Managing environmental and social risks is a key part of impact investing

Seela Sinisalo

There is a lot of buzz about sustainable finance, responsible investment, sustainable investment, ESG investing, impact investing and environmental and social impacts of investments. All this is diverse terminology aimed at communicating the positive changes and developments an investment can have. Depending on the perspective, slightly different things are meant by the different terms.

As an impact investor, Finnfund seeks to invest in projects and companies that create positive impacts, such as better jobs, sustainable energy, sustainable agricultural production, healthcare and education. The impact investing lens guides in finding these potential investments and focuses on measuring and communicating the positive impact of the investment. Clear, predetermined metrics such as numbers of jobs created, tonnes of CO₂ captured, number of patients treated are used.

However, the operations of all companies – even those with significant positive impacts – entail diverse environmental and social (E&S) risks. If not adequately managed, these risks could turn into negative impacts. Thus, in addition to seeking investments that create positive impacts, Finnfund requires its investees to adequately mitigate and manage the environmental and social risks associated with their operations. This is what we focus on in our E&S team.

Managing E&S risks protects the business

E&S risk assessment and risk management has been required since the investment world recognized that poor management of environmental and social issues and poor governance practices associated with business activities can create risks to the business itself, or to the financial institutions financing it. E&S impacts caused, or perceived to have been caused, by a business can result in consequences such as production delays, accidents, threats to operating licences and unforeseen expenditures and negative publicity.

The environmental and social risks of different Finnfund investments vary very much depending on the sector and the country. The IFC Environmental and Social Performance Standards define a minimum level of requirements for environmental and social responsibility in developing country conditions. The focus is on systematic management of environmental and social issues, which often in practice means that a tailored environmental management system needs to be implemented.

Flexibility is good, planning is better

The business environment can be difficult to predict in our target countries and the management has often learned how to navigate in the ever-changing situations in a creative and flexible way. The plan-do-check-act-way of thinking included in the environmental management systems often requires a change of approach as it focuses more on long-term planning and monitoring than the ability to adapt fast and survive in challenging situations.

This means that as Finnfund investees, companies may need to make concrete and sustain changes in the ways they operate. The changes may not be easy to implement but they often catalyse many kinds of positive impacts and developments both in the company and around it. The requirements can include hiring a capable E&S manager, monitoring the emissions more closely, improving the HR management, choosing and monitoring the subcontractors more carefully, switching to more efficient and safer equipment or adhering to international sector specific certification schemes (such as FSC, GlobalGAP, ISO 14001). Last but not least, these processes require capacity building to the company staff and relevant stakeholders in order to ensure long-term results and to sustain the positive changes over time.

Positive results as a reward

From an environmental and social adviser’s point of view, the most rewarding thing is to witness how our investee companies start seeing the benefits of developing an E&S management system – they see the results in employee satisfaction, it’s easier for them to get funding, the raw material or products improve in quality, the international certificates make it possible to expand to international markets. These are some of the tangible results from the requirements that Finnfund has made to its investees and the work we’ve done together with the companies. We’ve also seen the E&S managers receiving international education, an endangered bird species return to nest outside a power plant and the community relationships improving – all this thanks to a systematic way of planning and monitoring the environmental and social issues.

Impacts, risk management and sustainability

Successful E&S risk management requires a lot of time and continuous joint effort from both us as a financier and the investee companies. However, bringing E&S risk management up to international standards helps to achieve exactly what development financiers and impact investors seek, as it yields tailormade and company specific positive outcomes. These can be for example improved occupational health and safety, better pollution control, biodiversity conservation, and better management of community relations.

Our impact investment thinking and E&S risk management thinking complement each other and enable us to look at the same issues from different angles: For example, while impact approach may focus on the number of jobs an investment can help create, the E&S risk management approach focuses on ensuring that appropriate working conditions and terms of employment and appropriate OHS provisions such as personal protective equipment are in place. This complementary approach ensures, that the intended positive impacts of a specific investment are also sustainable over time. One of our internal development objects is to bring these two approaches even closer together during the life cycle of the investment.

Seela Sinisalo
Environmental and Social Adviser
Finnfund