System Financing Needs (Part 1): Systemic insights as a key to unlocking transformative impact
This is the first in a series of articles exploring one of our hallmarks of systemic investing: system financing needs. The series is being produced as part of the TransCap Initiative’s conceptual innovation work and is primarily being explored in a real-world context through our work on transforming the Swiss food system.
There is a well-known anecdote that acts as a metaphor for knowledge and ignorance:
A police officer sees a drunk man searching for something under a streetlight and asks what the drunk has lost. The drunk says he lost his wallet, and they both look under the streetlight together. After a few minutes, the police officer asks: “Are you sure you lost it here?” The drunk replies: “No, I lost it in the park, but this is where the light is.”
The streetlight effect is an observational bias that occurs when people only search for something where it’s easiest to look. We can sometimes observe this bias in purpose-driven finance, with investors defaulting to the solutions and strategies that are most familiar to them rather than what an issue calls for.
One reason such misallocation of capital might happen is that investors have an inadequate understanding of a system’s financing needs. By system financing needs we mean the volumes, types, and deployment mechanisms of financial capital required to transform a system in a specific direction.
Of course, there might be many reasons why the misallocation of capital occurs, including well-documented cognitive and behavioral biases. In a new strand of conceptual inquiry, we will focus on one such reason: the lack of systemic insight.
This article frames the need for this inquiry and sketches out how one might go about conceptualizing and quantifying system financing needs.
The importance of insights for unlocking impact
Let’s start with an example.
Venture funding for climate-related technologies has experienced a renaissance in the last decade. Between 2015 and 2022, the annual volume of climate tech venture capital (VC) grew more than 20-fold, and while the trend tapered off in 2023, the sector is expected to grow again in the years ahead.
But is the climate crisis really a technology development crisis and venture capital thus the kind of capital most needed? Or is climate change now largely a problem of technology diffusion, thus requiring growth equity and infrastructure finance, and venture capital just happens to be the asset class “under the streetlight”?
If purpose-driven capital of a particular type flows into a system in volumes greater than needed, the result is capital overshoot. As a consequence, some of this capital will be wasted, both in terms of impact and financial return. This is arguably what happened in transportation some years ago, when VCs flooded micromobility start-ups with money, and it might be happening today with AI start-ups.
In contrast, if too little capital of the kind actually needed is flowing, the result is capital undershoot, which might prevent a system from moving along a desired transition pathway. This is often the case in systems in which the business opportunities are not attractive enough for private capital to engage, e.g. because technology development or diffusion takes too long (as is the case for the decarbonization of industry).
In systemic investing, failing to take note of a system’s financing needs will almost certainly cause investors to miss their impact goals. The risk of this happening is prevalent because the energy in the investment world tends to be where transactions are possible within the existing landscape of opportunities and constraints, which doesn’t always coincide with where the energy should be.
There are different ways in which this issue could materialize in practice. Investors might pile a particular sector (think: hype) or evade one altogether (think: stigma), thereby contributing to capital overshoot or undershoot. Within a given sector, they might focus too much on a particular asset class while ignoring those that matter more. And, irrespective of the asset class, they might deploy their capital through vehicles and strategies whose underlying terms and incentive structures may even result in unintended side effects detrimental to investors’ transformational intent.
Specifically, in our systemic investing prototyping activities in food systems, we notice a plethora of venture capital funds focused on investing in technology and product start-ups. So venture capital is “where the light is.” However, farm-level de-risking mechanisms (such as new insurance products and advanced market commitments from agricultural product buyers ) and finance for overhauling the existing supply chain infrastructure (e.g., long-term transition investments, flexible operating loans, and compensation for decommissioning existing plants and machinery) are arguably more potent levers for driving change in the food system. But those interventions require vastly different quantities and qualities of capital and are significantly harder to develop, bring to market, and/or negotiate in the political sphere — one would have to be “looking in the dark.”
Understanding system financing needs is, therefore, about expanding the pool of light under the “capital deployment lamp.” By doing so, investors can increase their understanding of capital needs in order to improve the coherence between their intent and their approach.
The essence of grasping systems financing needs
What exactly are we trying to understand?
In studying systems financing needs, two knowledge concepts are of particular importance:
1) Financial Anatomy
In human biology, anatomy is the study of the form and structure of the parts of the human body. It tells us what parts we have (arms, legs), their features (size, color), their location relative to other body parts, and how the different parts interact.
In systemic investing, we are interested in understanding what types of capital matter in a system, their function, each type’s relative importance to the others, and how they interact. This conception includes notions of financial stocks and flows and asset class dynamics.
2) Transition Financing Needs
Systems change is about getting from one state of the world (status quo) to another (transformational intent). For a specific system to complete such a transformation, many interventions must be financed. Systemic investors should thus be interested in understanding the kinds of capital required (what), the scale at which they need to be provided (how much), and whether there are any particular requirements in terms of how these pots of money are designed and programmed (how).
For which moments in time do we seek to understand these things?
We need to foster an understanding of a system’s financial aspects at three distinct moments in time: the present, the future, and the transition period in between. For each of these moments, there is a set of questions that will help us illuminate the issue:
There are two critical points to be made here:
- A system’s financial anatomy can be investigated both for the status quo and for possible future versions of the system. Whereas the former is descriptive, the latter is speculative and will likely involve some form of scenario planning.
