Impact finance, like any other structuring sector, is seeing the blossoming of a number of terms aimed at better defining it.
With the objective of increasing the capital available by spreading rapidly to all strata of conventional finance, the players agree on a vague definition that facilitates consensus. In order to guarantee a vision that puts social and environmental issues at the heart of investor thinking, complementary terms have emerged: we speak of impact first approach (an investment philosophy), blended finance (a structuring method), and catalytic capital (the key element of blended finance), which we discuss more specifically in this text.
This semantic creativity or diversity carries a risk: it creates confusion and curbs public interest and the adhesion of conventional finance. It seems, however, necessary for impact finance to keep its promises.
Are we there yet?
With 10 years to go before the deadline for SDGs, and in light of the latest progress report on the 2030 agenda, the urgency of the situation calls for the immediate collective mobilization of investors and the shift from billions to trillions of billions of capital injected each year, in an attempt to keep the planet breathable and habitable with dignity for all. We are a long way from this goal, as highlighted by the latest annual GIIN survey, which estimates the impact finance market at $715 billion.
Beyond the quantitative challenges, the (social!) performance of the sector is also lacking. Harvey Koh in a SSIR recent article, highlights this situation and identifies the primary reason: “even as impact capital grows, it has failed to fully address critical needs around the globe (…), largely due to inflexible expectations for investment returns”.
Translated: we didn’t get there, and we may have taken the wrong path.
What is catalytic capital
Catalytic capital should help improve the allocation of impact capital for greater social utility. It is defined as “debt, equity, guarantees, and other investments that accept disproportionate risk and/or concessionary returns relative to a conventional investment in order to generate positive impact and enable third-party investment that otherwise would not be possible” in a study by the MacArthur Foundation. Greater patience, high risk tolerance, concessionality and flexibility in order to enable projects to happen are its essential characteristics.
What is it for?
Catalytic capital enables the financing of sectors/projects that meet major social challenges but that no one would finance because of high risk and the absence of risk adjusted returns. In particular, it opens the way for traditional investors in an underserved market, by establishing a track record that allows the risk associated with this market to materialize.
It also accelerates the development of a project or the structuring of a sector by injecting the capital needed to pass through several stages in the development of innovations.
Who are the catalytic capital providers?
On the forefront are public authorities and foundations. But in some geographies, you would find catalytic capital provided by institutional investors also. This is the case in France with the solidarity-based funds, vehicles composed 90% of classic listed assets (usually invested through a rigorous SRI lens) and up to 10% in unlisted solidarity-based values, namely equity or bond investments in social enterprises.
A path towards catalytic conventional finance?
Beyond the example of solidarity-based finance, it seems naïve to imagine a conventional finance ready to substantially adapt its modalities of action and its financial return requirements to deploy an impact strategy. However, this could be one of the many benefits of the work initiated by consortia such as C3 (Consortium on Catalytic Capital), if they succeed, for example, in highlighting and studying possible incentives for conventional financiers (beyond questions of reputation), and their key success factors. In particular:
- positioning oneself early on a future market in order to penetrate it more quickly in the event of success, based on a perfect knowledge of its risks and key success factors;
- improve the overall performance of its portfolio when the positive and negative externalities of companies will be taken into account if ever (as the European taxonomy prefigures)
- enable its customers to meet regulatory requirements: this is, for example, what has made the bedrock of solidarity finance in France (€9.7bn AuM in 2019).
Define, equip, unify
Catalytic Capital is much more than just a new name: it puts social issues and the collective at the heart of the action of impact finance.
Work such as that led by C3, aimed at defining (why and when is catalytic finance needed) and equipping (how) this particular field of impact finance must be encouraged and carried out diligently to enable a growing number of players to join it in order to collectively deploy its potential.