Transmission via to:

Transcription

1 European Commission DG Internal Market and Services B-1049 Brussels, Belgium European Investment Fund 96, Boulevard Konrad Adenauer L-2968 Luxembourg Tel: Fax: Transmission via to: MARKT-SOCIAL-INVESTMENT@ec.europa.eu Dear Sirs 13 th September 2011 EIF response to the public consultation The Social Business Initiative: promoting social investment funds The European Investment Fund (EIF) welcomes the opportunity to comment on the staff working paper entitled The Social Business Initiative: promoting social investment funds. The EIF is part of the EIB Group and is the European Union s specialist provider of risk financing for entrepreneurship and innovation across Europe. We deliver a full spectrum of financing solutions through financial intermediaries (i.e. equity instruments, guarantee and credit enhancement instruments, as well as microfinance). We are a leading player in the European venture capital market. A socially responsible investment market, which has many parallels to the venture capital market, is starting to develop, and specialized funds are emerging also in Europe. This market still lacks appropriate financial instruments and efficient market access for interested investors. EIF intends to play an important role in shaping the broader social impact investing market and to support the emergence of institutionalised specialised European Impact Investors who demonstrate sociality (social mission as strategic objective) and marketorientation (performance driven approach). In this context, EIF is also preparing the implementation of a European Social Innovation and Entrepreneurship Facility (ESIEF). EIF fully supports the European Commission s Social Business Initiative; please find attached our comments and responses. We stand ready to discuss, or expand on, any element of our comments. Yours sincerely Matthias Ummenhofer Head of Venture Capital Helmut Kraemer-Eis Head of Research & Market Analysis Annex: EIF response to the Consultation Paper The Social Business Initiative: promoting social investment funds

2 ANNEX European Investment Fund 96, Boulevard Konrad Adenauer L-2968 Luxembourg Tel: Fax: EIF response to the Consultation Paper The Social Business Initiative: promoting social investment funds Preliminary remark: our comments refer to venture capital-type social investment funds, which typically are unlisted and invest directly in SMEs or microenterprises (managed by social entrepreneurs). These funds aim to support social entrepreneurship and social impact, and also to apply investment principles in view of reaching self-sustainability via a minimum financial return in addition to capital preservation and capital efficient re-investment of profits. As such, many basic principles of traditional VC investing apply equally to social investment funds. For EIF, social investment funds are a part of the Impact Investing universe that is pioneered by two types of players on the one hand the social impact funds, and on the other hand microfinance institutions supporting individuals or micro-enterprises that would otherwise have no access to financing and foster the social inclusion of vulnerable and/or disadvantaged groups of people. The objectives of Impact Investing are fully in line with the Europe 2020 strategy that aims at smart, sustainable and inclusive growth to enhance high levels of employment, productivity and social cohesion. Box 1: What is the problem/framework Social businesses (or social enterprises) focus on business models that address tackling major social issues with a market driven business approach. Social issues addressed are typically related to unemployment, marginalisation of disadvantaged communities, and access to health care and education. These enterprises can be seen as hybrid businesses, lying between the traditional for-profit firms and purely philanthropic oriented companies with no profit orientation. They fill gaps not sufficiently addressed either by traditional profit oriented firms or by philanthropic companies. Social businesses (as opposed to traditional VC-backed companies) seek financial returns predominantly as a means to achieve self-sustainability and/or to scale their social impact. Social enterprises, having at the core of their business clear impact objectives, are used to high standards of accountability for their business, not only towards their direct investors but to their entire community of stakeholders. 2

