Impact investment trends from a global perspective What is the true value of impact leading to increased corporate value

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“Impact investing,” which is an investment method that aims to intentionally create measurable social and environmental impacts in parallel with economic returns, is a field that has rapidly attracted attention in recent years, and its importance and complexity are increasing. The SMBC Group, which began impact investing in April 2024, is putting effort into non-financial support such as holding workshops and impact assessment support for startups interested in impact investing along with investment activities.

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On Jul 24, 2024, at the share lounge “Hoops Link Tokyo” operated by the SMBC Group, a talk session was held between Mr. Hayato Hanaoka, acting general manager of the SMBC Social Value Creation Promotion Department, and Mr. Ishida Tomomi, Environmental Energy Investment Impact Officer/Capitalist Co., Ltd., with startups that have completed the workshop.

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Impact assessment as a means rather than a goal

Impact assessment is a process of qualitatively and quantitatively measuring and analyzing how much change or effect a business or investment aimed at solving social and environmental issues has actually brought about, and then evaluates the results. It is not limited to simply recording activities and measuring impact, but it is a practical approach aimed at comprehensively capturing a long-term and wide-ranging environmental and social environment and utilizing it for business growth, investment decisions, and even strategy planning aimed at maximizing social value.

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Mr. Hanaoka first asked about trends in Europe where impact investing is being actively carried out.

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Hanaoka: “Recently, there has been a lot of talk about impact evaluations and the importance of logic models, but what is impact evaluation for in the first place? Could you tell me about the position of impact evaluations from Mr. Ishida's point of view and the latest trends in Europe?”

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Ishida: “There is no globally uniform standard for impact investing, but three main factors are emphasized when creating impact in parallel with economic returns. The first is “intention,” in other words, having clear intentions about what you want to change about society and the environment. Second, there are factors that cannot be achieved without “additionality,” that is, impact investing. The third is “measurability,” that is, setting and measuring KPIs for creating impact through business, and then working to achieve them.

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These elements form the basic framework for impact investing. Intent clarifies the purpose and direction of an investment, and measurability provides a means to specifically evaluate its results. It shows that impact investing is not simply a well-intentioned investment, but an investment aiming for planned and measurable social and environmental change. However, at the same time, Mr. Ishida also pointed out the possibility that the evaluation itself in impact investment would become an objective.

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Ishida: “In Europe in particular, there is a greater demand for measurement due to concerns about greenwashing and impact washing. We believe that understanding issues and stakeholders at the system level and setting KPIs in order to create impact is essentially a means of leading to business success and greater impact creation, rather than making various disclosures and impact assessments themselves.

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Even globally, everyone is still going through trial and error. The attitude of thinking while doing is important. It's important to continue practice and learn in line with various guidance on impact investing.”

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Hanaoka “It's a place where it seems like it's useless if it's not perfect from the beginning, and since we aim for perfection, there may be a tendency to run into methodology theory.”

There are cases where logic models are used in the practice of impact assessment, but in response to an opinion from one participant that they “feel it is difficult to create logic models,” Mr. Ishida gave the following advice.

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Ishida: “The key point in thinking about logic models is understanding the relationships and stakeholders between output and outcome, what actually happened, and what impact it had. Meanwhile, the input and activity parts are key elements that reflect a company's uniqueness and unique solutions. It's an opportunity to clarify whether this is our company's unique strength.”

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Outputs and outcomes show direct results and medium- to long-term impacts, and impacts ultimately represent changes brought about in society and the environment. Meanwhile, input and activity are important elements showing the uniqueness of a company, and understanding these relationships will lead to deepening understanding of issues and markets, and even discovering market opportunities.

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Ishida: “Impact KPIs may change depending on how the business grows. At the early stage, there are cases where there are no products yet, so there is also a method of drawing a logic model and refining it a little more once the product is ready.”

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Hanaoka “Is there a difference between how European startups and Japanese startups talk about and show impact?”

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Ishida: “When I talk to VCs and startups that are making impact investments in Europe in particular, I have the impression that they give presentations with an emphasis on “intention.” Even if they have logic models behind the scenes, there are many people who set up social and environmental changes (impacts) they want to cause as a vision and talk specifically about how their business “contributes to CO2 reduction.” In other words, impact creation and business growth are the goals, and impact assessment is positioned as a means for business strategy.”

