SUSTAINABLE FINANCE: COURSE SUMMARY

Dr. Hema Gwalani amd Dr. Sachin Mathur

School of Business Management, Mumbai
SVKM's Narsee Monjee Institute of Management Studies (NMIMS) Deemed-to-University

1. Introduction to Sustainable Finance

Definition of sustainability
Sustainable development is “development that meets the needs of the present without
compromising the ability of future generations to meet their own needs” (Brundtland, 1987).
The concept of sustainability is underpinned by three primary pillars: economic, social and
environmental.
United Nations Sustainable Development Goals (SDGs)
The UN SDGs are an urgent call for action by all countries. They constitute the heart of “the
2030 agenda for sustainable development” adopted by all UN member states in 2015.
Collectively, the UN SDGs serve as a frame of reference for incorporating sustainability in
decision-making by public policy makers as well as private institutions. Each of the 17 UN
SDGs may be categorised into one of the three primary pillars, viz., economic, social or
environmental. (The 17 SDGs are listed at https://sdgs.un.org/goals.)
Sustainable finance and corporate value
Under traditional corporate finance, managements aim to maximise the shareholders’ value
stated in financial terms (F). The sustainability framework modifies the objective to be
optimised, subject to constraints. To incorporate sustainability, a corporate may refine its value
framework by subjecting the maximum shareholder value objective to minimum social (S) and
environmental (E) value constraints. More ambitiously, a corporate may pursue a stakeholders’
value objective, wherein an integrated value (I = F + S + E) is optimised (Shoenmaker &
Schramade, 2018).
Internalising externalities
Externalities are costs (or benefits) imposed by the actions of one party (such as a corporate)
on uninvolved third parties (such as the society). In traditional capital budgeting or firm
valuation, corporates evaluate projects or businesses without considering externalities. Under
the sustainability framework, corporates may choose to “internalise externalities”, by
considering such indirect costs in their project and business evaluations.
The spectrum of sustainable investing
Sustainable investing takes several forms ranging from ESG investing (closer to conventional
investing) to impact investing (closer to philanthropy). The investing approaches differ in terms
of intention. In ESG investing, the intention is to consider the effect of ESG factors on
investment risks and opportunities. In impact investing, the intention is to create societal (E or
S) impact while earning a financial return. Traditionally, socially responsible investing (SRI)
has been based on shared personal values, unlike ESG investing, which is based on objective
(usually third-party) frameworks.

This course summary has been prepared by Dr. Sachin Mathur and Dr. Hema Gwalani for the course
on Sustainable Finance at SBM, NMIMS
 Further Reading for Topic 1. Introduction to Sustainable Finance
Session 1 PPT
SF Ch 1: Introduction to Sustainable Finance (Pg 1-18)
https://sbm.nmims.edu/docs/2024/Sustainable-Finance.pdf

2. Climate Risk
Climate change
Climate change constitutes the most important long-term environmental risk. The most
important climate change is the long-term rise in earth’s temperature (global warming), which
manifests in various ways including melting of ice, rise in sea levels and long-term change in
weather patterns. The consequences of climate change are expected to be severe. Extreme
temperatures can reduce agricultural yields, reduce work productivity, and extreme hot and
cold weather conditions may even lead to fatalities. As a consequence of the climate change,
infrastructure that has been built under current climate assumptions would need to be rebuilt.
Greenhouse gas emissions
Global warming is primarily caused by the trapping of heat by greenhouse gases (GHG),
majorly carbon dioxide, but also methane and other gases. Fossil fuels (coal, petroleum, natural
gas) are a major source of GHG emissions.
Scientific consensus
The Intergovernmental Panel on Climate Change (IPCC) may be credited with evolving and
nurturing a consensus about climate change. Today there is broad agreement about the extent
of climate change, the role of human activity in causing climate change and future climate
scenarios. It is also well-accepted that some of the ongoing changes, such as the rise in sea
levels, are irreversible.
Policy responses
Mitigation and adaptation are two main forms of government policy responses to climate
change. Mitigation involves minimizing climate change in the first place, largely by reducing
GHG emissions. Adaptation refers to responding to the negative effects of climate change. For
example, in response to increasing sea levels, the adaptative response will be to build sea walls,
or relocate the vulnerable communities.

