and *with*.

<figure><img src="image_148.png" /><figcaption>Figure 5.6: The impact ecosystem spectrum</figcaption></figure>

Source: Gianoncelli et al. (2019, Figure 13, page 44).

Figure 5.6 reproduces the impact ecosystem spectrum developed by Gianoncelli et al. (2019). The difference between *for* and *with* comes from the nature of the enterprises or projects to be financed, which must have a social purpose. Table 5.5 outlines some characteristics of these two types of investors, according to the EVPA. Investors with impact are in fact traditional investors who invest in conventional companies, use a market benchmark and want to have a positive impact on society. The market risk of their investments and their management approach are very similar to those of their other investments. A typical example is an asset owner who has converted his investment in the S&P 500 Index into the S&P 500 Climate PAB Index. This decision has a positive impact on society, so it is an investment with impact.

<footnote n="22">²²The European Venture Philanthropy Association (EVPA), a non-profit organization based in Brussels, was founded in November 2003 by a group of European venture capitalists to apply the skills developed in the venture capital industry to the charity sector. In 2023, the EVPA becomes Impact Europe (www.impacteurope.net).</footnote>
<figure><img src="image_149.png" /><figcaption>Table 5.5: The roles of investors *for* and *with* impact</figcaption></figure>

The motivation and the risks taken by investors for impact are different. Their goal is to finance the development of companies with a social and solidarity vocation, with the aim of ensuring that vulnerable populations benefit from the services provided by these companies. If these companies are very attractive from a financial perspective, or if they have no difficulty attracting capital, it is not an impact investment. A typical example is an investment in a global pharmaceutical or multinational food company, such as Pfizer or Danone. The financing of Moderna in 2010 or Aspire Food Group in 2013 could be considered an investment for impact. Figure 5.7 presents the charter of investors *for* impact and its 10 principles developed by EVPA members and 65 experts.

<figure><img src="image_150.png" /><figcaption>Figure 5.7: The charter of investors *for* impact</figcaption></figure>

Source: Gianoncelli et al. (2019, page 85).
The terminology of investing for impact and investing with impact is close to a new impact investing framework developed by Busch et al. (2021), who suggests distinguishing between impact-aligned investments and impact-generating investments. They justify this new framework as follows:

> "Practitioners and academics have been using different terms to describe investments in the sustainability context. The latest inflationary term is impact investments — investments that focus on real-world changes in terms of solving social challenges and/or mitigating ecological degradation. At the core of this definition is an emphasis on transformational changes. However, the term impact investment is often used interchangeably for any investment that incorporates environmental, social, and governance (ESG) aspects. In the latter instance, achieving transformational change is not the main purpose of such investments, which therefore carries the risk of impact washing (akin to green washing). To offer (re-)orientation from an academic perspective, we derive a new typology of sustainable investments. This typology delivers a precise definition of what impact investments are and what they should cover." (Busch et al., 2021, page 1).

The typology is presented in Table 5.6. The authors justify this typology because they believe that intentionality is not objective and additionality is difficult to prove. They define 4 categories of sustainable investments: ESG-screened, ESG-managed, impact-related and impact-generated. The first category corresponds to investments that incorporate a minimum of ESG considerations, typically exclusion criteria. The second category applies exclusion criteria and another approach to ESG pre-investment decision making, such as norms-based screening, best-in-class, ESG integration or thematic funds. The third and fourth categories correspond to impact investments. These two categories require the use of at least one of the post-investment decision approaches, such as voting and engagement. For impact-aligned investments, materiality and impact are assessed through benchmark analysis or level of SDG alignment and can be done ex-post. For impact-generating investments, materiality must be assessed and measured ex-ante to quantify the expected impact. We have two comments on this topology. The first relates to thematic funds, as the distinction between thematic funds and impact investing is often unclear. Indeed, some thematic funds can be classified as impact investing. The second comment concerns voting. Unlike engagement, it is not obvious that voting creates impact and is seen as an active contribution.

This typology has been adapted and adopted by Eurosif (Busch et al., 2024). There are some important changes. For example, the first two categories have been renamed Basic ESG and Advanced ESG. Documentation has been removed, while the Materiality dimension has become Performance Measurement. Finally, the dimensions Ambition Level and Investment Focus have been added. The new typology is shown in Table 5.7. Certainly the most important change is the introduction of the term ‘investor contribution’ in place of ‘investor impact’. Investor contribution is<fnref n="23" /> “the contribution that the investor makes to enable enterprises (or intermediary investment managers) to achieve impact.” In this topology, investors need to assess the extra-financial performance of the two impact categories by measuring company impact. They also need to measure their contribution in the case of impact-generating investments. Finally, this framework is closely related to investing for and with impact. Impact-aligned does not imply active contribution from the investor; it can be seen as investing with impact. Impact-generating, on the other hand, involves active contribution and greater engagement from the investor, aligning more with investing for impact. Whatever the framework, this duality between with and for or aligned and generating needs to be taken into account when we want to classify and define impact investing.

