Why a fund needs a methodology to assess impact
Management expert Peter Drucker is often misquoted as having said: “If you can’t measure it, you can’t manage it.” But sometimes, misquotes outlive the original one and the world agrees that if you can measure something then there’s a good chance you can do something about it.
Climate change is no exception and we know all too well how big the problem is. In fact, that’s not entirely true. The problem is so complex that it’s hard to nail down the real amount of greenhouse gases (GHG) we, us marvellously intelligent and narcissistic humans, emit annually. For instance, for 2020 we have 33.3 Gt CO2 from a publication in Nature to 49.8 Gt CO2e in a report from the Dutch Environmental Assessment Agency. Did you notice that cute little ‘e’ in the second number? That stands for equivalent and means the higher number also includes the emissions of other greenhouse gases, such as methane and nitrous oxide, whose radiative forcing differs from that of carbon dioxide (CO2). That’s why we need an equivalent metric for harmonised reporting. Anyway, that’s for another time.
Let’s agree for a moment that 50 Gt CO2e is a good number of annual GHG emissions globally. What matters here is that these numbers identify the size of the problem (which is huge!). Therefore, we equally need numbers to identify the size or impact of the solutions we are so ingeniously rushing to develop to save ourselves and the planet. For instance, if we want to say that a specific technology is able to mitigate 10% of annual global emissions (or 5 Gt) we need to have a method of getting to that number. So far, so good. That method, though, needs to be credible and transparent, and hopefully rigorous and underpinned by science or we might think we’re saving the world, when in fact we’re playing with spreadsheets.
Impact investment funds are under particular scrutiny when it comes to this. In the EU, there’s a regulatory push, like the Sustainable Finance Disclosure Regulation (SFDR) coming into full force this year, bringing much-needed exigent reporting standards to funds with sustainability and impact claims. The EU Commission is asking us to walk our talk, and rightfully so. There is also a public side, whereby LPs are keen to know that their money is flowing towards fund managers who will actively work towards identifying and financing solutions that address the climate crisis. Therefore, the gut feeling and experienced investor’s hunch of “this is a good investment!” no longer suffices.
In an ideal world, there would be one supported methodology globally that’s agreeable to all funds. In a less-but-still-ideal world, there would be a regional, say EU-wide, methodology for all funds that harmonises impact assessment and reporting. We’re not there yet (keen to start a European Impact Investment Foundation, anyone?). So until and unless a top-down approach comes above us, we’re left with the bottom-up route.
At Extantia, we’ve had our go at developing our EPIC (Extantia Projected Impact Calculation) methodology nearly two years ago and made it available to the world here. EPIC represents a distilled and refined version of the best of science and impact assessment and reporting, tailored for the VC world within the climate tech space. We believe we were the first to make this type of methodology available for the venture capital industry in Europe. This is not to claim glory but rather to remind us we’re on a race against climate change and the clock’s ticking and blooming fast.
Other funds have their methodologies too. Perfection is the enemy of good, the saying goes, and this applies here too. Getting started, gaining traction, building momentum, and evangelising for reliable impact assessment in funds management is way more important than perfecting the numbers. However, there are some golden rules to follow if you’re thinking of going down the rocky road of developing your own methodology. Here are our top picks:
- Embodied carbon
- Embodied carbon (not a typo, and repetita iuvant as the Latins used to say)
- Avoid the carbon tunnel vision
- Don’t get stuck with E, and remember the S and the G (it rhymes, too!)
Briefly, embodied carbon is really important. Some of the readers won’t have heard of it until now, but once you understand it the usual reaction is “Of course!”. Watch this space for a dedicated post.
We have so far talked about carbon because that’s a good proxy for many of the environmental problems we have but carbon can’t tell the whole story. What if a super cool decarbonising solution requires an enormous amount of land to be effective? The carbon math might add up, but how much biodiversity would be destroyed by land clearance? Or what if we come up with a carbon capture solution that’s amazingly effective but produces as a by-product stuff that kills marine life? Carbon math wouldn’t capture that, and that’s why we must avoid the carbon tunnel vision and remember that many environmental impact categories are needed to produce a comprehensive picture of impacts.
And much as carbon can’t tell the whole story about environmental impacts, environmental sustainability can’t tell the whole story about the complex sustainability transition that lies ahead. While we see ESG and impact as distinct from each other, they are not mutually exclusive.
This is why we go beyond the environment in ESG, because we need to remember people too, and strive for equitable and just transitions that are fair. Albeit ESG being a clunky, often misrepresented and misunderstood set of concepts, the importance lies in looking at the picture as a whole. If we want to look at the positive impact a company has, we cannot ignore the holistic view of its business practices. For a company to have a truly positive impact, it must have strong ESG processes in place. This means looking at how companies conduct their operations, including employee relations, board structure and diversity, and occupational health and safety — to name only a few. It also extends to supply chain management and the inclusion of human rights at every level.
Once a fund has all of this, it’ll be in a position to say it can assess impact through a well-thought-out methodology. Until then, we will continue to do what mankind has always done: do our best, make mistakes, and get better.