Multilateral environmental agreements

The United Nations Framework Convention on Climate Change (UNFCCC), set up an
environmental treaty, signed by 154 countries, at Rio De Janeiro, Brazil, in 1992. Under the
UNFCCC framework, annual climate change conferences were held to serve as formal
meetings of UNFCCC parties. These were called UNFCCC Conference of the Parties, or COPs.
The COP 21 held at Paris, France, in 2015, adopted the Paris Agreement for GHG reduction.
The goal of the Paris Agreement is to hold “the increase in the global average temperature to
well below 2°C above pre-industrial levels” and make efforts “to limit the temperature increase
to 1.5°C above pre-industrial levels” (United Nations, 2015).
Under the Paris Agreement, each country had to submit a ‘Nationally Determined Contribution’
(NDC) – a climate action plan. The Paris Agreement requires countries to commit to
increasingly ambitious climate action in five-year cycles. As an example, India has committed
under its NDC to cut emissions by 45% below 2005 by 2030, to be net zero by 2070, and to
source 50% of installed power capacity from non-fossil fuel sources by 2030.

GHG Protocol

The GHG Protocol is a partnership between the World Resources Institute and the World
Business Council for Sustainable Development. It's the world's most widely used standard for
measuring and managing greenhouse gas emissions. The GHG Protocol categorizes a
company's emissions into three scopes to help businesses understand their entire value chain
emissions:

Scope 1: Direct emissions from a company's owned or controlled sources, such as vehicles and
factories

Scope 2: Indirect emissions from purchased energy, including electricity and heating for
production facilities.

Scope 3: Emissions across the entire value chain, including:

Upstream: Emissions from suppliers, raw material production, and parts manufacturing.
Downstream: Emissions by the users of products and services, including end-of-life disposal,
and other post-sale impacts.

Understanding these categories is important for mitigating the impacts of climate change.
Companies can use the scopes to identify the best opportunities to reduce their emissions

Challenges in Estimating these Emissions:

 Scope 3 Complexity: Difficulties in gathering accurate data across supply chain and
customer base.
 Data Availability & Quality: Limited visibility into supplier emissions and customer
usage patterns.
 Methodological Consistency: Challenges in standardizing emissions calculations
across diverse regions and suppliers.

Reliability for ESG investors:

 Dependence on Data Quality: Estimates rely on self-reported or third-party verified

data, which may lack transparency or consistency.
 Comparability Issues: Industry-specific measurement standards vary, limiting direct
comparison with competitors.

Carbon pricing
Carbon tax and emissions trading scheme (ETS) are the two main carbon pricing mechanisms.
The carbon tax is based on a predetermined tax rate on GHG emissions, or on the carbon
content of fossil fuels. Under carbon tax mechanism, the carbon price is predefined but not the
emission reduction outcome.
The ETS caps the total GHG emissions, and allows industries with low emissions to sell their
extra allowances to large emitters. Under ETS, the carbon price is not predefined but the
emission reduction outcome is well-defined. However, carbon tax is easier to administer than
the ETS.

Climate related business risks

Climate related business risks may be divided into physical risks and transition risks. Physical
risks arise due to hazards from changing climate. They may be acute (ex. floods, hurricanes,
wildfires) or chronic (related to rising temperatures or sea level). They may be direct, related
to the manufacturing or use of the products, or indirect. Indirect risks could be related to supply
chain, legal liability or systemic (ex. affecting employee productivity).
Transition risks may be structural or policy-related. Structural risks include technological (such
as substitution of conventional automobiles by electrical vehicles), those arising due to
consumer pressures for sustainable products, reputational risks or market risks. Policy-related
risks may range from outright prohibition to disincentives such as carbon taxes. Climate-related
risks can impact cashflows, as well as result in stranded assets & stranded human capital.
In order to manage business risks, a corporate must firstly assess it vulnerability to climate
risks. For physical risks, this will involve collecting data on local weather and climate at key
manufacturing and storage locations. It will also require building scenarios assessing the
likelihood and impact of climate changes and events. Corporates can buy insurance or build
adaptive infrastructure to handle physical risks. For transitional risks, the corporate must assess
the relevant trends in technology, customer preferences, competition and policy changes. The
corporate may also need to invest in new technologies and sustainable business models and
divest potential stranded assets and businesses.
Lenders and institutional investors, must assess vulnerability of each investment to financial
risks, reputational risk and legal liability. They must also periodically undertake portfolio level
assessment to consider the total exposure to climate risk, including the impact of climate risk
on the return correlations among the constituent loans or investments.
Further Reading for Topic 2. Climate Risk
Session 2 and 3.1 PPT
Background Note on Climate Risk
Case: : Driving Decarbonization at BMW
Why focus on carbon emissions in the full value chain?
Compare the life cycle carbon emissions of alternatives
Assess the reliability and comparability of carbon accounting metrics for Scope 1, 2 and 3