<footnote n="23">²³This definition comes from the impact investing framework developed by the Impact Management Principle (IMP), which is described on page 304.</footnote>
<table><caption>Table 5.6: A typology of sustainable investments</caption><thead><tr><th></th><th>ESG-screened</th><th>ESG-managed</th><th>Impact-Aligned</th><th>Impact-Generating</th></tr></thead><tbody><tr><td>Objective (underlying strategic purpose of the investment)</td><td>Mitigation of ESG-related risks and/or ethical considerations</td><td>Systematic reflection on ESG-related risks and opportunities</td><td>Address social and environmental challenges and goals</td><td>Actively contributing to social and environmental solutions and transformations</td></tr><tr><td>Materiality (measurement of tangible real-world parameters)</td><td>Materiality not addressed, i.e., no further detailed description of approach or outputs</td><td>Materiality not measured, i.e., only basic description of approach or outputs</td><td>Proof of materiality through the assessment of outputs via benchmark analysis or SDG alignment</td><td>Proof of materiality through the measurement of expected and generated impact</td></tr><tr><td>General approach (applied investment appraisal)</td><td>Any consideration of E, S, or G factors in investment appraisals; typically focusing on exclusion criteria</td><td>Comprehensive set of exclusion criteria; at least one further pre-investment decision approach* is applied</td><td>Comprehensive set of exclusion criteria; sophisticated combination of pre- and post-investment† decision approaches</td><td>Focus on impact generation by providing additional capital, incorporating forward-looking targets and/or post-investment† decision approaches</td></tr><tr><td>Documentation (efforts to increase transparency)</td><td>No detailed documentation</td><td>Basic description and ideally external verification</td><td>Detailed description and external verification</td><td>Detailed description and external measurement of impact achievements</td></tr></tbody></table>

<footnote>*Pre-investment decision approaches. Exclusions, norms-based screening, best-in-class, ESG integration, thematic funds.</footnote>

<footnote>†Post-investment decision approaches: voting, engagement.</footnote>
<table><caption>Table 5.7: Methodology for market studies on sustainability-related investments</caption><thead><tr><th></th><th>Basic ESG</th><th>Advanced ESG</th><th>Impact-Aligned</th><th>Impact-Generating</th></tr></thead><tbody><tr><th>Investment objective</th><td>Integration of ESG factors</td><td>Systematic analysis & incorporation of ESG factors</td><td>Align with positive impacts on environment and/or society</td><td>Measurable contribution to positive real-world impacts</td></tr><tr><th>Investment approach</th><td>Binding negative or positive screening</td><td>Binding negative & positive screening (≤ 80% of initial universe investable)</td><td>Binding negative & positive screening for assets with positive impact</td><td>Exclude non-transformable activities & use stewardship or provide new capital to assets to generate measurable positive impact</td></tr><tr><th>Performance Measurement</th><td></td><td>Measurement of ESG performance</td><td>Measurement of company impact</td><td>Measurement of company impact & investor contribution</td></tr><tr><th>Ambition level</th><td>Low</td><td>Moderate</td><td>Medium</td><td>High</td></tr><tr><th>Investment focus</th><td></td><td></td><td></td><td>Double materiality</td></tr></tbody></table>

Source: Busch et al. (2024).
### 5.1.4 Impact measurement

The issue of measurement is central to impact investing. It is one of the three dimensions of the intentionality-additionality-measurability framework, it corresponds to the How much and Contribute dimensions of the IMP framework, and it is also essential in the FOR or WITH approach. In addition, we need to distinguish between two types of impact:

1. The impact of the company, project or investee<fnref n="24" />;

2. The contribution of the investor.

#### General formula

The investor impact $\mathbb{I}_j^{(\text{investor})}(t)$ for metric $j$ is then equal to:

$$ \mathbb{I}_j^{(\text{investor})}(t) = \sum_{i=1}^{n} c_i^{(\text{investor})} \mathbb{I}_{i,j}(t) \qquad (5.1) $$

where $\mathbb{I}_{i,j}(t)$ is the impact measure of project $i$ for metric $j$ and $c_i^{(\text{investor})}$ is the investor's contribution to project $i$. In some special cases, we may use a specific contribution $c_{i,j}^{(\text{investor})}$ that depends on metric $j$. To compute the investor's impact, we must first collect the impact metrics measured at the project level.

