This blog reviews a few new ideas on Transformative Investment research from the Deep Transitions Futures project. The Deep Transitions Futures project is run by an interlinking team of researchers and science communicators from the Science Policy Research Unit (SPRU) at the University of Sussex Business School, and the Utrecht University Centre for Global Challenges. The project is led by Johan Schot, Professor of Global History and Sustainability Transitions and Ed Steinmueller, Professor of Information & Communication Technology Policy. The central premise is that a new concept for impact – Transformative Investment (TI) – can steer the sector to work for the 21st century’s sustainability revolution, or in the discourse of Deep Transitions theory – the Second Deep Transition.
Get on with it
The world knows what it needs to do. Businesses, governments and society have made the pledges and the promises. One hundred and ninety countries ratified the Paris Agreement to keep global warming at 1.5 degrees. Yet with the world convening again at November 2021’s COP 26 climate conference to ‘rachet’ the commitments, 2.4 degrees of warming is looking more likely, based on current national commitments. The voices and actions for change are loud and clear. Britain’s chancellor, Rishi Sunak, announced plans to make the UK the first net-zero financial centre as part of the push towards a 2050 net-zero economy. Leading businesses realise the pertinence of changing to stop the climate emergency. Paul Polman, CEO of Unilever, has called the United Nations Sustainable Development Goals (SDGs) ‘the world’s greatest business plan’, stating that ‘the SDGs are the growth story of the next century.’
As every good business student would know – from even a simple climate-change SWOT (Strength, Weakness, Opportunity, Threat) analysis – threats, turned upside down, are opportunities. Inaction on climate change is, of course, a huge threat. It is, therefore too, a huge opportunity. Finally, it seems that the process towards decarbonisation, equality and sustainability has business, policy and civil society fully out of the blocks. Attention is roused and on alert. Enough majority consensus has been built. The gun has fired on ‘the race to net-zero’.
Yet for this to happen at the speed vital to survival on planet Earth – to make it a ‘race’ rather than a ‘slow shuffle’, the pivotal global investment sector, including public funding and private investment from governments and business around the world, must rush to the front of this race for everyone to be a winner.
Sustainable Finance – Mind the Gap
In a new Working Paper – The Promise Of Transformative Investment: Mapping The Field Of Sustainability Investing (Penna, Schot, Steinmueller, 2021) the question is asked: how can sustainable investing bridge the finance gap for meeting the SDGs?
The paper outlines the extent of the issue, demonstrating with United Nations data that in 2014 the financial needs for achieving the SDGs were estimated at USD 5-7.5 trillion per year, with emerging markets and developing countries requiring investments of USD 3.3-4.5 trillion per year (UNCTAD, 2014). In those developing economies, the financial gap – considering the availability of international and domestic public and private finance for “SDG sectors”– stands at USD 2.5 trillion per year.
The question this raises, and where many debates are focused on, is who is going to fill this gap? While this is an important question, another is to ask, what type of investment is needed for meeting the SDGs? This is the question driving The Deep Transitions Futures project working with a Global Investors Panel consisting of representatives from science, technology and innovation ministries; public innovation agencies; public development banks; private investment banks, impact investors, philanthropic foundations and others. Penna et al., review the development of various types of investment strategies in private finance (see figure 1) while in an earlier paper Schot and Steinmueller (2018) have explored public funding strategies. Both papers come to the conclusion that investment needs to focus more on transformative change
Figure 1: Expectation of Likelihood of Return on Investment
Transformative Investments to Accelerate a Second Deep Transition
Despite all the good intentions and aims, with the continued focus on investments whose short or longer-term value are easily monetised (with calculable risk), and likewise public funding being defended in terms of contribution to economic growth, we see a ruling out of other radical yet uncertain investment opportunities (which may be categorised as having unquantifiable risk) which could address ecological and social concerns. They may not lead to economic growth and returns on investment in the short or even medium term yet have longer ecological and social return . In other words, alternative (within sustainability transitions these would be termed ‘niche’) companies, projects and programs that offer the highest potential to disrupt dominant unsustainable practices are likely to pose the highest risks, and therefore these alternative niches are adversely selected and not properly shielded, nurtured and scaled by both public and private funders.
Yet it is precisely those initial ‘transformative’ investments in uncertain niche companies, project or programs that should set in motion developments to: (a) reduce the value of some existing unsustainable practices, and (b) open-up space for the growth of alternatives, which may themselves only become monetizable and economically valuable in the medium-to-long term. They may also generate a new type of economic development more focused on well-being and human flourishing.
The level of monetization for the ‘set in motion’ investments will vary – some may not yield near market rate returns (even in the long-term). However, the ‘follow on’ investments that benefit from these initial investments can be expected to yield substantial returns. This enabling and ‘coupling’ of short-term investment with longer-term returns-oriented investment can be thought of as a type of intertemporal portfolio management strategy that Penna et al call transition-enabling or a ‘transformative investment’ strategy. This is not about a wait-and-see strategy . This will not do for the urgent changes that are needed. It is about generating the conditions, or environment selection, that will support the development of alternative niches to challenge our current unsustainable practices and systems. To do this involves a coordinated collective effort of private and public investors to swim against the current by providing capital to develop niches that may pay off financially only in the long-term, or only via the associated future investment. This type of strategy may be perceived as a traditional split between public and private investment, in which the former is de-risking the latter. However, the Transformative Investment research proposal goes beyond this traditional split because of the need for coordinated and collection action across a wide range of investments.
This need for collective action, as represented by the Global Investors Panel’s composition, rises to the fore for another rationale. From a sustainability transitions perspective, change will not come about because of investment in specific companies, policy projects or programmes. System change needs a portfolio of related investments in a series of companies (which are connected through the value chain, for example) and across projects that build on each other. For system transformation other actions needed may include: investments in complementary actions and policies that help to support the niche, for example the build-up of an intermediary actor that brings together supply and demand, but will not bring about any financial return by itself; or the development of a new policy that breaks down regulatory barriers for change. One may argue that what is missing is a new type of Transformative Investment framework that aligns various parallel investments (while considering their systemic independencies) which are needed for constructing and scaling of niches. Such a framework may have to consider how to transfer returns from investments that bring this benefit to ones that have been instrumental in this, but do not bring the returns themselves. Post COP 26 this is the type of framework needed to bring about a ‘Great Reset’ with a ‘Green Recovery’ and a Just Transition captured by the notion of a Second Deep Transition.