3. Regulatory Frameworks for Sustainability Reporting and Disclosure

Sustainability financial disclosure standards
Responsible investing depends in part on the usefulness of data. Data availability and quality
require regulations and standards for reporting, particularly on ESG-related issues that are
financially material. A number of disclosure standards and guidelines have developed across
the world. These include global standards and region-specific or country-specific local
standards. Among the global standards, two are dominant – the GRI Standards and the SASB
Standards (to be replaced by IFRS Sustainability Disclosure Standards, IFRS-S).
In addition, European Commission is developing its own draft “EU Sustainability Reporting
Standards” (ESRS). In several countries, the security regulators and exchanges have developed
their own guidelines. In India, BRSR is the SEBI-mandated sustainability reporting framework.
The Task Force on Climate-related Disclosures (TCFD), promoted by the Financial Stability
Board, has provided recommendations for relevant disclosures to investors. In the future,
disclosure frameworks are likely to ensure interoperability and align with TCFD. The GRI and
IFRS Foundation have signed a memorandum to coordinate their standard-setting activities.
The ESRS has incorporated the features of the new IFRS-S standards as a subset of its
standards.
However, there are some fundamental differences in the approaches among the recommending
bodies and standard-setters, which may prevent complete harmonisation. Some (including
TCFD and IFRS) define material issues from the viewpoint of investors and lenders, with
greater emphasis on climate. In contrast, others (such as ESRS and GRI) consider double
materiality from the perspective of both investors/lenders and other stakeholders, and place
emphasis on environment and social development.
BRSR
The Securities and Exchange Board of India (SEBI) introduced the Business Responsibility
and Sustainability Reporting (BRSR) guidelines in May 2021 (SEBI, 2021). The new
guidelines replaced the Business Responsibility Report (BRR) guidelines prescribed by SEBI
in 2015.
As per the BRSR, listed companies must report on performance under nine principles. The
performance indicators cover environmental, social and governance parameters and are
classified as essential (mandatory) and leadership (voluntary). The disclosures are quantitative
and standardised per the BRSR format prescribed by SEBI. The format covers the following
nine attributes – GHG emissions, water footprint, energy footprint, circularity, employee well-
being and safety, gender diversity in business, inclusive development, fairness in dealing with
customers and suppliers, and openness of business (SEBI, 2021). BRSR filings became
mandatory for the top 1000 listed companies by market capitalisation from 2022-23.
In July 2023, the SEBI prescribed a framework for assurance (for BRSR Core), updated the
BRSR format, and included ESG disclosures and limited assurance for the value chain (SEBI
2023). The BRSR Core covers a subset of the ESG performance indicators under the nine-
attributes of the BRSR. In the updated format, companies have to disclose the name of the
assurance provider, report on additional essential indicators, some which are new and others
that were earlier leadership indicators (i.e., voluntary). The assurance provider must have the
required expertise and must be independent.
Top 1000 listed entities have to prepare BRSR Core disclosures as part of their annual reports,
starting with top 150 companies from 2023-24. The ESG disclosures for value chain are
required under ‘comply or explain’ approach for the top 250 companies from 2025-26.
ESG Ratings
Institutional investors, investment managers and banks may conduct assessments internally or
use third-party ratings. Globally, there are more than 100 providers of ESG ratings. Providers
like Bloomberg and Refinitiv collect and aggregate publicly available data from company
filings, websites, and non-profit organisations. Providers such as MSCI, Sustainalytics, V.E.
and S&P Global combine publicly available information, including information collated by
analysts from public websites and media, with data collected through company
questionnaires/interviews. Other ESG data providers may automate their processes instead of
relying on analysts to create company scores.
Another area of differentiation is the rating methodology. Raters differ in the extent to which
their rating methodology has evolved to incorporate the data's materiality (relative importance).
Increasingly, most ESG rating providers use materiality in their rating methodology to provide
different weights to criteria for different industries (or even countries in case of governance).
Divergence in ESG ratings between the multiple rating providers is a key concern for the users
of third-party ratings. Empirical research shows that the correlation between ESG ratings from
different providers is moderate and can vary depending on what the raters choose to measure
and whether it is measured consistently.
Further Reading for Topic 3. Regulatory frameworks
Session 4 and 5.1 PPT
SF Ch 3: Regulatory Frameworks for Sustainable Finance (Pg 37-58)
https://sbm.nmims.edu/docs/2024/Sustainable-Finance.pdf

