Impact investment sits at the intersection of a number of trends, such as the environmental, social, and governance (ESG) movement, socially responsible investment (SRI), the growth of microfinance, and venture philanthropy. Impact investors are mission-driven and seek to combine financial returns with measurable social, environmental, or other types of impact. Non-profits are a growing segment of this community. They see impact investing as a way to diversify funding sources and, in some cases, generate revenue.
Impact investors often invest in markets and sectors with high corruption and bribery risks. Therefore, impact investors should take these risks into account in order to properly safeguard both themselves and their investments. Compared to traditional firms, impact investors have an added incentive to reduce these risks: the harmful effects of corruption on society can negate some or all of the positive impact of investors.
What are the risks?
Reputational Risk: When an investor engages with a corrupt entity, either knowingly or because of a lack of due diligence, they run a tremendous risk of being viewed as dishonest, disrespectful, or incompetent by their fellow organizations. This negative reputation in turn challenges an investor’s status as a mission-oriented organization and can ruin the impact of their future projects.
Monetary Risk: Impact investments often go to investees operating in challenging environments and industries with high bribery risks. As a result, there is a higher chance that investees will use these funds for illicit payments or fraud, jeopardizing the investee’s growth as well as the investment’s potential for a larger social or environmental impact.
Legal Risk: Both for- and non-profit impact investors face legal risks under the U.S. Foreign Corrupt Practices Act (FCPA) and similar statutes around the world. In 2010, the Department of Justice (DOJ) issued an opinion stating that a U.S.-based microfinance non-profit was a “domestic concern” and was therefore subject to the FCPA. This means that even international non-governmental organizations (INGOs) are liable under the FCPA. Moreover, the U.S. government has taken to interpreting elements of the FCPA quite broadly, including its understanding of “business advantage.”
In addition, impact investors are potentially liable under Section 7 of the U.K. Bribery Act, which criminalizes a commercial organization’s failure to prevent bribery. The U.K. courts define “commercial organization” as an entity incorporated, registered or formed in the U.K. or abroad, regardless of whether the entity is a for- or non-profit.
Bad Business Practice: When investees are operating in high-risk environments and high-risk sectors, they are forced to focus their time and investors’ money on the complexities of operating in such places rather than the actual firm. This in turn leads to bad business practices by investees, thus impeding their ability to provide investors with the desired financial and social return on their investment.
How do impact investors mitigate their risk?
Knowing that these risks exist, how can impact investors mitigate their risk and protect their investments? The answer is to communicate the importance of integrity to investees. Integrity—which many investors understand through their company’s integrity statement—is key because it sets a general ethical climate incompatible with bribery. This can help impact investors shape a healthy business environment that uplifts all firms. In other words, they can amplify the overall impact of their investment to the wider economy.
The term “integrity” is not always easily translated. It can mean something different to different people. In fact, many recipients of impact investments may have never heard of the term before or understand it differently due to dissimilar cultural standards. Therefore, investors must make a long-term commitment to working with investees from the onset of their relationship to define what integrity means. This in turn will mitigate risks as it increases the likelihood that investees are setting a strong tone from the top and good anti-corruption practices are built into investees’ business systems.
Sharon Kimel, Intern, Europe & Eurasia Department