3 Social investment funds (also called social enterprise funds) are a type of VC funds that focus on these social enterprises, i.e. they look at business models that address social issues. At the same time they seek self-sustainability via capital preservation and a minimum financial return. Hence, the initiative should not focus solely on social businesses that do not distribute profits to their investors but rather on the support of social entrepreneurship in general and i.e. any kind of company seeking to generate positive social impact. This double objective should also help attracting investors who are more and more willing to give something back to society, and realise that philanthropy is not sufficient to address all kinds of social issues as it often materialises through one-shot contributions and lacks the perspective of a sustained support. Box 2: The funding challenge The competitive challenge of social entrepreneurs is typically not a competing business model in the market, but rather to demonstrate the effectiveness in addressing a social problem with its own business concept. The most challenging funding need for social enterprises is in the launch phase; once it has been understood and validated by the different stakeholders, the business needs to reach self-sustainability. Although emerging, the social impact investment market still lacks appropriate financial instruments to enhance an efficient market access for interested investors. EIF has notably been in contact with several fund managers trying to raise funds but failing because of the misunderstanding of their strategy by traditional institutional investors. This resulted in difficulties for social businesses to finance their growth. Moreover, social investment funds are cyclical, i.e. they are market dependent and suffer particularly during economic downturns. Trusts, endowments, and the public sector, which have been the backbone of the social sector until now, have either themselves been depleted of resources or have diverted their priorities to resolve more immediate problems. It is for this reason that in the long-term, social entrepreneurship funds cannot emerge or reach critical size until there is broad private sector support for the market. However, such support can only be rallied during up-cycles when institutional investors would be willing to diversify their portfolios. We see a clear need of public support for this market which is reinforced by the current economic environment that has accelerated the need for policymaking aimed at developing and fostering social entrepreneurship and innovation, given its potential to deliver valuable social goods. Often, existing and emerging investors, who want to invest/allocate higher amounts can not do this efficiently because the structures to deploy larger amounts are not established yet. Typically, today, they fund/support individual projects or companies, and find themselves quickly at the limit of what can be done with the human resources available to manage these activities. Providing fund-of-funds solutions, establishing a common sense infrastructure for social VC funds, can remedy this. Central, EU sponsored, interventions would have clear EU added value with regard to a) effectiveness: central measures are the most efficient way to address the fragmentation of the market and to incubate a segment that has no viable investing infrastructure in place yet and that has a subcritical mass at pure national level, and 3

4 b) efficiencies and synergies: a central platform has model character, will promote an investment model and helps to promote best practices across the EU. Pooled expertise through experienced managers in equity investing allows for efficient coordination and enhanced impact to the benefit of EU policy objectives in (social) innovation. Box 3: The role of investment funds Target investees of social investment funds are mostly micro enterprises, at least at start with increasing staffing if business model proves scaleable in addressing a social problem. The funds are usually smaller in size than other venture capital funds, partly due to the relative immaturity of the social capital market but also because the capital requirements and investment patterns in underlying investees are of a different nature than in traditional VC funds. Social investment funds could be covered by the framework for traditional venture capital funds. However, in our response to the EC consultation A new European regime for venture capital we stressed already the fact that the Alternative Investment Fund Managers Directive (AIFMD, the Directive) has not been designed for venture capital funds. We believe that the specific needs of the venture capital industry can be more efficiently dealt with under a standalone initiative. Simply modifying the Directive, which was designed for a rather different market segment, would lead to a situation where many of the original (non-fitting) concepts laid down in the Directive would be maintained and efforts would be made to adjust and fine-tune those provisions which would be identified seen as most inadequate or unnecessary. Such approach is likely to be incomplete and as such not properly addressing the issue. Box 4: The role of investors/retail investors We note that the European investor base comprise a broad range of investors, including not only classical institutional investors but also to an increasing extent investors such as high net worth individuals, entrepreneurs and other Business Angels. These types of investors are sophisticated and knowledgeable and will in many cases provide very hands-on support in the process aiming at ensuring growth of the underlying investee companies. The investment activity of this growing segment of non-classical investors should definitely be supported. However, we think that investment in non listed funds is not a suitable investment form for non-sophisticated investors. This is one of the reasons why the EIF s initiative would be materialized as a dedicated fund-of-funds, aiming to gather different kinds of investors who will not have enough resources to invest directly in social investment funds. Those investors usually want to give something back to society but in another form than philanthropy. Box 5: Liquidity As already mentioned above, the socially responsible investment market has many parallels to the traditional venture capital market and has to apply investment principles in view of capital preservation and capital efficient re-investment of profits. As such, many basic principles of traditional VC investing apply equally to impact investing or are even 4

5 indispensable to support its development and up-scaling. Short term redemption of fund units, be it daily, weekly, or monthly, are not feasible but long term investment principles should apply. Basically, redemption of fund units should be prohibited. In addition, as investments in non-listed financial assets are by nature long-term, distributions in cash decided by the fund managers under precise terms should be the only liquidity events. Box 6: Risk diversification An appropriate diversification of the investment portfolio is a critical success factor. However, the diversification should be at the discretion of the fund manager (and respective decision making bodies). Meanwhile, by applying some basic governance rules of traditional VC funds, an entity representing the most important investors should be constituted and should be in charge of some specific issues, notably advising the fund manager on portfolio management (including risk diversification) and resources allocation. This should result in a balanced risk/return portfolio amongst social oriented assets. Box 7: Types of assets and strategies Like for boxes 5 and 6, professional investment principles should apply. Social investment funds serve their investees through a wide range of instruments of traditional equity, hybrid structures, and debt products including micro-finance instruments especially in the start-up phase. The funding needs of social enterprises range from start-up capital to growth and expansion type capital for funding projects and/or associated working capital but in a different way than that applied to traditional private equity or venture capital funds investees. Funds should be free to select their strategies, investors deciding then to support them or not. Box 8: Asset valuation/financial assessment We agree that it would be impractical for social investment funds to have frequent valuations of assets. The investee companies are typically not listed and reporting in short term intervals would be cost and resource intensive. Also here, the principles of venture capital investing should apply. In line with industry standards, we would favour that social investment fund managers would produce quarterly reports for each fund as recommended by VC-industry standard entities such as EVCA and according to industry valuation guidelines (such as IPEV (International Private Equity and Venture Capital Valuation) for VC and IRIS 1 (Impact Reporting and Investment Standards, see also response to box 9) for Impact Investments). Particular attention should be paid to commercially sensitive information which should not form part of a reporting obligation. The sole non-social assets allowed should be non risky monetary and liquid products with a very low (if not null) probability of loss for treasury management purposes. 1 See also response to box 9. 5

