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From invisible hand to invisible heart: Sir Ronald Cohen’s plan to rewire capitalism

Oliver Balch  Writer / Reuters Events Sustainable Business / Thomson Reuters

Oliver Balch  Writer / Reuters Events Sustainable Business / Thomson Reuters

In an interview with Thomson Reuters, veteran British financier Sir Ronald (Ronnie) Cohen spoke about how impact-weighted accounting would price in negative environmental and social externalities and create a virtuous race to the top.

Cohen is a dyed-in-the-wool capitalist — just not capitalism in its current form. As the sub-title of his new book Impact: Reshaping Capitalism to Drive Real Change makes abundantly clear, he believes the time has come for some serious rewiring.

Capitalism’s critics are not hard to find, but few are closer to the belly of the beast. Co-founder of Apax Partners, one of Britain’s first venture capital firms, Cohen is an Egyptian-born British financier who jets between residencies in Tel Aviv, London, and New York.

Yet, reshaping capitalism isn’t a retirement project for the 75-year-old Cohen. Despite (or, perhaps, because of) his almost half-a-century at the hard end of finance, Cohen is deeply concerned. As he told the audience during a session at Reuters Events’ Transform discussion: “We’ve been trying to tinker within our system using different approaches… yet companies are continuing to pollute and to create societal problems.”

The value of impact-weighted accounting

Today, Cohen chairs the Global Steering Group for Impact Investment, an alliance of leading impact advocates in business, finance, and philanthropy. In this last capacity, he recently penned a Financial Times opinion piece about today’s “glaringly self-defeating” economic system. His case, in a nutshell, is that companies are permitted — even incentivized — to pursue business models that create widespread environmental and social damage. However, this damage never appears on companies’ books and is instead passed on to governments and citizens, through public taxes, to try and fix. Unfortunately, they see little success in this because the damage keeps coming, untapped.

Fortunately, Cohen’s damning critique comes with a ready-packed solution. His proposition for getting capitalism back on track can be summed up in the three words: impact-weighted accounting. The term, which crops up 30-plus times in his recent book, already has a project team at Harvard Business School (Cohen’s alma mater) dedicated to its development.

In short, impact-weighted accounts are an augmented form of traditional financial accounting that explicitly and empirically tallies the cost of the social and environmental externalities of a corporation’s assets and activities — something, as he notes, that is wholly absent from current income statements and balance sheets.

It may sound a simple idea but behind it lies a methodology of fiendish complexity. Not only does Cohen’s proposal require re-writing century-old financial accounting norms, it involves doing so with a set of impact-related metrics for which the base data is thin at best — and while ensuring the results dovetail with existing financial and business analysis tools.

Sir Ronald (Ronnie) Cohen

Cohen and his Harvard colleagues are not starting from scratch, as Cohen himself is quick to concede, dozens of “worthwhile efforts” have been made over recent years to measure the non-financial impacts of companies. “Each one has been carving out a piece of the puzzle,” he says. “The impact-weighted accounts initiative is putting the picture on top of that puzzle, so making it much easier to assemble all the important work that has already been done.”

This breakthrough dataset, available online, lays out in full the environmental costs associated with 1,800 companies (an equivalent evaluation for social costs will be published next year). In the spirit of transparency and shared learning, the methodology is all open-source and the data for the most part (around 80%) is drawn from the public domain.

A quick scan of the headline findings is enough to ram home the extraordinary divergence from conventional accounting. Take the chemical giants, Sasol (based in South Africa) and Solvay (based in Belgium), with annual revenues of around $22 billion and $12 billion, respectively. Both are portfolio stalwarts for mainstream investors. Tally in their environmental damage, however, and $17 billion and $4 billion would be immediately shaved off their top lines, respectively.

Total transparency to positive & negative impacts

Cohen’s impact-weighted calculations make for a fascinating mathematical exercise. But to bring about the change he wants, investors will have to start getting on board. Only when capital flows away from the social and environmental damage-makers and towards more sustainable businesses, he rightly reasons, will meaningful change take place. “The only way in my view to do this is to bring total transparency to the positive and negative impacts that companies create in different areas — through products, through employment, through operations — so we can look at a different bottom line and create a race to the top,” he explains.

So, will the capital markets buy in? There are certainly signs of hope. Interest in impact investment is on the up. While the estimated value of U.K. impact-linked funds now stands at around $4.7 billion, if you widen the picture out to all funds with some form of environmental, social or governance (ESG) screen and you’re suddenly looking at a colossal $30.7 trillion.

While only a tiny fraction of ESG finance is earmarked for positive impact companies, the vast majority is oriented towards avoiding risk. And the COVID-19 pandemic plays squarely into this emerging mindset, prompting Cohen to hope for a revolution in company accounting similar to that which followed the 1929 Wall Street crash. “We are at a historic crossroad similar to the one in 1929,” he says. “It [COVID-19] has shaken our habits and our beliefs and has led to a questioning of capitalism and democracy. This opens the door to major change.”

In Cohen’s view, contemporary capitalism isn’t bad because capitalists are bad; capitalism is bad because those who drive it and give it shape are misled. Everyone knows about the invisible hand of the markets, he notes; yet, less well known is the “invisible heart” that Cohen believes needs to guide it. “By measuring and valuing impact, we can bring the invisible heart of markets to guide Adam Smith’s invisible hand and create the kind of world we want to live in.”

This is an edited version of an article that first appeared on Reuters Events Sustainable Business. You can read the full article here.

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