<table><caption>Table 5.8: Impact data (Example 19)</caption><thead><tr><th>Project</th><th>Investor contribution</th><th>Avoided CO<sub>2</sub> emissions</th><th>Amount of renewable energy</th><th>Number of additional jobs</th><th>Number of new homes built</th></tr></thead><tbody><tr><td>1</td><td>10%</td><td>1 700</td><td>1 300</td><td>300</td><td></td></tr><tr><td>2</td><td>5%</td><td>1 500</td><td>650</td><td>100</td><td></td></tr><tr><td>3</td><td>20%</td><td>700</td><td>1 150</td><td>75</td><td></td></tr><tr><td>4</td><td>50%</td><td>5 000</td><td></td><td>150</td><td>5 000</td></tr><tr><td>5</td><td>12%</td><td>3 200</td><td></td><td>510</td><td>15 000</td></tr></tbody></table>

**Example 19** Consider an investor who has established an infrastructure fund in Africa that specializes in clean energy and housing. The investor's portfolio has financed three energy projects (two solar farms and one wind farm) and the construction of new homes in two countries. The impact data is reported above.

For the avoided CO₂ emissions, we have:

$$ \begin{aligned} \mathbb{I}_{\text{avoided}}^{(\text{investor})}(t) &= 0.10 \times 1\,700 + 0.05 \times 1\,500 + 0.20 \times 700 + 0.50 \times 5\,000 + 0.12 \times 3\,200 \\ &= 3\,269 \end{aligned} $$

These five projects have avoided 3 269 tCO₂e emissions. Similarly, the investor's portfolio has helped generate 392.5 MWh/year of renewable energy, created 183 jobs, and built 4 300 new homes.

Figure 5.8 presents two examples of impact reporting. Panel (a) displays data for Useroles, taken from the Mirova Energy Transition Infrastructure Impact Report 2023. The Useroles wind farm was developed and built by WKN France in the Burgundy-Franche-Comté region of the Côte d'Or. It is operational since 2019. Panel (b) provides figures for the BlueOrchard Microfinance Fund as of

<footnote n="24">²⁴In the following, we will use project as a generic term for company and investee.</footnote>
December 2023, taken from its Annual Impact Report 2023. Panel (a) therefore illustrates an impact report of a project, while Panel (b) illustrates an impact report of an investment. Note that the two reports are different in terms of the impact theme. The first report is based on environmental metrics, while the second report is based on financial inclusion. This means that the impact report is adapted to the investment strategy, which is normal. However, we also note that the Useroles wind farm report has a social component with an estimated 50 jobs supported and 100% women on board. In fact, the study of several impact reports shows that there is always a social aspect, even when the investment is in renewable energy. The opposite is not true.

<figure><img src="image_151.png" /><figcaption>Figure 5.8: Impact reporting</figcaption></figure>

Source: www.mirova.com & https://wwwblueorchard.com/products/blueorchard-microfinance-fund-bomf.

Calculating $\mathbb{I}_j^{(\text{investor})}(t)$ requires defining the impact of the project $\mathbb{I}_{i,j}(t)$. At the same time, there is a large literature on calculating impact and causality, and few resources when applied to impact investing<fnref n="25" />. There are several ways to calculate $\mathbb{I}_{i,j}(t)$. We can use discretionary methods or more scientific and technical methods (GDN, 2021, page 24). Regarding the later, So and Staskevicius (2015) group them into four categories: expected return (social return on investment or SROI, social cost-benefit analysis), theory of change (logic model), mission alignment methods (social value criteria, scorecards) and experimental methods (randomized controlled trial or RCT, historical baseline, pre/post assessment, regression discontinuity design, difference in differences).

<footnote n="25">²⁵Nevertheless, we can cite Reeder and Colantonio (2013), So and Staskevicius (2015), Mishra (2018), EIB (2021) and GDN (2021).</footnote>
Certainly the most used approach is the pre-post comparison:

$$ \mathbb{I}_{i,j}(t) = \mathrm{KPI}_{i,j}(t) - \mathrm{KPI}_{i,j}(t-h) $$

This method compares the pre-investment KPI at time $t-h$ and the post-investment KPI at time $t$. For example, consider a company that had 20 employees five years ago and now has 150 employees. The number of additional jobs is:

$$ \mathbb{I}_{i,j}(t) = 150 - 20 = 130 $$

Another approach is to use a benchmark:

$$ \mathbb{I}_{i,j}(t) = \mathrm{KPI}_{i,j}(t) - \mathrm{KPI}_{i,j}^{*}(t) $$

where $KPI_{i,j}^*(t)$ is the benchmarked KPI. For example, the benchmark may be a control group. In the case of microfinance, a typical control group is the set of microenterprises that do not benefit from microfinance support. A third method is to use randomized controlled trials:

$$ \mathbb{I}_{i,j}(t) = \frac{1}{n'} \sum_{i'=1}^{n'} (\mathrm{KPI}_{i,j}(t) - \mathrm{KPI}_{i',j}(t)) $$

where $i' \in C$ and $C$ is the control group that serves as the baseline against which the impact of the investment is compared. The idea is to randomly select projects in the control group and compare the KPI of project $i$ with the KPI of the selected projects.