4. Sustainable Financing
Sustainable financing instruments
Financing is also be categorized by purpose into green or social. A subcategory within green is
known as transition financing, raised by firms for activities that can reduce environmental
impact but would not meet the stricter requirements of green bonds or loans. Debt which is
used for a combination of environmental and social activities is labelled as sustainability debt.
Firms may also raise sustainability-linked debt, which is raised for general corporate purpose,
with terms (usually coupon rate in case of bonds, and interest margin in case of loans) that are
linked to sustainability metrics.
Advantages of green financing
Market reports and empirical academic research documents the existence of a price premium
(lower yields) in the case of green bonds compared with similar conventional bonds, known as
greenium. Over a period of time, the reported greenium has reduced to around 5 basis points.
Oversubscription in the case of green bonds tends to exceed that in the case of plain vanilla
bonds. Green bonds also enjoy lower yield volatility in the secondary market, which provides
flexibility to investors who may later decide to sell. The stronger flexibility is especially
valuable in uncertain markets, more so in a crisis. Stable demand is an advantage for issuers
too, as even if they may not always achieve a meaningful greenium, they can be more certain
of subscription.
Beyond greenium and favourable demand, a third benefit for issuers is that green debt issues
signal issuers’ green commitment and can help attract stock investors who are sensitive to the
environment.
Greenwashing
The term greenwashing means making unsubstantiated or misleading claims about the
environmental commitments or performance of the firm or environmental benefits of a product
or service.
Some of the measures being used to combat greenwashing include lawsuits, development of
sustainable taxonomies, more specific disclosures (for instance, about indirect emissions),
sustainable financing guidelines, certifications, and second party opinions. The purpose of
these measures is to ensure that the utilisation of the proceeds of the issue is in accordance with
the stated objectives of the issue, and aligned with taxonomies, principles and standards.
Green taxonomies
Taxonomies are required to define sustainable activities, to reduce the chances of greenwashing
by borrowers. One of the earliest and most well-established green taxonomy has been
developed by the European Union (EU).
The EU Taxonomy is a classification system defining economic activity criteria aligned with
environmental goals. The EU officially published the EU Taxonomy Regulation in June 2020.
The objective of the framework is to “create security for investors, protect private investors
from greenwashing, help companies to become more climate-friendly, mitigate market
fragmentation and help shift investments where they are most needed” (European
Commission).
The International Platform for Sustainable Finance (IPSF) is coordinating with the EU, China
and some other countries to develop a Common Ground Taxonomy (CGT) which can improve
the compatibility and interoperability of the existing taxonomies.
Principles and standards
The International Capital Market Association (ICMA) provides guidance to issuers in the form of the
Green Bond Principles (GBP) which are voluntary. It requires issuers to build a green bond framework,
which must be aligned with the following four components of the GBP: use of proceeds, process of
project evaluation and selection, management of proceeds and reporting. One of the key
recommendations of ICMA is that issuers should obtain a second party opinion on their green
bond framework from an independent reviewer, to confirm its alignment with the GBP.
Apart from ICMA’s principles, there are other standards which issuers may comply with
depending upon the regulatory and market requirements. These include the Climate Bond
Standards and the EU Green Bond Standards. In India, SEBI has prescribed a regulatory
framework for the issues of green debt securities.
Further Reading for Topic 4. Sustainable Financing
Session 6 PPT
Background note: Financing Sustainability
Case: Does Sustainability Pay? Barry Callebaut’s Sustainability Improvement Loan
Explain the overall design logic of the sustainability improvement loan (SIL).
How might you improve the design of the SIL?
Case: Climate Risk and Banking: Citi’s Net Zero Future
Why has Citi decided to issue/underwrite $1 trillion in sustainable finance by 2030?
Why did Citi/Fraser decide to announce a net-zero target by 2050? Do you agree? Why or
why not?