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For companies such as startups where the business environment changes rapidly, it is said that impact assessments are not fixed and should be adjusted flexibly according to business growth and changes. Specifically, Mr. Ishida seems to think that the method of setting hypothetical KPIs in the early stages and refining them as the business progresses is a realistic and effective approach, and will contribute to strategy formulation and value creation.

Evaluation of essential corporate value and impact The path of an IPO

Hanaoka: “I think it's important that impact leads to corporate value. However, many startups feel that “impact cannot be understood unless they are impact investors,” and it seems that they are unable to explain it well. How can startups incorporate impact into corporate value, and how can they incorporate impact into IPOs and exit strategies?”
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Ishida: “I think the term 'impact IPO' itself is relatively unique to Japan. From a Western perspective, exit through M&A is a growth option rather than an IPO. There is a low perception that impact is factored in as a premium at the time of an IPO, and I understand that there are cases where it is incorporated into equity stories.”

Currently, the fact that impact has not been sufficiently evaluated as a premium at the time of an IPO reflects the difficulty of impact evaluation in the Japanese market and the situation where relationships have not yet been sufficiently established. However, Mr. Hanaoka argued that the impact of impact on corporate value is becoming something that cannot be ignored.

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Hanaoka: “Conversely, I feel that an era where no impact leads to negative evaluations and discounts is coming.”

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Ishida: “That's right. In Europe, for example, consideration for society and the environment is becoming a baseline, such as not being able to participate in public tenders without an ESG (Environment/Social/Governance) policy. On the other hand, it is also true that the hurdles for claiming to be “sustainable” have been raised due to changes in regulations. There are also cases where it is difficult for companies that are really working on it to make the opposite claim. The pressure for this kind of greenwashing is stronger in Europe and America than in Japan.”

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This change in regulations shows an important turning point in the field of impact investment and ESG investment, and it is now required to show “sustainable” and “impact” based on specific standards and data rather than simply self-reporting. This is likely to be thought to lead to preventing impact washing and promoting a truly sustainable business model.

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While interest in impact investing is growing, questions were raised about how impact-oriented startups should prepare as Japan approaches a form similar to Europe and the United States from now on.

Ishida: “Markets are being formed in Europe driven by regulations. For example, due to a regulation called SFDR (Sustainable Finance Disclosure Regulation) in Europe, there are cases where even early-stage companies that receive investment from impact investors are required to disclose up to Scope 3 of CO2 emissions. This is burdensome for small-scale companies, but there is also movement on the VC side to support it.

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Even in Japan, it may become necessary to comply with such strict standards in the future. However, it's not a good idea to delay action too late to aim for perfection. First, think about what kind of impact your business is generating, and how it can be measured and evaluated, and then the approach of gradually improving accuracy would be effective.

Also, it is important to draw a specific story about how to achieve a balance between financial return and impact so that not only impact investors but also general investors can understand it. To that end, it is necessary to reassess the company's business and clearly show the relationship between solving social issues and business growth.”

It seems that it will become important for Japanese startups not to miss the trend of impact investing, but rather to utilize it as an opportunity for growth. It can be said that using impact assessments and disclosure efforts not simply as compliance, but as a tool to clarify the company's strengths and deepen business strategies and dialogues with investors will become important in future startup growth strategies.

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What is business building from the perspective of “Born Global”

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Regarding overseas expansion in the context of impact investing, the importance of building a business from the viewpoint of Born Global (with a view to global expansion from the time it was founded) was discussed.

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Hanaoka: “I felt that all the startups that participated in the workshop had an opportunity to expand overseas. Please tell me about European startup trends about “Born Global,” that is, an approach aiming for global expansion from the time it was founded. Are we going to target overseas markets from the beginning, or are we going to start with the local market first?”

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Ishida: “It depends a lot on the business area. While it is necessary to consider language barriers and market regionality, when tackling global issues such as climate change countermeasures, there is a tendency to look at the global market from the beginning.