Box 5.3: Microeconomic impact assessment of the EIB's support for small businesses in the EU

The EIB Group supports access to finance for SMEs through commercial banks with the aim of promoting business performance, job creation and investments that increase productivity and competitiveness. This support is provided through multi-beneficiary intermediated loans, which benefit SMEs in two main ways:

1. Lower financing costs or longer loan maturities
Financial intermediaries pass on the EIB's advantageous funding conditions to SMEs, resulting in lower financing costs or longer loan maturities. This improves the profitability of SMEs, leading to increased investment and job creation.

2. Improving access to credit
EIB funding helps to ease credit constraints for SMEs, especially during economic downturns. By broadening the funding base of banks, the EIB enables them to lend to more companies with viable projects that might otherwise struggle to secure financing.

The EIB's Economics Department evaluated the benefits of intermediated lending to EU SMEs using quasi-experimental methods, comparing supported SMEs with similar un-supported firms. The results showed that EIB-supported loans led to a 4-6% increase in employment and an 8-14% increase in fixed assets for recipient firms. Smaller or younger firms experienced even larger positive employment and investment effects.

Source: EIB (2021, pages 20-21).
<figure><img src="image_152.png" /><figcaption>Figure 5.9: Impact on employment of EIB-supported lending to small and medium-sized enterprises</figcaption></figure>

Performance of EIB loan beneficiaries (Treated) against the comparison group (Control) in the three years before and after the loan allocation, which takes place in year $t = 0$.

Source: EIB (2021, Figure 12, page 21).

Another issue in the calculation of $\mathbb{I}_j^{(\text{investor})}(t)$ is the determination of the investor's contribution $c_i^{(\text{investor})}$ to project $i$. It is rare that a project is fully supported by one investor, most of the time several investors participate in the financing of the project and not always at the same time and in the same phases. For example, a renewable energy project is typically divided into three main phases: development, construction, operation. Each phase is assigned an allocation key that represents a percentage of the total project value. Suppose the allocation key is 20%, 30%, and 50%, respectively, and the investor owns 10% of a company that participated in 60% of the development phase and 30% of another company that participated in 40% of the operation phase. In this case, the investor's contribution to the project is:

$$c_i^{(\text{investor})} = 10\% \times 60\% \times 20\% + 30\% \times 40\% \times 50\% = 1.2\% + 6\% = 7.2\%$$

If the project generates 1000 MWh, the impact of the investor is:

$$\mathbb{I}_{i,j}(t) = 7.2\% \times 1000 = 72 \text{ MWh}$$

**Remark 48** The allocation to project phases is a difficult task. It is common in private equity, but not in public equity. Moreover, there may be some issues of double counting, which is a real problem in the case of impact investing when we refer to the dimension of additionality. Let us take the previous example and assume that the renewable energy project is operated by a listed company. The listed company may report that it generates 1000 MWh, while the impact allocation for the operational phase is only 500 MWh.
## Impact measurement tools

There are really no standards that have emerged for impact reporting. Comparing two reports is not easy, especially if the two impact funds have two different impact investment focuses (Table 5.9). For example, we cannot compare Blue Ocean, Financial Inclusion and Agriculture & Forestry impact funds because the impact metrics are so different.

<table><caption>Table 5.9: Impact investment focus</caption><tr><td>Affordable housing & community development</td><td>Place-based impact & local economic resilience</td></tr><tr><td>Arts and culture preservation</td><td>Media, technology & mobile</td></tr><tr><td>Clean technology, alternative energy & climate change</td><td>Microfinance, low-income financial services & micro-insurance</td></tr><tr><td>Demographic-based impact</td><td>Natural resources & conservation</td></tr><tr><td>Diversity, equity and inclusion</td><td>Nutrition, health & wellness</td></tr><tr><td>Education</td><td>Racial equity and justice</td></tr><tr><td>Fair trade</td><td>Small/medium business development</td></tr><tr><td>Global health</td><td>Sustainable agriculture</td></tr><tr><td>Job creation and workforce development</td><td>Water, sanitation and hygiene (WASH)</td></tr></table>

Source: ImpactAssets (2024), https://impactassets.org/ia-50.

This is less true when we look at impact funds with the same focus. For example, here are five well-known financial inclusion (or microfinance) funds:

* BlueOrchard Microfinance Fund (BOMF), www blueorchard com/products / blueorchard - microfinance - fund - bomf

* Triodos Microfinance Fund, www.triodos-im.com/funds/triodos-microfinance-fund

* ResponsAbility Global Micro and SME Finance Fund, www.responsability.com/en/ investment - products / responsability - global - micro - and - sme - finance - fund

* MicroVest Capital Management, www.microvestfund.com/impact-reports

* EIB Financial Inclusion Fund, www.eib.org/en/publications/financial-inclusion-fund

We find that these five impact reports use similar metrics, such as number of beneficiaries, female borrowers, rural borrowers, SMEs supported, number of jobs created or saved, average loan size, etc. However, beyond these common metrics, there are some differences in the information available, such as portfolio holdings, maturity statistics, location, etc.