5. Sustainability and Firm Value

Impact of sustainability on value-drivers
Sustainability can potentially affect firm value through four value drivers. The channels of
impact on each value driver are discussed below.
Long-term revenue growth (g) – A company with more (less) sustainable products/ services
can attract more (less) customers and gain (lose) market share. Government and community
relations can also affect access to resources. Policy violations can result in constraints on
advertising and sales, while sustainable businesses may receive incentives.
On the other hand, businesses such as tobacco, alcohol, fossil fuels, weapons (“sin stocks”)
which are perceived to harm E or S, may have to sacrifice revenues if they are to become more
sustainable.
Net operating profit margin (NOPAT/Revenue) – Reducing (increasing) energy and water
consumption, waste generation and packaging can reduce (increase) costs, resulting in better
(worse) margins. Policy violations can result in fines and penalties.
Companies with a strong perception of being fair employers and socially responsible will be
able to attract talent through social credibility and achieve higher employee productivity from
motivated employees. Conversely, companies with weak purpose and social stigma cannot
attract or retain employees.
On the other hand, costs may rise for some companies if they have to use more sustainable
inputs, or their suppliers have to invest more in sustainability.
Investment efficiency (Revenue/Invested Capital) – By ignoring long-term environmental
effects, companies making myopic investments will likely end up with stranded assets, asset
write-downs, or equipment with lower energy efficiency. Companies allocating capital to more
sustainable plants and equipment will achieve more optimal investment returns on such assets
in the long run.
On the other hand, the investments into sustainability are likely to be more certain and upfront,
compared to the benefits, and a decline in capital efficiency is also plausible.
Cost of capital (k) – Higher (lower) sustainability may also result in lower (higher) cost of debt
as well as equity, if the debt investors are prepared to sacrifice yield (in the form of greenium)
and adequate proportion of equity investors display a preference for sustainability.
Further, sustainable companies may become less vulnerable to extreme events (tail risks), and
hence may perform better in worst case scenarios.
Empirical evidence of impact of sustainability on investment value is mixed. There is more
evidence of higher cost of capital in case of “sin stocks” and the reduction in tail risks than
increase in value across companies.
Hence the channels of impact and empirical evidence suggest that while it is essential to
consider sustainability in firm valuation, the direction of the effect can vary. Hence, it is
necessary, to carefully analyse the impact of sustainability on the value of each company
through the effect on each value driver.
Steps to incorporate sustainability in firm value
The following description of steps is adapted from Schramade (2016).
Step 1. Identify the most material ESG factors. Focus on the products/services (good/bad for E
and S) and the process (material, labour, energy, transport inputs for production or delivery
including supply chain). Use sector materiality maps such as those provided by SASB.
Step 2. Analyse the impact of the material factors on the value drivers. A qualitative analysis
must be done for each value driver and will entail the three dimensions of probability, impact
and time horizon of the impact. The effects may be favourable or adverse.
Step 3. Quantify the impact by adjusting the assumptions related to the value drivers.
Assumptions that can be subjectively adjusted based on the output of Step 2 include, among
others, sales volume, unit realisations, unit operating costs, fixed costs and PPE investments.
Cost of capital may also be adjusted provided there is a strong basis.
Apart from building a base case valuation based on the above steps, it is prudent to conduct a
scenario analysis, given the subjectivity in assessment, uncertainty about the future, and the
importance of considering tail risks.
In select cases, where there is reasonable basis, and the factors predominantly indicate either
negative or positive net effect, the impact of sustainability can also be incorporated in relative
valuation, by subjectively adjusting the valuation multiples relative to the peers or historical
trend.
Integrated Value
Schoenmaker and Schramade (2023) make a case for integrated value (IV) that includes three
dimensions: financial value (FV), social value (SV) and environmental value (EV). As per their
methodology, S and E issues can be expressed in their units and multiplied by shadow prices
derived from welfare theory to estimate value flows (analogous to financial cashflows). SV is
calculated as the NPV of the social flows and EV as the NPV of the environmental flows. The
discount rates used to estimate SV and EV are much lower than for FV, considering the
argument for equal treatment of current and future generations and, hence, low time preference
between generations. Scenario analysis can help develop insights into the possible
internalisation of externalities.
Further Reading for Topic 5. Sustainability and Firm Value
Session 9 PPT
Background note on Sustainability and Firm Value
Case Study: McDonald’s a sustainable finance case study
What are the most material ESG factors?
How do you rate the effect of material sustainability issues on the value drivers going
forward?
How would this affect your valuation of the company?

