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Responsible Investing is a process in which the Environmental, Social and Governance (ESG) criteria are taken into account along with the usual financial criteria. Part I deals with listed RI (SRI funds and stocks) : Is it still a credible alternative against the mainstream ? Part II deals with microfinance. Part III deals with impact investing, as direct investment in not-listed SMEs The author, Xavier Heude has been entirely dedicated to the development of Responsible Finance by the mean of promoting Impact Investing, mainly. He is convinced that Private and Institutional investors are growingly interested in putting some part of their money in business activities or projects where they can themselves follow up the financial performance, and last but not least, the social and environmental outcomes generated. He is Co-founder of meso IMPACT Finance, a Luxembourg-based holding company aimed at taking stakes in SMEs that generate a social and environmental (measurable) impact. MIF helps them develop through a financial and extra-financial support (i.e. technical assistance). He is also Délégué Général of SAKURA Initiative, a Luxembourg-based not-for-profit organisation promoting social and responsible practices in the economic and financial sector, through various means such as conferences and communication. Xavier Heude founded also the “PEERS Direct Investment” – registered trademark in 2011, after having stated for many years, that there are still quite few incentives and operational frameworks and guidelines allowing and encouraging a large public to invest in socially responsible business activities or to support valuable social initiatives. A network is being built, in order to contribute to expand the mark and get it known worldwide.
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Impact Investing Direct investment in (not-listed) SMEs : are we inventing the
« social private-equity » ?
Xavier Heude [email protected]
Version - March, 2014
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1.0 - SRI negative screening (bad actors) ban certain activities … Return OR Impact 2.0 - ESG policies positive screening (good actors) choose the best in class … Return AND Impact 3.0 - Shared value Get positive impact being financially profitable … Return FROM Impact
EVOLUTION in the Sustainable Investment case
In the light of the dominance of capitalistic socio-economic models in our societies – and the lack of credible alternatives
the challenges of sustainability can only be overcome
if they are integrated into market logic
“How the SRI industry has failed to respond to people who want to invest with conscience.” Paul Hawken (Natural Capital in 2004)
« An unconventional perspective on Impact Investing » - 2011
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The scope of challenges facing society today can no longer be solved with a purely philanthropic approach : - threat of possible climate change - poverty leading to major political instability - human rights issues - supply change management (e.g. food security) - scarcity of primary resources - demographic challenges - etc …
The socio-economic context
Bamboo workshop (Vietnam) – copyright Xavier Heude
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5
10
15
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30
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Improve society Generate profit Drive innovation Produce goods and services
Enhance livelihoods
Enable progress Drive efficiency Exchange goods and services
Create wealth
Primary purpose of business … according to the Millennial Generation (% of survey respondents)
Source : Deloitte 2013 Nearly 7,800 participants from 28 countries across Western Europe, North America, Latin America, BRICS and Asia-Pacific about business, government and innovation
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The popular assumption that impact investing involves a trade-off between financial gain and social impact is wrong …
Unless this positive correlation is evident, any investment with a social goal is simply philanthropy
Clean technologies have paved the way : the benefits for society and financial profitability are so closely interwoven in the business model that one cannot be separated from the other
=> the origin of an investment decision should be the judgement of a business model that happens to include a given social impact
Financial return is not assessed in isolation from the risks taken => why assess investment performance separately from social and environmental sustainability ??