In fact, there is no equivalent to TCFD reporting or SFDR in impact investing. For each impact topic, we need to find a reporting framework that fits the themes of the fund. For example, for water, sanitation and hygiene (WASH) and biodiversity, the Climate Disclosure Standards Board has published two application guidelines for disclosure (CDSB, 2021a,b). The most popular framework
for general topics is IRIS+. It can be found at https://iris.thegiin.org. There are more than 500 metrics available. To navigate, a system of filters is provided with the following sections^26: Impact Category, SDGs, Joint Impact Indicators, Dimensions of Impact, Operational Impact, Product Service Impact, Focus, Investment Lens and Financials. Within each section, we can select one or more items. For example, the Impact Category section has 18 items: Agriculture, Air, Biodiversity & Ecosystems, Climate, Diversity & Inclusion, Education, Employment, Energy, Financial Services, Health, Real Estate, Land, Oceans & Coastal Zones, Pollution, Waste, Water, Cross Category and Infrastructure. The Dimensions of Impact section corresponds to the IMP framework and there are 7 items: What, Who, How Much Scale, How Much Depth, How Much Duration, Contribution Depth and Risk. The Focus section has two elements: Environmental and Social. If we filter on the impact category Biodiversity and Ecosystems and the focus Environmental, we get the following metrics: Biodiversity Assessment (OI5929), Biodiversity Footprint (PI6887), Critical Marine Habitats (OI3846), Forest Management Plan (OI2622), Indigenous Rights and Stewardship Practices (OI6482), Land Directly Controlled: Cultivated (OI1674), Marine Area Directly Controlled: Total (OI7876), Pesticide Hazard Classification Type (OI7394), Species Abundance (PI8027), Species: Total (PI7728) and Threatened Species Policy (OI1618). Each metric has a code, a reporting format (e.g., decimal, percentage, text), a metric type, a metric level, an IRIS metric citation, usage guidance, a list of impact categories and themes, a list of SDG goals and targets, and a metric history. For example, code II6610 corresponds to the value of investments in communities historically marginalized on the basis of race and/or ethnicity^27. The reporting format is decimal, and the list of impact categories and themes includes diversity and inclusion (gender lens, racial equity lens), financial services (financial inclusion), real estate (affordable quality housing, green buildings), and water (water, sanitation, and hygiene WASH).

## 5.2 Sustainable Development Goals

The Sustainable Development Goals have already been introduced in Chapter 1 on page 19. The SDGs are a set of 17 global objectives established by the United Nations to address critical issues such as poverty, inequality, climate change and environmental degradation by 2030. Impact investing always refers to the SDGs, which are ubiquitous in impact reporting. For example, below we report on the SDGs addressed by the BlueOrchard Microfinance Fund (BOMF).

<figure><img src="image_153.png" /><figcaption>Figure 5.10: SDGs addressed by the BlueOrchard Microfinance Fund (BOMF)</figcaption></figure>

Source: www/blueorchard.com/products/blueorchard-microfinance-fund-bomf.

<footnote>^26The direct link is https://iris.thegiin.org/metrics.</footnote>

<footnote>^27"This metric is intended to capture the amount of capital managed by the organization that is invested into communities in which a majority (51%) of individuals are from groups historically marginalized due to race and/or ethnicity as defined locally." (source: https://iris.thegiin.org/metric/5.3/ii6610).</footnote>
5.2.1 Where we stand with the SDGs

At first glance, the 17 SDGs may seem like a list of different goals. However, they are highly interconnected. For example, Johan Rockström argued that all sustainable development goals are directly or indirectly related to sustainable and healthy food. Therefore, it is common to group the SDGs into a few clusters. For example, the 5Ps framework groups the SDGs into five key areas:

1. People: **SDG 1** (no poverty), **SDG 2** (zero hunger), **SDG 3** (good health and well-being),
   **SDG 4** (quality education), **SDG 5** (gender equality);

2. Planet: SDG 6 (clean water and sanitation), SDG 13 (climate action), SDG 14 (life below water), SDG 15 (life on land);

3. Prosperity: **SDG 7** (affordable and clean energy), **SDG 8** (decent work and economic growth),
   **SDG 9** (industry, innovation and infrastructure), **SDG 10** (reduced inequality), **SDG 11** (sustainable cities and communities),
   **SDG 12** (responsible consumption and production);

4. Peace: **SDG 16** (peace, justice, and strong institutions);

5. Partnership: **SDG 17** (partnerships for the goals).

Another famous grouping model is the SDG wedding cake, which is a visual representation to show
the interconnectedness of the SDGs (Figure 5.11). The cake is represented by several layers stacked
on top of each other. The bottom layer represents the biosphere, which is the foundation for all
life on Earth. It includes elements such as clean water, healthy ecosystems, and biodiversity (SDGs
6 & 13-15). The middle layer represents society, whose goals focus on human needs and social

<figure><img src="image_154.png" /><figcaption>Figure 5.11: The SDG wedding cake</figcaption></figure>

Source: www.stockholmresilience.org.
well-being (SDGs 1-5, 7, 11 & 16). The top layer represents the economy and consists of goals focused on economic growth and industry (SDGs 8-10 & 12). SDG 17 (partnerships for the goals) is shown alone and outside of the three-layer structure because of its unique role and the importance of cooperation between countries in promoting inclusive development (Gupta and Vegelin, 2016).

