Scotland must bolster its ecosystem for delivering impact investment if it is to achieve its ambitious target of becoming net zero by 2045, according to a report from the Scottish National Investment Bank, in partnership with impact advisory firm The Good Economy.

Published last month, Unlocking the Potential of Impact Investing in Scotland concludes that public investment alone will not be enough to address the range of future environmental and social challenges that the nation is set to face. Indeed, it argues that significant pools of aligned capital will be required to support a successful economic transformation.

With a quarter of Europe’s offshore renewable energy potential in its hands, Scotland is well placed to support a transition to a low-carbon future, the report says. “However, reducing Scotland’s heat demand at the same time as accelerating energy efficiency and the decarbonisation of heat will be some of the most challenging elements of achieving net zero – and areas where impact capital can play a catalytic role.”

Meanwhile, from a social perspective, the report says improved business dynamism would create employment opportunities and drive quality job creation, essential to Scotland’s aim to become a Fair Work Nation. As such, tackling the root causes of inequality to improve life chances will mean directly targeting structural drivers of exclusion and poverty as well as meeting a range of local needs, from housing to health.

“There is a clear and present opportunity for impact investment to drive the creation of positive outcomes that otherwise would not have been achieved at that same scale, pace or depth,” the report says.

Bridging the gap

At present, the Bank puts the total value of Scotland’s impact investment market at £4.3bn – but with the overall UK market estimated at £58bn, the report suggests, Scotland is punching billions below its weight.

One promising vision for Scotland’s investment community is that, by 2030, all of its investors could become purpose-driven entities that profit from supporting solutions for people, places and planet. That would require risk, return and impact to be routinely integrated into investment decisions as the ‘normal’ way of working – and would also require the support of “an active, thriving impact-investing ecosystem.”

The report highlights five barriers currently blocking the fruition of that scenario:

1. Small transaction sizes The average size of impact dealmaking in Scotland is smaller than the UK average. In part, that reflects a strong focus on social impact investing and early-stage funding rather than larger, subsequent growth rounds.

2. Inadequate deal flow Stakeholders interviewed for the report conveyed a sentiment that Scotland has been disproportionately good at starting up companies but bad at developing them – leaving a ‘missing middle’ between promising startups and large corporates.

3. High origination costs Scotland’s geographical character and population density mean that there is a lower concentration of investible propositions, creating higher transaction costs to source them.

4. Lack of identity Interviewees formed a consensus that Scotland does not yet have a specific investing identity or community for impact purposes. For example, apart from a strong social investment scene driven by Social Investment Scotland, Edinburgh is seen as having a relatively small impact ecosystem, linked largely to universities.

5. Gaps in market infrastructure Interviewees repeatedly cited the lack of an effective intermediation function between capital supply and demand as a barrier to bridging the gap between impact potential and practice.

Educating and enabling

The report proposes a four-point roadmap, supported by a significant programme of work across the investment community, public agencies and industry bodies, to create more fertile ground for impact finance in Scotland.

It says they must provide clarity on what impact investing is – and is not – in the context of Scotland, with clear principles and standards of practice. They should also improve the flow of capital that meets the risk-return-impact expectations of a variety of investors. 

Meanwhile, they should provide specialised tools and services that support the incorporation of impact into investors’ analysis, allocation and dealmaking activities. Finally, it calls on all actors across the ecosystem to improve their competencies and capacities for originating and closing deals.

Commenting on the report, ICAEW Climate Change Executive Sarah Reay said: “Traditional investing has focused solely on the financial returns it will achieve. Impact investing goes beyond that. In addition to financial returns, this type of investment can generate positive environmental and social outcomes – whether that’s in renewable energy, microfinance, affordable housing or education, for example. We are seeing those types of ESG investment becoming increasingly popular as investors look to decarbonise their portfolios and have more positive impacts, while also achieving strong financial returns.

“Given there are various labels associated with these types of investments, such as ‘ESG’, ‘impact’ and ‘sustainable’, having a central definition for them, as the report suggests, would certainly provide clarity on what these fund types aim to do, and not do,” Reay adds. “The report highlights education as a priority, and across the finance profession we’ve noted knowledge gaps around sustainable finance that need bridging to support the growth of this sector. As a member of the Green Finance Education Charter, ICAEW is aiming to fill those knowledge gaps through our various education and content channels.”

Reay adds: “When chartered accountants are advising clients on where to invest, making sustainable funds the default option can really drive capital to the right areas, providing long-term, sustainable financial returns that also benefit people and planet. For instance, in her practice, Rebecca Trudgett – one of our Climate Champions – is doing just that.”