Source : http://www.lupuschick.com/terminology/

Despite all the dire consequence of the 2008 financial crisis, it did help to question the paradigms of modern days’ finance especially its role in addressing economic, social and environmental issues. As a result, multi-lateral development institutions, think tanks, academic institutions, regulators and financial players have undertaken various initiatives aiming at integrating sustainability and finance into a unified business model. The central focus has been to move beyond the “do well and then do good” approach as in corporate social responsibility to a “do well while doing good” approach that views sustainability as a strategic competitive advantage. Nowadays, concepts like ESG (environment, social and environment) investing; Socially Responsible Investing (SRI), Impact investing, mission-driven investing and responsible finance are gaining traction both in developed and developing countries and are even promoted by “traditional / orthodox” large financial players !  However, the finance and sustainability hype brought also confusion to investors looking for “double bottom line returns”. Are these concepts similar? If not, what are the differences between them? These questions are critical because the proliferation of terms related to financing and sustainability creates fuzziness that ultimately leads to inertia among investors and other market players. Therefore, clarifying the different concepts is key to the development of the impact finance industry.

In this post, I will focus on explaining the difference between ESG, SRI and Impact investing terms. Although, there are many others similar concepts used in the financial markets, the chosen terms are the most common.

ESG refers to the environmental, social, and governance practices of an investment that may have a material impact on the performance of that investment. The integration of ESG factors is used to enhance traditional financial analysis by identifying potential risks and opportunities beyond technical valuations. However, the main objective of ESG valuation remains maximizing financial performance.

Socially responsible investing goes one-step further than ESG by actively eliminating or selecting investments according to specific ethical guidelines. The underlying motive could be sharia compliance, personal values, or political beliefs. Unlike ESG analysis, which is valuation-centered, SRI usually uses ESG factors when applying negative screens on the investment universe. For example, an investor may wish to avoid companies engaged in firearms production, child labor or gambling.

Similar to SRI, impact investing also considers social and environmental effects. However, the difference is that impact investments are only made in companies, organizations or funds where the main purpose is to achieve positive impacts, alongside a financial return. In general, SRI is more concerned with negative screening whereas impact investing is more concerned with positive screening.

As part of the current initiatives to bring finance to its natural orientation, stakeholders (especially regulators) should not omit to take active steps to clarify the different concepts under the impact finance umbrella. Although, this effort looks pretty basic but it is much needed to transform the enthusiasm on impact finance into a more meaningful transformation.

This article was first published in Islamic Finance news Volume 16 Issue 39 dated the 2nd October 2019

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