6. Impact Investing
Impact investing definition
The Global Impact Investing Network (GIIN) defines impact investing as follows.
Impact investments are investments made with the intention to generate positive, measurable,
social and environmental impact alongside a financial return. (https://thegiin.org/impact-
investing/need-to-know/#what-is-impact-investing)
Note the following words in the definition.
Impact: Impact (social and/or environmental) is essential. The impact must be intended, and
should not be only incidental.
Financial return may vary between zero (return of principle) to market rate depending upon the
investors’ objectives.
Measurable: The S or E impact of the investment should be measurable.
Impact investors tend to prioritise impact, but also manage the returns (for instance, by
selecting investments where the impact scales with revenues and the unit economics is
favourable).
Impact measurement frameworks
According to a survey of impact investors conducted by the GIIN in 2023, the top 3 challenges
to the development of impact investment industry were all related to impact measurement and
comparison.
Unlike, ESG investing, where investors predominantly rely on third-party data aggregation and
ratings, investment managers and direct impact investors tend to use proprietary investment
frameworks, though GIIN has developed IRIS+ system, to enable consistency in measuring
and managing the impact of investments. Further, in impact investment, the measurement
should preferably be of outcomes, or of outputs if a direct relation between the outputs and the
outcomes can be established.
Though ESG ratings also vary a lot, there is possibility of convergence in the future due to
standardisation of scope, data inputs, and identification of key materiality factors at sector
level. However, comparing impact measurement frameworks of different impact investment
managers or investors reveal wide variations in terms of measurement objectives and
approaches that may be difficult to bridge due to the significant emphasis on customisation and
differentiation.
Impact investors
Impact investments prioritize impact over financial returns. This makes it challenging for
institutional investors like pension funds, insurance companies and mutual funds from making
impact investments, since they have a fiduciary duty to protect the returns of their clients. They
can make impact investments only if they have an explicit mandate (based on investment
policy), or have dedicated impact funds, and are not otherwise restricted by regulations.
Further, the need to measure impact makes direct investments difficult for most investors (other
than development financial institutions and banks). Thus, most investors choose to invest
through impact investment managers. Including both direct and intermediated investments, the
key impact investors are development financial institutions, foundations, family offices,
endowments, pension funds and insurance companies (those who choose to invest in impact),
banks, sovereign wealth funds and HNIs.
Impact investors also play a significant role in ensuring alignment of investee organisations
goal with impact objectives and prevent mission drift. The need for measurement and influence
makes impact investments feasible mostly in smaller organisations and rarely in listed
corporates. Consequently, impact investments are mostly made in small private unlisted firms.
Since the focus on impact creation limits the requirements of both investors and investees, the
total quantum of impact investments is much smaller than that of ESG investments.
Impact bonds for development
Impact bonds are used for social development. They form an instrument of blended finance.
Blended finance refers to “the use of catalytic capital from public or philanthropic sources to
increase private sector investment in sustainable development”
(https://www.convergence.finance/blended-finance).
An impact bond is an innovative financing mechanism in which governments or foundations
enter into agreements with social service providers, such as social enterprises or non-profit
organisations, and investors to pay for the delivery of pre-defined S or E outcomes. They are
referred to as social impact bonds (SIBs) if the outcomes are funded by the government and
development impact bonds (DIBs) if the outcomes are funded by foundations.
Impact bonds work on the principal of pay-for-success, wherein the payments earned by
investors are contingent upon the achievement of the outcome.
The parties involved in impact bonds include the following.
 the target beneficiaries, who undergo the social intervention
 the delivery partner(s) who are social enterprises or NGOs
 a project manager who helps raise upfront capital and is also responsible for performance
management
 impact investors who invest the required capital
 an outcome funder (government authority, foundation or philanthropic organisation) who