« An unconventional perspective on Impact Investing » - 2011
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True impact investing has 4 key-characteristics : - profit as an objective - a positive correlation between the intended social impact and the financial return of that investment - an intentional, pre-determined social impact - a result that produces a net positive & measurable change to society
Ambition of impact investing is to justify the investment case (investment decision is based on a holistic assessment of business objectives, including their social and environmental impact)
- how it could be integrated in the investment decision ? - how it could be monitored ? - the only difference between impact investing and traditional investing is in the
intentional measurability of non-financial impact
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If impact investing has not yet become a genuine asset class, it is primarily because it has failed to define its industry standards, and impact metrics are these standards’ centre of gravity
Attempts to come up with standardised, comparable and transparent measures have so far failed because of this lack of homogeneity in the expected purpose of metrics for various stakeholders In order to be a meaningful expression of achieved impact : - KPIs need to be closely tied to the activity’s characteristics - Individuality, however, defies comparability of KPIs, which is the expectation of investors who seek to compare impact-related investment performance
=> it is more important for impact to be measurable than how impact measurement is actually done
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Social Business (Yunus’s definition) - business model that does not strive to maximize profits … - … but rather to serve humanity’s most pressive needs - aims at solving social problems with products and services at affordable prices (education, health, technology access, environment)
company’s dividend behaviour is not a feature that determines whether or not a business is an impact business
flexibility of different share classes (privileged dividend rights vs. waive of rights)
- only original investments are paid back - all profits are reinvested (no dividends) - workforce is professional and paid according to market wages - losses must not incur, in order to be sustainable
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Impact investing (Wikipedia’s definition) - practice of assessing not only the financial return on investment - … but also the social and environmental impacts of the investment that happen in the
course of the operations of the business and the consumption of the product or service which the business creates
- take an active role mentoring or leading the growth of the company - similar to the way a venture capital firm assists in the growth of an early-stage company
(Monitor Institute’s definition) - actively placing capital in businesses and funds that generate social and/or environmental
good and at least return nominal principal to the investor - equity, debt, working capital lines of credit, and loan guarantees
Forms of Impact Investing microfinance, community development finance, clean technology investments …
(IESE Business School’s definition) Any profit-seeking investment activity that intentionally generates measurable benefits for the society
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Impact investors can be broadly classified into 2 groups based on their primary objective :
• Impact first investors, who seek to optimize social or environmental impact
with a floor for financial returns - primarily aim is to generate social or environmental good - investors are often willing to give up some financial return if they have to
• Financial first investors, who seek to optimize financial returns with a floor
for social or environmental impact - typically commercial investors who seek out subsectors that offer market-rate returns while achieving some social or environmental good
13 Derived from Monitor Institute
Rational behavior
Emotional behavior
14
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Moving beyond Socially Responsible Investment
The market should be driven by : • Prominent family offices : executing investments to address a range of challenges (climate
change, poverty …)
• Clients of leading private banks : calling on their investment managers to provide them with more choices than just traditional investment and pure philanthropy
• Private foundations : making investments in areas related to their social mission
• Private equity funds : aiming to provide growth capital profitably to businesses
• Mutual funds : dedicating a portion of their assets to emerging companies committed to
generating social and environmental value
• Pension funds and sovereign wealth funds : using their substantial resources to deploy capital in ways that benefit the communities they serve
• Corporations : finding ways to materially improve the lives of the poor while creating products and services that generate a profit
• Governments : investing in funds that support economic development in poor areas
Source : Monitor Institute
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• the pull of more values driven consumer behavior, combined with the push of current and expected regulatory incentives and mandates
• A steadily developing track-record with early successes in community development, microfinance, and clean-tech attracting broader interest
• A flock of talent interested in careers in this space, creating a next generation of leaders
Opportunities
• Lack of efficient intermediation (high search and transaction costs caused by fragmented demand & supply ; complex deals ; lack of understanding of risk) lack of impact investing opportunities into which large amounts of capital can be placed at investors’ required rates of return
• Market being still organised around a clear divide between philanthropy (for impact) and investment (for returns)
• Lack of reliable social metrics makes the suspected trade-off between financial and social
benefits even harder to address
Challenges
Source : Monitor Institute
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168 funds identified
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Microfinance Impact funds
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Raising opportunities of long-term value creation
for investors
and beneficiaries in rural areas
For reasons of confidentiality, the identity of some business-cases may not released
Rural finance gap and the missing middle
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Investment targets
Microfinance
Medium to large companies
SMEs
Profile : - startups - going concerns
Investment needs : 200.000 to 2.000.000 €
Mesofinance (the missing middle)
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The approach …
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Business-case : Empowerment of the rural communities in the Philippines, with developing a competitive national milk industry,
Key-success factors in this project : 1) Animal sourcing and crossbreeding : the capacity to set up a scalable livestock 2) Training, monitoring and coaching of the farmers (= microfinance techniques) 3) Export sales
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Small-hold farmer (Aug. 2012, Philippines)
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Dairy plant Philippines
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major NEGATIVE weighting major POSITIVE weighting
LEGAL Corp. management Strong management / business skills
Mission statement Clear written mission statementStakeholders relation Strong relations with local actorsStakeholders adherence Slow process of knowledge acquisition with
the small-hold farmers
OPERATINGProduction capacity Flexible, scalable
MODELOrganisational structure Proven procedures manual, monitoring tools, MIS
Innovation & Dvlpt Good command of technology
HR management Jobs creation (SH farmers) an assistance
Training, internal communication, incentives …
MARKET Customers Customers diversification
Clear payment policy
& COMPETITIONQuality / Reputation Good products quality and diversification
Strong products & services advantages and few
shortcomings
Market and climate Unsecured breeding during monsoon season
(?)