6 Box 9: Asset valuation/social assessment and reporting In their attempt to address specific social issues, social entrepreneurs operate as dedicated market intermediaries for translating social-issue-related measures into individualised support. It is therefore important that the final impact achieved through investments in social entrepreneurship is not only measured at the fund level or the level of the social enterprise but at the level of the beneficiaries of a social enterprise s focus of action. As opposed to traditional VC-backed companies social enterprises seek financial returns predominantly as a means to achieve self-sustainability and/or to scale their social impact. Social enterprises, having at the core of their business clear impact objectives, are used to high standards of accountability for their business conduct not only towards their direct investors but to their entire community of stakeholders. The social impact investment sector has emerged over the recent years and moved from a sector of uncoordinated activity of a few individuals and charitable organisations with a strong bias towards philanthropy, to an organised industry that has accepted the challenge to operate alongside capital efficiency and constraints dictated by the capital markets. Currently, the most visible platform of social impact investment is the European Venture Philanthropy Association (EVPA EIF is a member of this association) which, over the last couple of years has grown to an organisation of more than 120 members spread over the entire continent. The increasingly coordinated approach of financial markets to social impact investing has also resulted in emerging industry standards that define the scope of social entrepreneurship and drafts of standardised relevant methodology for accountability and impact metrics. On the basis of these concepts social entrepreneurship investing differentiates itself from other asset classes such as traditional technology and innovationoriented venture capital. In general, there is still no standard metrics for social performance and most impact investors (one of the most well-known being Bridges Ventures) have developed their own measurement system (resulting in a lack of comparability between investors and projects). Anyway, the social impact should then be clearly identified and measurable in order to comply with the main purpose of the funds. In terms of measurement, standards are emerging and the development of IRIS (Impact Reporting and Investment Standards) is important. IRIS aims at developing a single, consistent reporting standard for measuring and reporting the social and environmental impacts of investments. The metrics shall allow investors to compare outputs and outcomes across investments and the development of benchmarks is foreseen. Other initiatives include the SROI framework (Social Return on Investment) to measure impact in monetary terms, or various approaches to analyse impacts on stakeholder groups; the B-Ratings System which considers five stakeholder perspectives (consumers, employees, suppliers, community and environment); the HIP (Human Impact + Profit) framework that considers five categories of impact (health, wealth, earth, equality and trust) for three stakeholder groups (customers, employees and suppliers) and weigh them relative to five management practices, and the approach of Trucost that focuses on the comprehensive environmental impacts of business operations across industries. However, social impact measurement is still a challenge that should not prevent the set-up of social investment funds, especially as one can start from simple hypothesis. 6

7 Box 10: Investor participation Generally, fund managers have either a basic or a very strong knowledge of the best market practices related to investment fund governance and day to day business. In the context of emerging asset classes (such as social venture funds), investors with strong investment experience can have high added value, i.e. with regard to the implementation of best market practices. Indeed, based on their past investments, they will help newly created fund managers regarding the deployment of their strategy as well as to avoid as much as possible classical mistakes (conflicts of interest, confusion on respective tasks and missions of each governing body, bad management of the capital deployment, etc.). This is an essential key of success for social investments. More importantly, one has to keep in mind that fund managers will always be the sole to decide regarding investment decision making. In the case of the planned ESIEF product, any participation in terms of investment decision making will be prohibited. Meanwhile, this should not prevent investors to actively support those emerging fund managers by many ways such as networking, dealflow sourcing or even possible co-investment agreement (in this latter case, investors could be allowed to co-invest once the fund manager has decided to invest itself). Box 11: Risk management Risk management traditionally does not only cover financial risk, but also non-financial elements (e.g. reputational risk, compliance risk, etc). With regard to impact investing, the traditional risk management principles should apply but, compared to risk analysis in traditional VC investing, there should be more emphasis on non-financial risk elements. In particular, the level of social impact created directly by the funds activity should be carefully monitored. In addition, two specific risks should be avoided, namely (i) a refocus on financial return risk in order to reach more easily self-sustainability, and (ii) a reputation risk in case of fraud or any similar problem, especially in an area where the highest ethics standards are required. Box 12: Depositary EIF believes that social venture funds will invest in companies, and then the depositary entity will have the same role as for traditional VC funds, i.e. mainly (i) holding the shares certificates of the investees, (ii) issuing statements of holdings, and (iii) some by-laws functions as well. Box 13: Remuneration and cost structures In the past, social entrepreneurship funds have largely been unable to attract institutional investor support due to concerns about exit routes for the investee companies. There is a notion that social entrepreneurship funds are not able to achieve returns on their investments due to the difficulty in reconciling profitable businesses with social causes. While this may have been the case in the past, the increasing visibility of financially successful and socially responsible investments is gradually removing or even inverting this investor bias, opening new funding and hence acquisition channels for social enterprises. 7