pays the investor principal and a rate of return which depends upon success
 an outcome evaluator, who defines, measure and verify the social outcomes against agreed
metrics
An impact bond seeks to align the interests of all the involved parties. The outcome funder is
satisfied because it would make payments only if the project is successful. The delivery partner
gets capital upfront for the project and the project manager earns a fee. For both the delivery
partner and the project manager, the reputation is at stake; it will be enhanced if the project is
successful, but will be affected if it fails. For the impact investor, the structure has the attractive
features of impact measurement and returns aligned with impact, which are consistent with the
definition of impact investing. Ultimately the target beneficiaries have a better chance of
effective intervention, given that the contracted parties have financial or reputational stake in
the project’s success.
Further Reading on Topic 6. Impact Investing
Session 12x PPT
SF Ch 6. Impact Investing (Pg 105-119) https://sbm.nmims.edu/docs/2024/Sustainable-
Finance.pdf
Case: The Rise Fund: TPG Bets Big on Impact
Should Rise invest in EverFi? Why or why not?
What are the pros and cons of the IMM approach?
Case: DBL Partners: Double Bottom Line Venture Capital
What is DBL’s “edge” or special advantage in investing? What motivates its investors?
Exhibit 8 of the case gives a template for a Second Bottom Line Report for a portfolio
company – how would you improve on it? How would you characterize DBL’s social impact
more generally?
Case: Omidyar Network: Financial Inclusion at Omidyar Network
Try and understand Omidyar Network's (ON) investment framework. What should be the
right mix of categories from a portfolio perspective?
Should Microensure remain a grant investment, or should ON make a more substantial equity
investment?
Case: Paying to Improve Girl’s Education: India’s First Development Impact Bond
What makes the design of the Development Impact Bond attractive to the various parties?
Which evaluation method (Pg 10) would you recommend and why?
7. ESG Investing
Definition of ESG investing
ESG investing involves considering financially material environmental, social and governance
factors alongside financial factors in evaluating investment risks and opportunities.
Note that unlike impact investing where E & S are outcomes, in ESG investing, E & S (along
with G) are inputs in investment decision-making. Further, ESG investing does not explicitly
imply sacrificing financial returns, though incorporating ESG factors is likely to change the
return and risk profile of investment portfolios.
ESG investing approaches
ESG incorporation can be carried out using any of the three broad strategies – screening, ESG
integration and thematic investing.
Screening. Screening involves applying filters to a universe of securities, in one of three ways
– negative/ exclusion, norms-based, and positive/ best-in-class.
Negative screening means filtering out companies based on investors’ preferences, values or
ethics. One approach is exclusion of specific activities such as alcohol, tobacco, gambling,
adult entertainment, military weapons, fossil fuels, and nuclear energy. Exclusion criteria can
also be based on company practices (example, animal testing, violation of human rights,
corruption) or controversies. Another approach is exclusion of worst-in-class stocks.
Norms-based screening involves excluding companies that fail to meet international norms,
based on norms related to specific S and E aspects set by UN, ILO, OECD, or NGOs such as
Transparency International.
Positive screening implies filtering in companies based on investors’ preferences, values, or
ethics. It is generally implemented by investing in best-in-class or best practice leaders against
industry peers based on ESG ratings.
ESG integration. ESG integration involves including ESG factors in investment analysis and
decisions to better manage risks and returns. It is often used in combination with screening or
thematic investing. ESG integration can be based on either fundamental (qualitative) or factor
(quantitative) investing approaches. ESG integration can also be passive, based on multifactor
indices that combine ESG with other factors.
Thematic investing. Thematic investing focuses on broad ESG themes, and involves investing
in companies because of S and E benefits of their products/services, processes, or practices.
Examples include sustainable agriculture, green buildings, lower carbon emissions, diversity,
gender equity.
Some thematic investors may call themselves impact investors. However, to be categorised as
impact investors, they must meet the requirements of intentionality and measurement of E and
S impact. Community investing, a related sub-category targets investments to traditionally
under-served individuals or communities.
Stewardship