Large-sized market with steady growth
Competition Promotion and advertisement to intensify (?) Weak competition so far (not concentrated market)
FINANCE Financial statements Sound financial projections
Insurance Livestock not insured so far (no competitive
offer vs. mortality rate)
SOCIAL & ENVIRONMENTAL INITIATIVESLocal development Good to high social / environmental impact along the
supply-chainLobbying and awards Local dialogue, intense networking
Unofficial recognition
PROJECT’S SCORING
Score : 3,11 / 4
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Financing & technical assistance to saving/credit cooperatives, rural banks, NGOs, SMEs 1,7 mio. end-beneficiaries around
Business-case : Finance company in the Philippines, serving loans to socially responsible driven MFIs
End-beneficiaries (Aug. 2012, Philippines)
major NEGATIVE weighting major POSITIVE weighting
LEGAL Corp. management Strong management / business skills
Mission statement Clear written mission statementStakeholders Strong relations with local actors
OPERATINGOrganisational structure Proven procedures manual, monitoring tools, MIS
MODELInnovation & Dvlpt Good command of technology
HR management Jobs creation
Training, annual assessment, incentives …
Internal communication, code of conduct …
MARKET Customer Customers diversification
Clear payment policy
& COMPETITIONQuality / Reputation Good products quality and diversification
Strong products & services advantages vs. medium
shortcomings
Market Medium-sized market with steady growth
Competition Interest rates being under pressure due
to the growing competition
Good sales (and promotion ?) strategy
FINANCE Financial statements Sound financial projections
Insurance Culture of risk
External factors Government support to the microfinance sector
SOCIAL & ENVIRONMENTAL INITIATIVESInternal / external initiatives Good to high social / environmental impact
Local dialogue, social / environmental lobbying
Score : 3,60 / 4
PROJECT’S SCORING
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Philippines
NPFC, Manilla (2011) - Credit to around 300 SMEs in 2014 - Finance company - Investment : 350 K€ in shares – lock-up 5 years
Yield : 10% gross / year
Investment
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NPFC’s philosophy
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In the Philippines, upper-range loan in microfinance is around 50.000 PHP (less than 1.000 €) NPFC grant loans in a range from 50.000 PHP to 2.500.000 PHP (less than 50.000 €)
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NPFC clients (March 2014)
Manufacturing of spare parts for the automotive industry
Studio of massages performed by blinded masseurs
Manufacturing of hand-crafted decorative items
Score : 3,44 / 4 major NEGATIVE weighting major POSITIVE weighting
LEGAL Company's history 3 years only …
Corp. management Strong management & business skills
Mission statement Clear written mission statement
Stakeholders relation Good (still to expand)
OPERATINGOperational capacity Flexible, scalable
MODEL Organisational structure Policies, risk management (still to reinforce),
reporting, full integrated MIS expected soon …
Innovation & Dvlpt NPFC's strength
HR management Several employees with a banking background ,
training and incentives
MARKET Customers Customers diversification, clients' rights
& COMPETITION Quality / Reputation High-valuable products & client monitoring
Market Medium market's size that could expand with
economic growth ; good sales & promotion strategy
Competition Competition might loom up on the long term
(?)