- A system’s financing needs during the transition period will differ from those of a future steady state. One concept is about the journey, and the other is about the destination.
What can even be known?
We believe the kind of understanding of a system’s financing need is one that is directionally correct but perhaps not detailed. For instance, having a sense of the relative importance of different asset classes (e.g., venture capital vs. growth equity vs. infrastructure finance vs. insurance capital) and the orders of magnitude at which they need to be provided (e.g., hundreds of millions, dozens of billions) matters more than specific numbers (e.g., $2.75bn p.a. of infrastructure finance over the next 8 years). This work is thus more about “grasping” — in the word’s etymological sense of “reaching, feeling around” — rather than “knowing.”
We’re saying this in part because, by definition, the behavior of complex adaptive systems is impossible to predict. So there is a degree of fundamental uncertainty at play when trying to grasp system financing needs.
In addition, there are also issues of measureability, which is different from uncertainty. Whereas in the context of uncertainty things are fundamentally unknowable (i.e., there is no data to be generated), sometimes things are knowable (i.e., there is data to be generated and insights to be derived from that data) but we may not be able to work with that data in the first place (i.e., we can’t locate, generate, or access it).
For instance, in our work on food systems transformation in Switzerland, it will probably be impossible to predict with any degree of accuracy what the future system’s financing needs will be, given the indefinite number of ways in which a sustainable food system will be able to express itself (🡪unknowability). However, it should theoretically be possible to estimate existing financial stocks and flows for particular food supply chains (🡪knowability), but we might not have access to the data because that data is dispersed across a plethora of stakeholders along the supply chain (🡪immeasurability).
What can we learn from past attempts?
The motivation behind grasping system financing needs isn’t new. Analysts have tried to predict the investment needs for ambitious projects or new industrial policies for a long time. For instance, a study published by Swiss Banking and the Boston Consulting Group estimates that CHF 12.9 billion p.a. would need to be invested between 2020 and 2050 for Switzerland to reach its net-zero targets.
Such studies exist for many countries and sectors. They usually follow a standard methodology: First, form an opinion about the kinds of technology needed to transform a particular system; then, estimate the units of such technologies that must be deployed; third, apply a cost degradation curve; finally, estimate investment needs over time.
This approach is different from our conception of systems financing needs in a number of decisive ways:
- Narrow set of financial levers: These studies usually center around the deployment of units of technology, which biases the analysis toward infrastructure finance and perhaps consumer spending and public-sector R&D support, depending on the context. Thus, the focus is on a relatively narrow set of financial levers and not the broad toolbox of systemic investing, including risk transfer mechanisms (e.g., insurance products), carbon markets, and advanced market commitments.
- Lack of actionability: These studies tend to sit at a level of abstraction often not directly actionable for investors. Knowing that Switzerland has net-zero investment needs of CHF 12.9 billion p.a. is useful for getting a sense of market opportunity but tells investors little about where, exactly, deals can be found.
- Determinism vs. Uncertainty: These studies are typically done with a deterministic mindset, forecasting a singular transition pathway over an impossibly large time horizon. They are thus examples of the Danish proverb that “making predictions is difficult, especially about the future”. In contrast, grasping system financing needs is about engaging with the inherent uncertainty of complex adaptive systems, accepting that estimates are hypotheses that need to be frequently updated, and using sensemaking tools designed to resolve uncertainty.
That said, some information that can be generated following the methodological playbook of such studies is useful. But such information needs to be made sense of in a methodological framework that works with a greater aperture with respect to the tools in the finance toolbox, sits on a level of abstraction that is actionable for investors, and has the capacity to engage with the uncertainty inherent in complex adaptive systems.
What are the ramifications of grasping system financing needs?
Having a grasp of system financing needs might challenge how purpose-driven finance is practiced today in different ways.
First, it invites a shift from capital-centric to system-centric investing, moving the core question for investors from “What’s the greatest impact I can generate in a system with the kind of capital I have?” to “What’s the kind of capital needed to transform a system, and what role can I play in its transformation?”.
Second, it questions the relevance of some existing investment funds because their contributions may be found to be of marginal value. Do we really need one more $100-million venture fund for climate technology? Is that going to make a difference or should our focus rather be on filling other holes in the finance landscape of a system?
Third, the information generated through a systems financing needs analysis can inform strategies of other societal stakeholders in the system, such as field-building strategies for NGOs and industrial policy of governments.
Lastly, it can galvanize wider systems change efforts, as understanding where the entry and leverage points are can be energizing and mobilizing.
Key research questions
As we set out in our inquiry into system financing needs, there are many questions to be addressed. Some of the most important ones include:
- How can we conceptualize “finance anatomy” in general and for specific systems? What are the different perspectives that can be taken?
- How can we quantify financial stocks and flows today and in the future?
- How do we estimate the volumes of financing needed for a system’s transition?
- How much is knowable? How do we deal with the challenges of uncertainty and immeasurability?
- What’s the methodology for grasping system financing needs, and to what extent can it be standardized?
These are the questions we will address in this work stream, using our prototype in food systems transformation in Switzerland as a primary backdrop. If you’d like to weigh in, drop us a line.