The data for the 231 unique indicators can be found at https://unstats.un.org/sdgs/dataportal. There are four approaches to analyzing them, corresponding to 4 different tags: Global Database, Country Profile, SDG Analytics, and Advanced Access through an API. The first tag is used to compare countries on selected indicators. For example, the indicator 1.1.1 measures the proportion of the population living below the international poverty line by sex, age, employment status and geographic location (urban/rural). It includes two variables. SI_POV_DAY1 corresponds to the proportion of the population below the international poverty line (%), while SI_POV Emp1 corresponds to the employed population below the international poverty line, by sex and age (%). The screenshot of the indicator selection window for all countries and the year 2020 is shown in Figure 5.12. The Country Profiles window helps track progress toward global sustainability goals.

<figure><img src="image_155.png" /><figcaption>Figure 5.12: SDG indicator selection window</figcaption></figure>

Since 2016, this SDG data has been analyzed annually by the United Nations, which produces a report to track the world's progress. The 2023 report comes to a pessimistic conclusion about achieving the SDGs by 2030:

> "Halfway to the deadline for the 2030 Agenda, the SDG Progress Report shows we are leaving more than half the world behind. Progress on more than 50 per cent of targets of the SDGs is weak and insufficient; on 30 per cent, it has stalled or gone into reverse. These include key targets on poverty, hunger and climate. Unless we act now, the 2030 Agenda could become an epitaph for a world that might have been." (United Nations, 2023, page 2).

The 2023 report highlights significant setbacks in achieving the SDGs due to the climate crisis, the war in Ukraine, economic difficulties, and the lingering effects of the COVID-19 pandemic. Here are some examples:

* Extreme poverty has increased, reversing decades of progress. Projections indicate that 575 million people will remain impoverished by 2030, and only one-third of countries will have
halved their national poverty levels by then. The COVID-19 pandemic has contributed sig-
nificantly to this setback. In 2020, 97 million more people were living on less than $2.15 a
day compared to pre-pandemic levels, bringing the total number of people living in extreme
poverty to 724 million.

* More than 600 million people worldwide are projected to be hungry in 2030. Nearly 2.4 billion people, or one in three, were moderately or severely food insecure in 2021. The prevalence of undernourishment increased from 7.9% in 2019 to 9.2% in 2021. Conflicts, economic shocks, and climate change worsened food security, with food prices increasing by 30% in 2021.

* Education gaps are widening, with 84 million children expected to be out of school by 2030 and 300 million students lacking basic numeracy and literacy skills by that year. In low-income countries, 40% of children of primary school age lack basic reading skills.

* Gender inequality persists, with 56% of countries lacking anti-discrimination laws for women. At the current rate, it will take 300 years to end child marriage, 286 years to close gaps in legal protection and eliminate discriminatory laws, and 140 years to achieve equal representation in workplace leadership. In 2020, women made up 40% of the global workforce but held only 28% of managerial positions, 25% of women aged 15-49 experienced physical or sexual violence by an intimate partner, and one in five young women were married before their 18th birthday.

* Global temperatures have risen by 1.1°C and may reach or exceed 1.5°C by 2035.

Despite these challenges, there have been notable improvements:

* Significant reductions in child mortality have been achieved, with 146 out of 200 countries on track to meet the under-5 mortality target. Effective HIV treatment has reduced AIDS-related deaths by 52% since 2010.

* The global population with access to electricity rose from 87% in 2015 to 91% in 2021. Renewable energy capacity in developing countries reached a record 268 watts per capita in 2021. Despite progress, 759 million people still lack electricity, and 675 million people still live in the dark.

* Internet access expanded by 66%, reaching 5.3 billion people in 2022.

On average, the UN estimates that 15% of the 231 indicators are on track, 48% are moderately or severely off track, and 37% are stagnant or regressing. The breakdown by SDG is shown in Figure 5.13, Panel (b). Some goals face a contrasting picture, with a high proportion of both on-track and off-track indicators, such as **SDG 12** (responsible consumption and production) and **SDG 14** (life below water). Some goals show a negative and doomed picture, such as **SDG 1** (no poverty), **SDG 4** (quality education), **SDG 6** (clean water and sanitation), **SDG 8** (decent work and economic growth), **SDG 13** (climate action), and **SDG 16** (peace, justice and strong institutions).