Weak competition so far
FINANCE Financial statements Sound financial statements & projections
Insurance No public liability insurance policy (not
required by law in the Philippines)
SOCIAL & ENVIRONMENTAL INITIATIVESLocal development Good to high social / environmental impact
Supply chain Social / environmental specifications along the supply-
chain
External factors Favourable regulations from the government for
SMEs
PROJECT’S SCORING
NPFC offices August 2013, Philippines
NPFC Shareholders’ meeting - March 2014
NPFC Capacity Building session - March 2014
47
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Overview and principles
A methodology applicable whatever : • the location (worldwide) • the activity (industry – agriculture – services) • the business development’s step (start-up – going concern)
Appraisal process :
1. a conventional Due Diligence-process (101 questions) 2. a scoring system 3. a risk-management audit framework (30 to 60 questions)
Impact Investment processing :
4 steps
Monitoring process :
• social-environmental KPIs (Key Performance Indicators) • a technical assistance plan (applicable on a case by case basis)
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1. A conventional
Due Diligence approach
Corporate overview Operating Model
Market - Competition
Financial statements
Social – Environmental Initiatives
An in-depth analysis … (101 questions)
Financial return
Social- environmental
return
Check … tracking risk (4 categories)
Operational
Reputation
Financial
Legal
Operational
Reputation
Financial
Legal
Operational
Reputation Financial
Legal
Operational
Reputation
Financial
Legal Clear strategic
vision
50 50
Value analysis in Impact Investing
(extract from the Due .Dil. check-list)
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2. A scoring system Ranking of notes
Weighting system : 3 scales of notation
Weighted notes Risk’s intensity
Feature of the case / situation
appraised
Scales of notes
N (negative) Average
to High
Case / asset / situation making neither compromise nor significant advantage, whatever it occurs. Negative to neutral impact (at best)
- 5 1 2 = should be the case to reach
D (double sided)
High to Low
Case / asset / situation having negative or positive advantage, depending on the action taken
- 5 1 2 3 4
P (positive) Average
to Low
Case / asset / situation having neutral to positive advantage (can never be negative)
3 4 = minimum requirement to
reach
1 2 3 4
Poor Very good Satisfactory Below
standard
Neutral
- 5
Significant warning !
(average note)
3. Closing of analysis
• A risk-management audit Findings are classified below under 5 parts : - governance risk - operational risk - IT and physical risk - credit risk - ALM (asset & liability management)
• A validation by the Investment Committee Covenants … ?
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4. Investment set-up
• Private placement memorandum (private bond) Private investors from Retail (mini. 5000 €) to “sophisticated” investors (+50.000 €) Institutional investors Investment companies, family-offices … Foundations
• Portfolio of +1 million € invested in 3 to 4 projects (2014) Philippines sector-based diversification : finance, agri-business, energy … Target net return 5% per annum
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• JEREMIE (Joint European Resources for Micro to Medium Enterprises) : EU Structural Funds to finance small and medium-sized enterprises (SMEs) by means of equity, loans or guarantees. It operates through selected financial intermediaries
Set up in 1994 to help small businesses :
European Venture Philanthropy Association. Established in 2004 Network of venture philanthropy organisations and others committed to promoting high-engagement philanthropy in Europe Diverse membership (+150 members from 19 countries) : - venture philanthropy funds - grant-making foundations - private equity firms and professional service firms - philanthropy advisors - business schools
74 European organisations specifically identified as impact investors (EUROSIF)
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Vocation to support SMEs and microfinance institutions • Series of financial instruments designed to expand already existing
organisations or to help companies to set up in business : - Equity and quasi-equity stake - Long-term loans - Guarantees • Capacity Building Fund : BIO provides grants to co-finance feasibility
studies and technical assistance programmes • Support of technical assistance programmes upon request of the
investee companies in order to improve performance
Germany's leading development bank , with the Federal Ministry for Economic Cooperation and Development (BMZ), as a main client. Funds allocated from the federal budget, for the promotion of developing countries + additional resources raised on the capital markets Finance programmes and projects : - purely from federal budget funds (grants and loans) - mixture of federal budget funds and KfW funds (development loans) - loans at near-market conditions from pure KfW funds
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Founded in 1980 (USA) Named, created and pioneered the global field of social entrepreneurship
