The financial services industry has come to be seen as a source of societal damage over the past couple of years. However, it can be easy to forget that finance can be a force for good, too — and a growing movement toward socially useful investment may help restore the financial services industry’s good name.

In late November, a Canadian group, the Task Force on Social Finance, published a report calling for greater efforts from both governments and the private sector to deploy private capital for public good by investing in organizations that aim to do good works. The report argues that the historical distinction between governments as a provider of public good and businesses as a source of financial returns needs to be broken down, and that these roles can coexist.

The problem for many non-profits, the report notes, is that they are “trapped in a cycle of short-term subsistence funding” that diverts too much of their attention to raising money and away from their missions. This shortage of funding limits innovation, prevents organizations from scaling up solutions and threatens their survival.

“Social finance offers an unprecedented opportunity for Canada’s charities and non-profits to open up new sources of financing,” the report suggests, as this would provide these do-gooders with the financial flexibility and stability they need.

From an investor’s perspective, this sort of investing is a step beyond socially responsible investing, as it targets investment opportunities in enterprises that are seeking to do good works — such as building affordable housing or addressing environmental problems — while also generating a financial return.

This sort of socially productive investing has already begun to happen, but, the report argues, more needs to be done to create the sort of institutional infrastructure necessary to facilitate this type of investing on a larger scale. The primary challenges to a more robust social finance segment in Canada, according to the report, include: a lack of investment vehicles in this area that can attract private capital and manage their costs effectively; a tax and regulatory environment that divides ventures into either business or charity and doesn’t allow for more flexible arrangements; and a shortage of attractive investment opportunities in the pipeline.

The report estimates that if the necessary regulatory reforms, tax changes and other steps it recommends (see sidebar, below) were taken to help encourage social finance, this sort of investing could eventually be worth about $30 billion in Canada.

Indeed, social finance, a.k.a. “impact investing,” is emerging as a legitimate alternative asset class, argues a new report co-published by JPMorgan Chase & Co. and the Rockefeller Foundation. That report examined the characteristics of this evolving asset class and tried to gauge its potential considering five basic sectors: housing, rural water delivery, maternal health, primary education and financial services. It estimates that the market opportunity for delivering these sorts of services to the portion of the global population that earns less than US$3,000 a year amounts to US$400 billion to US$1 trillion of invested capital over the next 10 years. That implies a profit potential of US$183 billion to US$667 billion.@page_break@The sorts of investors that are making these kinds of commitments include high net-worth investors, philanthropic foundations, pension funds and even traditional financial services institutions. Says the JPMorgan/Rockefeller report: “With increasing numbers of investors rejecting the notion that they face a binary choice between investing for maximum risk-adjusted returns or donating for social purpose, the impact investment market is now at a significant turning point as it enters the mainstream.”

The Canadian task force’s report isn’t the work of idealists, either. The task force includes Stanley Hartt, chairman of Macquarie Capital Markets Canada Ltd.; Sam Duboc, founder of private-equity firm EdgeStone Capital Partners Inc.; former prime minister Paul Martin; and Tamara Vroo-man, CEO of Van-cou-ver City Savings Credit Union.

Given the diversity of prospective participants in this segment, there is a wide range of aspirations for these investments. JPMorgan, as part of its report, surveyed leading social-financing investors to get a sense of the sort of returns they aim to generate and found that return expectations vary dramatically. Some investors expect to trade off financial returns for social benefit, while others expect to match or outperform traditional investments.

In fact, as the social-financing market grows, investors seem to have progressively lofty return requirements, says the JPM/Rockefeller report: “Increasingly, entrants to the market believe they need not sacrifice financial return in exchange for social impact.” The report adds that many in the space are obliged to generate risk-adjusted returns that compete with traditional investments.

The hope that these investments can generate competitive returns is particularly present in emerging-market ventures that target traditionally underserved populations. The JPM/Rockefeller report found that investors expect more competitive returns from both debt and equity investments in emerging markets but anticipate forgoing some financial return in developed markets in order to see a societal payoff.

Investments in Canada, then, may be expected to underperform traditional asset classes. So, driving more private capital into these sorts of projects requires developing an institutional and regulatory structure. British Columbia’s Ministry of Finance has looked at introducing a new type of hybrid corporation — a “community interest company” — to allow inves-tors to receive a limited return from ventures designed to generate some sort of public benefit.

B.C.’s proposal is modelled on a similar concept that was developed in Britain a few years ago. Like the British model, B.C.’s version contemplates allowing firms to incorporate as CICs but would subject them to an “asset lock” that caps the dividends that equityholders could receive or the interest that bondholders could get. Any excess profit beyond the limit has to be put back into the company. And these firms cannot later convert into or sell out to for-profit ventures — nor can they fold and distribute their assets to shareholders. They can only pass assets along to other asset-locked CICs.

Unlike the British model, in which CICs are subject to initial approval and ongoing regulatory oversight, the B.C. model would leave the decision to organize as a CIC up to the company, allowing it to “tie its own hands” by choosing this structure. Firms would be required to maintain a “community purpose” and to report their performance publicly.

The proposal’s consultation period ended Dec. 1, but, in the wake of the task force’s report, the B.C. ministry will continue to consider submissions for as long as possible before developing any further recommendations on CICs. IE