The United Nations does not publish country-by-country analysis, but SDG country profiles are available at https://unstats.un.org/sdgs/dataportal. Another way to access the country profile is to look at the annual report written by Sachs et al. (2024), which uses the same SDG data from the United Nations. The advantage of this report is that the authors aggregate all SDG information data to calculate average scores and indices by SDG, country or region in full transparency, as defined in a detailed methodological paper (Lafortune et al., 2018). Moreover, the raw data from the United Nations and the scores and indices from Sachs et al. (2024) are
<figure><img src="image_156.png" /><figcaption>Figure 5.13: Progress assessment for the 17 SDGs based on assessed targets, 2023 or latest data</figcaption></figure>

Source: United Nations (2023, pages 8 & 11).

freely available at https://dashboards.sdginDEX.org. Two examples of SDG country profiles are available in Figures 5.14 and 5.15, and correspond to those published in the Sustainable Development Report 2024. The website offers an interactive interface and more information on each country. In addition to the SDG level and trend scores for the 69 goals calculated using the 231 unique indicators, the authors also produce two synthetic scores:

* The SDG index (or overall score) measures overall progress toward achieving all 17 SDGs. The score can be interpreted as a percentage of SDG achievement. A score of 100 indicates that all SDGs have been achieved. Therefore, the difference between 100 and a country's SDG index score is the distance, in percentage points, that must be overcome to reach optimum SDG performance.

* The spillover index assesses a country's spillover effects. Indeed, each country's actions can have a positive or negative impact on the ability of other countries to achieve the SDGs. The spillover index aggregates such spillovers along three dimensions: environmental and social impacts embodied in trade, economic and financial, and security. A higher score means that a country is causing more positive spillovers and fewer negative ones.
<figure><img src="image_157.png" /><figcaption>Figure 5.14: SDR country profile (Finland, 2024)</figcaption></figure>
<figure><img src="image_158.png" /><figcaption>Figure 5.15: SDR country profile (South Sudan, 2024)</figcaption></figure>
The top five countries with the highest SDG index scores are Finland (86.35), Sweden (85.7), Denmark (85), Germany (83.45), and France (82.76), while the bottom five countries<fnref n="28" /> are South Sudan (40.14), Central African Republic (44.21), Chad (45.07), Somalia (45.42), and Yemen (46.87). In terms of the spillover index, the top five countries are Sierra Leone (98.71), Madagascar (98.67), Zambia (98.33), Maldives (97.67) and Malawi (97.44), while the bottom five countries are Singapore (28.49), Luxembourg (42.53), Qatar (43.33), Cyprus (44.61) and Switzerland (45.30). It is interesting to note that the two rankings are very different. In particular, we observe that poor countries have both a low SDG index and a high spillover index, while the opposite is true for rich countries. This illustrates the principle of ‘do no significant harm’. For example, rich countries can import goods from poor countries, which means that some of the consumption-based greenhouse gas emissions are outside the rich countries. Figure 5.16 shows the scatter plot between the SDG score and the spillover score for the 167 countries. In particular, we observe that a high SDG index is correlated with a low spillover index. On average, we obtain a Spearman correlation of -61% between the two series. The red curve corresponds to the fitted second-order polynomial regression:

$$ \text{Spillover}_i = -16.57 + 4.06 \times \text{SDG}_i - 0.0374 \times \text{SDG}_i^2 + \varepsilon_i $$

This negative relationship, especially for countries with high SDG scores, calls into question the global equilibrium. Does it mean that in order to achieve all the SDGs, a country must necessarily have a negative impact on other countries? The answer is complex. But it highlights the special status of SDG 17. The global achievement of the SDGs requires a global and strong partnership between countries, because sustainable development cannot be achieved in a fragmented world.

<figure><img src="image_159.png" /><figcaption>Figure 5.16: Relationship between the SDG index and the Spillover index</figcaption></figure>

<footnote n="28">²⁸To minimize bias due to missing data, the authors do not calculate the overall SDG index score and rank for countries with missing data on more than 20% of the indicators. Of the 193 UN member states, 167 countries are then scored and ranked.</footnote>
### 5.2.2 SDGs and impact investing

Although the SDG framework and indicators were designed for countries rather than companies, ESG investors have swiftly adopted this framework to align their investments with the SDGs. We can find several mapping tables between the 17 SDGs and the three ESG pillars. For example, Khaled et al. (2021) suggests mapping SDGs 2-3, 6-9, 11-15, and 17 to the E dimension, SDGs 1-5, 8, 10, 12, and 16-17 to the S dimension, and SDGs 5, 12, and 17 to the G dimension. Below we visualize the mapping we propose in Table 1.5 on page 20, which is very close to the mapping recommended by the private bank Berenberg<fnref n="29" /> in 2018.

