Socially Useful Finance

Much of the finance sector is “socially useless” argued Lord Turner, Britain’s top financial regulator, the other week. Many people have been especially sceptical about the social value of financial innovations, such as as derivatives (credit default swaps, for instance) and other financial engineering (such as sub-prime mortgage securitisation). Happily, the recent failure of the financial sector has inspired a movement, whose leaders include many philanthrocapitalists, to create a more socially useful finance sector. Moreover, rather than rejecting financial innovation, they are embracing it but using it in ways that will potentially drive positive social change.

The SoCap conference earlier this month was a showcase for some of the best thinking about how to put social mission at the heart of the capital markets, and (though this may be a more controversial claim) to put capital markets at the heart of social mission.

Matthew moderated a fascinating plenary involving practitioners from every part of the social capital market spectrum, ranging from classic gift philanthropy through lending (at or below market rates of interest) to unabashedly for-profit. The panelists broadly agreed that each of these different sorts of capital had a useful role to play – there is nothing inherently better or worse about any of them – but there needs to be a much better understanding of the strengths and weaknesses of each type, so that the right sort of capital is used at the right stage in the solution of any social problem.

One panelist was Jed Emerson, who has been grappling with the twin needs of profit and social mission longer than most, coining the term “blended value” to describe the triple-bottom line goals of businesses (profit, environmental sustainability, social good). He has now joined a hedge fund “fund of funds”, Uhuru, which is trying to make for profit investment using sustainability as a criteria for selecting the hedge fund managers it invests in.

Emerson put up a spirited defence of hedge funds – which are typically seen as evil by social-mission driven folk – arguing that many of them base their investments on taking a long-term view of a company’s prospects, which often makes them keener on sustainability than short-term focused investors. (However, he does not regard as socially-useful “black box” hedge funds that profit by making short-term trades based on churning vast amounts of data in search of short-term trends or anomolies to exploit.)

Emerson even made the case, persuasively, for short-selling being a force for social good, by allowing investors to drive down share prices that rise too high (perhaps because of an excessive focus on short-term factors at the expense of sustainability). He is writing a paper on the subject, which should be an interesting read. He has also written an excellent cri de couer about how we need to see this crisis as an opportunity to reform capitalism in a must-read special issue of the Federal Reserve Bank of San Francisco’s Community Development Investment Review.

Another panelist, Alvaro Rodriguez Arregui of Ignia, a bottom-of-the-pyramid investment firm, called on philanthropists in particular to take bigger risks. As we argue in Philanthrocapitalism, philanthropic capital is uniquely well-placed to take the sorts of risks that no other capital can – a theme Rodriguez elaborated by arguing that philanthropic capital should be used to develop “proof of concept” business models in new markets which traditional for-profit investors currently regard as too risky. Microfinance is the role model here, which went from charity to profit over a 30 year period, meeting the needs of many more poor people as it did so. Rodriguez thinks the same can happen in other markets serving the poor, but in less time if philanthropists and others learn from the experience of microfinance – and take bigger risks.

Rodriguez explains this in more detail in an article (with Vera Makarov) in the latest issue of Alliance magazine. This also features an editorial on “discontinuous thinking” by Matthew, who guest-edited the issue, and two other articles that focus on socially-useful finance.

The first, by Peter Blom of Triodos, a Dutch development bank, talks about the need for values to be at the heart of banking. The second, by Reuben Abraham, highlights several fascinating examples of how financial innovation is helping the poor of the developing world.

There remain big challenges, not least to create the infrastructure of law and market institutions within which impact investing can thrive. But, it is wonderfully clear, there is now a lot of intellectual power and entrepreneurial talent going into making finance more socially useful. Let’s hope it succeeds.