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Japan has a relatively large domestic market, so there are aspects where it is difficult to feel the need for global expansion, but in small countries such as Estonia and South Korea, there has been a strong global orientation from the beginning.”

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For startups in small countries, international expansion has become part of a survival strategy, and Ishida said that a country's market size has a big impact on the startup's strategy.

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Ishida: “Climate change issues are global issues, so I think there are cases where starting points and markets to look at are global. Also, Japan is sometimes referred to as a “country with advanced issues.” The issues facing Japan, such as aging and population decline, will become problems in other developed countries in the future. Therefore, there is a good chance that solutions originating in Japan will work overseas. However, since Japanese companies tend not to look closely at overseas markets, it is important to look at overseas demand from an early stage and adjust business. Determining what is needed will create new opportunities and possibilities for business expansion.”

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Hanaoka: “The SMBC Group also has many bases overseas, and I feel that there is potential to make use of that network. If megabanks start moving in this field, I think major changes will occur, but what do you think?”

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Ishida: “As can be said for large Japanese companies in general, not limited to megabanks, there are aspects where the company does not fully understand why they collaborate with startups, and the significance of collaborating with impact startups in particular. CVC is also increasing, but it seems that there are still places where synergy and exit strategies after investment are still being explored.

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On the other hand, in regions where infrastructure is lacking, such as Africa and Indonesia, social change and impact creation are likely to occur due to bold innovation.

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For example, the reason why the mobile payment “M-PESA” spread rapidly in Kenya was that the population with bank accounts was small, there were no ATMs, and there was a high risk of holding cash. In such an environment, the need for digital solutions is extremely high, and innovation is likely to occur. There is far more urgent demand than in Japan, so on the contrary, there may be many things to learn. There is also a possibility that regions in Japan are sharper in terms of change and sense of crisis.

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Another interesting example is that a group company of Hokkoku Financial Holdings' established a base in Kenya. The idea is to challenge new innovations in regions with new possibilities when considering the growth of one's own company. There may be difficult aspects because it is a megabank, but I think the approach of balancing growth and social contribution with such new ideas is very interesting.”

In response to this discussion, participants asked questions about European regulations and their impact. In particular, there were calls for specific examples of the impact of regulations relating to impact investing.

Ishida: “In Europe, SFDR requires disclosure of various sustainability-related risks at different stages along with commitments to impact.

Also, in some impact funds, there are ways to link the company's carry (success reward) to impact KPI and incorporate not only business growth but also commitment to impact creation as an organization.

On the other hand, impact investing also has certain burdens. For example, detailed information disclosure is required, and there are costs associated with system development. This can be a burden for both startups and investors. There is also a risk of litigation for non-compliance with regulations. The severity varies from country to country, but there are also cases where lawsuits are brought when there is a discrepancy between the claim and the actual situation.”

Furthermore, participants were interested in how social impacts, which are difficult to quantify, are incorporated into investment decisions regarding the balance between economic benefits and social impacts in impact investing.

Ishida: “In the environmental energy investment field, for example, there are indicators that are relatively easy to understand, such as CO2 reduction, so investment in companies whose core business is environmental value and contribution to the environment is central. Specifically, it can also be expected to create an impact, such as a decrease in CO2 emissions if sales increase due to services and businesses.

However, not everything can be quantified. Therefore, qualitative evaluations are also carried out using globally recognized assessment methods. For example, we understand customers and comprehensively determine what benefits there are, and whether there are any environmental or social disadvantages as side effects.

In impact investing, there are investors seeking various asset classes and different financial/impact returns. Basically, we are funds that aim for market rate returns, but there are also impact funds that prioritize impact. For example, if it is a fund that specializes in measures against population decline, the degree of contribution to solving that issue is an important criterion for judging. At the end of the day, our policy is to support businesses that truly contribute to society and the environment, not just business growth, while aiming to balance financial returns and impact.”

Impact investing is not just one of the investment methods; it shows a new paradigm that balances solving social and environmental issues with economic growth. Japanese investors and startups are required to have a global perspective and search for unique approaches that make use of Japan's unique strengths. Furthermore, innovation born in this process will be the driving force for the realization of a sustainable society and new economic growth.

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Click here for other articles on impact investing by Sumitomo Mitsui Banking Corporation