Introduction
The intuitive appeal of impact markets lies in the fact that they translate liquidity, diversity, and risk-taking of financial markets to the field of philanthropic endeavors. This comparison has genuine value, and I’m thrilled by the possibility of harnessing the intelligence and motivation that goes into financial markets for charitable endeavors. However, for impact markets to grow, they must develop an infrastructure that fosters trust and scalability.
The size of large financial markets, such as the U.S. stock market, stems from their trustworthiness and accessibility, allowing average investors to participate without exhaustive due diligence – but this is not an intrinsic quality of these markets. Instead, these markets are function well in part because they offer a standardized venue for comparing different investments. If these markets didn’t exist, allocating capital to investments would be far more inefficient. As these financial markets have grown, they’ve also developed more standardized tools for reporting and comparing investments – for instance, the US stock market required uniform annual and quarterly reporting in the Securities Exchange Act of 1934.
Impact markets will need to make an analogous transition in order to operate at a similar scale. Right now, these markets are small and informal, with individualized approaches to reporting impact for certificate buyers. However, as impact markets grow, the techniques and standards applicable in financial markets may not be directly transferable. Crucially, whereas traditional financial markets thrive by directing capital towards economically productive uses, impact markets rely on retroactive funders who reward projects that have already been executed. These retroactive funders have a task that is fundamentally different from the role of investors in financial markets. However, if the role of retroactive funders is made easier, it will be more likely that future impact markets will be able to succeed. Ideally, improving the judgements of retroactive funders will also encourage investors to fund more speculative new projects, knowing that their impact will be discernable in the end.
To try to encourage the growth of future impact markets, I have created a framework and report template for future project managers to use when reporting on their work for potential retroactive funders. As a proof of concept, I’ve used this framework when reporting results for three of my own projects related to forecasting.
This work is informed by three key differences that exist between impact markets and other financial markets:
1. Impact Certificates Aren’t Like Other Financial Assets
Impact certificates do not represent a claim on a limited resource in the same way that say, a share of stock represents a claim on a share of a corporation’s future profits. Instead, the “impact” that impact certificates represent is often hard to isolate – there’s a possibility that the same “impact” could be attributed to multiple projects. For example, consider two separate projects that might be funded by impact market investors that do similar things in the same location: one installing improved sewer systems and the other building a new hospital. Disentangling impact for these two projects is hard – particularly if a retroactive funder is interested in outcomes that are plausibly affected by both projects. This is particularly important for assigning “social credit” to projects – it wouldn’t be desirable for impact markets to reward publicity over actual impact – for instance, by providing retroactive funding for a project that essentially “takes credit” for work done by others.
In many cases, it will be tempting for retroactive funders to avoid this issue altogether by running “impact” markets that are effectively “action” markets – for instance, a funder aiming to improve education in a region might focus on some limited and well-defined outcome (student-years of schooling provided, with quality validated using some metric derived from standardized tests).
2. Impact Markets Have a Principal-Agent Problem
With many impact markets the people most informed about the impact of a particular project are not the same as the people who will financially benefit from the purchase of these impact grants. In financial markets this is not quite the case – while most of the owners of shares in a publicly traded company also don’t have the same amount of knowledge about the internal state of that company as the managers of that company do, they are able to align incentives because shareholders also indirectly (through the corporate board) hire and fire those managers.
This difference is not all bad! If the people running projects funded through impact markets don’t have a financial interest in the results of retroactive funding decisions removes the incentive for people to overstate the value of their projects. But this also has downsides because reporting itself is inherently tricky and time consuming – it’s not desirable for impact markets to reward “people who are best at communicating their results for impact market purchasers” – ideally a standardized format would help level the playing field by making reporting easier for these projects.
3. Financial Assets “Price In” Externalities in a Way That Impact Markets Can’t
Projects participating in impact markets might have positive or negative externalities that aren’t readily apparent to the retroactive funders. In financial markets these externalities are incorporated into asset values to the extent that legal systems enforce liability (look, for instance, at the value of Hawaiian Electric Industries stock after the Maui fire), but the same relationship is unlikely to exist in impact markets – nobody has proposed making impact market purchasers assume future liability for the impact that they purchase.
Some retroactive funders will be experts in a particular field and will focus on rewarding projects where they can judge outcomes effectively, while others might fund a wide variety of work. This creates a dilemma: while impact certificates attract investors by incentivizing them to fund innovative philanthropic projects, these investors are also inclined to focus on projects with easily understandable benefits for potential future retroactive funders.
My Solution
Any reporting standard used to inform retroactive funders must strike a balance between the value of extra information for the funders and the reporting burden on those managing the projects. For these projects, I’ve created a reporting template which I think provides an ideal solution for small projects with impact on the order of a few thousand dollars. Unlike investors with specialized knowledge who provide initial funding for these projects, retroactive funders are more likely to be allocating funds across a variety of projects, making a common basis for comparison more helpful.
This report template focuses on the disclosure of essential pieces of information intended to help retroactive funders make informed decisions about the projects they fund:
- The goals of the project – this section sets the stage for the reader, giving context for the rest of the document.
- The specific actions involved in the project. Ideally, this would allow the retroactive funder to independently validate the actions performed as part of the project, mitigating a failure mode common in markets for carbon credits, where credit are loosely defined, fungible assets representing everything from active carbon removal to the not-chopping-down of forests that were unlikely to be logged in any plausible scenario.
- The results of this project, describing the most relevant metrics to support the calculation in step 4.
- How people working directly on the project calculate their impact. This section could be tailored to report the specific impact sought by the certificate buyers/retroactive funders. Of course, buyers can also make their own calculations.
- Any other positive or negative effects not included above that buyers might want to factor into their valuation for retroactive funding.
You can find the blank template here and are free to use, adapt, and modify it as you wish: https://docs.google.com/spreadsheets/d/1Jr3ijiFDL5LmsrpxMUJUUwk6QeO2JPTC/edit?usp=drive_link&ouid=100840257409434904343&rtpof=true&sd=true
Examples of this form in use for my partner projects can be found here:
- College Forecast Dissemination: https://drive.google.com/file/d/1x_qesK_3KfAvLE7oZjSxuYcc_2Z7AWYN
- Hurricane Forecast Dissemination: https://drive.google.com/file/d/1g8x0jZpX0jYDn1o67hPkOz2eRmEgvFN9
- Earthquake Forecast Dissemination: https://drive.google.com/file/d/1iIWe30mnWEIjwqVwunE4vcfqQl2B41qQ