<table><caption>Table 5.10: Aligning SDGs with ESG</caption><thead><tr><th>E</th><th>S</th><th>G</th></tr></thead><tbody><tr><td><strong>6</strong> CLEAN WATER AND SANITATION<br><img src="e6_image.png" alt="A water drop with a corresponding statement about clean water"></td><td><strong>7</strong> AFFORDABLE AND CLEAN ENERGY<br><img src="e7_image.png" alt="A sun with corresponding statement about affordable energy"></td><td><strong>8</strong> DECENT WORK AND ECONOMIC GROWTH<br><img src="e8_image.png" alt="A bar chart with corresponding statement about economic growth"></td></tr><tr><td><strong>9</strong> INDUSTRY, INNOVATION AND INFRASTRUCTURE<br><img src="e9_image.png" alt="A group of buildings with corresponding statement about industry and innovation"></td><td><strong>11</strong> SUSTAINABLE CITIES AND COMMUNITIES<br><img src="e11_image.png" alt="A group of buildings with corresponding statement about sustainable cities and communities"></td><td><strong>11</strong> SUSTAINABLE CITIES AND COMMUNITIES<br><img src="e11_image.png" alt="A bar chart with corresponding statement about sustainable cities and communities"></td></tr><tr><td><strong>12</strong> RESPONSIBLE CONSUMPTION AND PRODUCTION<br><img src="e12_image.png" alt="A circle with corresponding statement about responsible consumption and production"></td><td><strong>13</strong> CLIMATE ACTION<br><img src="e13_image.png" alt="A circle with corresponding statement about climate action"></td><td><strong>13</strong> CLIMATE ACTION<br><img src="e13_image.png" alt="A circle with corresponding statement about climate action"></td></tr><tr><td><strong>14</strong> LIFE BELOW WATER<br><img src="e14_image.png" alt="A fish with a corresponding statement about life below water"></td><td><strong>15</strong> LIFE ON LAND<br><img src="e15_image.png" alt="A group of trees with corresponding statement about life on land"></td><td><strong>17</strong> PARTNERSHIPS FOR THE GOALS<br><img src="e17_image.png" alt="A circle with corresponding statement about partnerships for the goals"></td></tr><tr><td><strong>1</strong> NO POVERTY<br><img src="e1 image.png" alt="A family with corresponding statement about no poverty"></td><td><strong>2</strong> ZERO HUNGER<br><img src="e2 image.png" alt="A bowl of food with corresponding statement about zero hunger"></td><td><strong>5</strong> GENDER EQUALITY<br><img src="e5 image.png" alt="A person with a corresponding statement about gender equality"></td></tr><tr><td><strong>3</strong> GOOD HEALTH AND WELL-BEING<br><img src="e3 image.png" alt="A heart with corresponding statement about good health and well-being"></td><td><strong>4</strong> QUALITY EDUCATION<br><img src="e4 image.png" alt="A book with corresponding statement about quality education"></td><td><strong>9</strong> INDUSTRY, INNOVATION AND INFRASTRUCTURE<br><img src="e9_image.png" alt="A group of buildings with corresponding statement about industry, innovation, and infrastructure"></td></tr><tr><td><strong>5</strong> GENDER EQUALITY<br><img src="e5 image.png" alt="A person with a corresponding statement about gender equality"></td><td><strong>6</strong> CLEAN WATER AND SANITATION<br><img src="e6 image.png" alt="A drop of water with corresponding statement about clean water and sanitation"></td><td><strong>12</strong> RESPONSIBLE CONSUMPTION AND PRODUCTION<br><img src="e12_image.png" alt="A circle with corresponding statement about responsible consumption and production"></td></tr><tr><td><strong>8</strong> DECENT WORK AND ECONOMIC GROWTH<br><img src="e8 image.png" alt="A bar chart with corresponding statement about decent work and economic growth"></td><td><strong>9</strong> INDUSTRY, INNOVATION AND INFRASTRUCTURE<br><img src="e9_image.png" alt="A group of buildings with corresponding statement about industry, innovation, and infrastructure"></td><td><strong>16</strong> PEACE, JUSTICE AND STRONG INSTITUTIONS<br><img src="e16 image.png" alt="A person with a corresponding statement about peace, justice, and strong institutions"></td></tr><tr><td><strong>10</strong> REDUCED INEQUALITIES<br><img src="e10 image.png" alt="A series of vertical lines with corresponding statement about reduced inequalities"></td><td><strong>12</strong> RESPONSIBLE CONSUMPTION AND PRODUCTION<br><img src="e12_image.png" alt="A circle with corresponding statement about responsible consumption and production"></td><td><strong>17</strong> PARTNERSHIPS FOR THE GOALS<br><img src="e17_image.png" alt="A circle with corresponding statement about partnerships for the goals"></td></tr><tr><td><strong>16</strong> PEACE, JUSTICE AND STRONG INSTITUTIONS<br><img src="e16_image.png" alt="A bird with a corresponding statement about peace, justice, and strong institutions"></td><td></td><td></td></tr></tbody></table>

<footnote n="29">²⁹Source: Berenberg (2018). Understanding the SDGs in Sustainable Investing. Report, December, 27 pages, www.berenberg.de.</footnote>