Apart from incorporation of ESG factors based on the above three broad strategies, institutional
ESG investors who are PRI signatories also emphasise stewardship. Stewardship refers to the
use of influence by investors to maximise overall long-term value including the value of
common economic, social and environmental assets (https://www.unpri.org/reporting-and-
assessment/reporting-framework-glossary/6937.article).
Institutional investors may engage with managements primarily to better understand their
thought process, collect inputs for ESG research, and communicate ESG concerns and
suggestions. Investors may also engage with industry associations and regulators. Apart from
engagement, investors can seek to influence the firm directly through proxy voting, board seats
and threat of divestment. Extreme actions including litigation or shareholder activism may be
used infrequently.
Growth drivers of ESG investing and concerns
The key growth drivers of ESG investing are listed below.
Perceived opportunity to improve investment performance. Investors tend to believe that ESG
investing can improve risk-adjusted returns.
Development of ESG information infrastructure. The improvement in quantity and quality of
corporate level disclosures and the development of third-party ESG ratings and ESG indices
have made ESG investing scalable.
Rising influence of millennial investors. Studies have shown millennial investors to be more
ESG-aware and ESG-motivated, resulting in greater preference for ESG investing.
Growing share of passive investing. A large component of ESG investing being driven by
passive strategies, enables ESG investing to ride on the trend of increasing share of passive vis-
à-vis active investing worldwide.
Increasing global focus on environment. The increasing global focus on environment has
facilitated investment opportunities in new business models, created sustainable business
transition risks, and have raised the ESG-awareness of investors.
Development of ESG regulations. Self-regulatory initiatives such as the Principles of
Responsible Investment (PRI) provided the initial impetus to ESG investing.
The key concerns that can affect the growth of ESG investing include uncertainty that ESG
investing will meet investor expectations, divergence in ESG ratings, greenwashing by
investment managers, increasing burden of regulatory compliance and risk of political backlash
against ESG investing.
Regulations for ESG investing
Principles for Responsible Investment (PRI). Established by leading institutional investors in
2005, the PRI is a non-profit organisation that has developed principles for responsible
investing. Investor signatories must meet specific minimum requirements, including a written
responsible investment policy covering at least 50% of the AUM, senior-level oversight, and
internal/external staff implementing responsible investments. Signatories must also report
annually on their responsible investment activities.
ESG regulations. Regulators intend to stimulate sustainable finance, but are concerned about
greenwashing. In 2021, the International Organisation of Securities Commissions (IOSCO),
which includes regulators across several countries, published recommendations to the members
to address issues relating to risk mismanagement and greenwashing by asset managers.
In July 2023, the Securities and Exchange Board of India (SEBI) introduced measures to
facilitate green financing and mitigate the risk of greenwashing. These measures included a
new category of mutual fund schemes for ESG investing and related disclosures by mutual
funds (SEBI, 2023). As part of its new measures SEBI introduced a separate sub-category of
‘ESG Investments’ under the category of Equity schemes. Any ESG scheme can be launched
with one of the following strategies – exclusion, integration, best-in-class/ positive screening,
impact investing, sustainable objectives, transition and transition related investments.
Minimum 80% of the total AUM of the ESG equity scheme should be invested in the stated
strategy and the remaining 20% must not be in contrast with the strategy.
Further Reading on Topic 7. ESG Investing
Session 14 PPT
SF Ch 8. Creating Impact through Public Investments (Pg 145-159)
https://sbm.nmims.edu/docs/2024/Sustainable-Finance.pdf
Case: Finance for a Sustainable Society at Triodos Investment Management: An ESG
Portfolio Investment Decision
Which of the three companies shall make it to the portfolio of Triodos ESG Investment, Philip
Morris International, Tesla Inc., and Yamaha Corp.? Why?
Case: OpenInvest
Can OpenInvest create societal impact? How?
What would be the expected impact of OpenInvest's SRI screening approach on financial
returns and risk for an investor?
Case: Blackrock: Linking Purpose to Profit
Do you think Blackrock can be effective in driving investee companies to be sustainable?
What according to you is Blackrock’s motivation in driving sustainability?