8 Social business funds focus on investment strategies which aim at maximising social innovation and impact but also apply investment principles in view of capital preservation and capital efficient re-investment of profits. Hence, also with regard to remuneration and cost structures, traditional VC principles apply. As financial performance is not the primary objective, financial returns can not be the only element helping investors to make the decision to commit to social investment funds. The performance fee which is usually agreed in traditional VC funds should be replicated, with the exception of considering both social and financial returns/impact. A classical distribution cascade is as follows regarding the available cash: a) first, to investors until they have received an amount equal to their investment; b) second, to investors until they have received an amount equal to a specific preferred return; c) then, to the fund managers until they have received an amount equal to the catch-up (market standard, i.e. right of the fund managers to receive an amount equal to twenty-five (25) % of the preferred return); d) finally, the balance of the net income and net capital gains of the fund, if any, is distributed between the investors and fund managers as follows: (i) eighty (80) % of such balance for the investors, (ii) twenty (20) % of such balance for the fund manage (i.e., the carried interest). Such a distribution cascade will need to be adapted to social investment funds to take into account the social impact generated by their investments. Given that the focus is not on financial returns, one can for instance imagine that the preferred return can be removed or/and the level of carried interest is related to the impact generated. Box 14: Box 15: Box 16: Improving transparency and clarity Improving transparency through common criteria A common EU label? Boxes 14, 15, and 16 refer to the traditional problems of asymmetric information in financial markets that can be solved via screening (by the investors) and signalling (by the social investment funds). As already mentioned above (our response to box 9), the social impact investment sector has emerged over the recent years and moved from a sector of uncoordinated activity of a few individuals and charitable organisations to an organised industry that has accepted the challenge to operate alongside capital efficiency and constraints dictated by the capital markets. Currently, the most visible platform of social impact investment is the European Venture Philanthropy Association (EVPA). In our opinion the definition of common criteria and labelling should be industry-led. Certified social assessment agencies could undertake ratings/gradings/assessment. The increasingly coordinated approach of financial markets to social impact investing has 8

9 already resulted in emerging industry standards that define the scope of social entrepreneurship and the relevant methodology for accountability and impact metrics. Public support should not try to dominate this process, but to support the development. This could e.g. be via the setting of certification standards for social assessment agencies, the support of the set-up of these agencies, or technical assistance to the benefit of social investment funds. The latter could be a similar approach to the microfinance industry, where technical assistance is provided via the programme JASMINE: technical assistance to microfinance institutions (MFIs) takes the form of an assessment by a specialised rating agency and subsequent training in areas where improvement is needed. This may mean helping MFIs to adopt good governance and sound management procedures and demonstrate that every part of their business is reliable. How an MFI manages the risk, how it carries out strategic planning and the completeness of its information system, is likewise reviewed and improved through training if need be. The opportunity of a common EU label can only be successful if (i) it is industry-led and (ii) the entity delivering such a label is an independent structure (possibly supported by public money). Indeed, the current issues regarding rating agencies which are paid by the companies they have to rate, have demonstrated the importance of independency. This is a potential major risk of failure for a social-focused environment. Box 17: Ensuring effective integration with social businesses and distributors In the view of facilitating a better intermediation between funds and social businesses, one could think about an electronic platform with up-to-date information about the market and contacts (i.e. active funds and investors); it could as well be a platform where social enterprises and funds can find each other. Box 18: Use of other incentives, including tax Our recent response to the VC market consultation emphasizes that measures should be taken to establish a sustainable venture capital ecosystem in Europe, supporting innovation and entrepreneurship. In addition, as already mentioned for Box 3, tax incentive could be a useful and easy to set-up motivating factor for investors to allocate resources to social investment funds. This should also have a catalytic effect in the fundraising process for social investment vehicles. 9