Philosophy : founded on the premise that the most effective way to promote positive social change is to invest in social entrepreneurs with innovative solutions that are sustainable and replicable, both nationally and globally
Established programs in over 60 countries and supports the work of nearly 3000 Fellows
Support Social Entrepreneurs - identifying / investing in leading social entrepreneurs and helping them
achieve maximum social impact
Promote Group Entrepreneurship - facilitating collaborations and knowledge sharing
Build Sector Infrastructure - helping close the historical gap between the business and civil society - creating important avenues for integration and synergy between both
communities
Global Impact Investing Ratings System
Comprehensive and transparent system for assessing the social and environmental impact of companies and funds Ratings and analytics approach analogous to Morningstar investment ranking
Ensuring success means measuring for success
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(EuSEF)
Benefits of this approach Social businesses will get easier access to private finance, helping support their growth. This will benefit many ordinary citizens: creating inclusive and sustainable jobs and growth across Europe. Professional investors will find it easier to identify and choose funds that are targeting investments in social businesses (European Social Entrepreneurship Funds). Investment fund managers will find it less costly and complex to raise funds, including cross-border
A recognised EU brand for social entrepreneurship funds: Funds that market themselves using this brand would have to invest at least 70% of their money in social businesses Improved investor information Each European Social Entrepreneurship Fund would have to provide key information to investors in a standardised way Break down barriers to fundraising across Europe: European Social Entrepreneurship Funds will also act as a passport
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Peter Blom, CEO "Profit is not an objective in itself"
Stay close to the real economy; hold a direct relation to what you invest in
Reappraise the role of money and its place in the economy
Banking to make a positive impact
Services : - Banking services - Fund management - Project development - Investment management - Venture capital funds - Corporate finance - Private banking
Geographic focus : Western Europe and emerging economies
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Principles of Ethical Finance : • ethically oriented finance is aware of non-economic consequences of economic
actions • access to finance, in all its forms, is a human right • profit produced by the ownership and exchange of money must come from
activities oriented towards common well-being and shall have to be equally distributed among all subjects which contribute to its realisation
• maximum transparency of all operations is one of the main conditions of all ethical finance activities
• the active involvement of shareholders and savers in the company's decision making process must be encouraged
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rémunération annuelle de 0,70 % au lieu de 0,90 % pour un compte d’épargne traditionnel
Association sans but lucratif (1995) ayant pour objet de promouvoir des financements alternatifs et de réfléchir au développement de l’argent éthique
Over a 3-year period, SEIIF is intended to raise USD 100 million, which will be invested in debt and equity investments deemed to have relatively low-risk and high-impact.
It is not only a moral impetus that is driving socially responsible investment. The potential for financial returns has made it an attractive proposition for an increasing number of banks and corporates.
Managed by Symbiotics and advised by Oxfam GB
How does SEIIF work? Fund structure / Key terms • Registered as an open ended mutual fund in Luxembourg, in the form of a SICAV-SIF • 5-year lock up period, followed by quarterly exit opportunities, for each investor • Invests in a portfolio of debt and equity instruments • Aims at a low-risk, high-impact profile, with a target net return of 5% per annum
SEIIF targets “the missing middle” - the financing gap for small enterprises - by investing in a variety of local financial intermediaries focusing on small enterprise development
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The 4 golden rules
1st rule : Scarcity lies in the good investment opportunities, not in the investment flow
- Secure the projects sourcing, with building strong networks - Maintain strict due-diligence standards
2nd rule : Dialogue with the business owner / stakeholders never stops
- Share common values (not just check professional skills & financial projections) - Cross-check information steadily
3rd rule : Emotion is – in a certain extent – part of the decision-making process to invest
- Tell the story and report thoroughly - Get investors involved …
4th rule : But … at the end of the day, financial performance comes first
- No philanthropy 68
Lessons learned
Barriers to Impact Investing
Motivations for Impact Investing
500 wealth managers, private banks, family offices and HNWIs (between April-June 2012)
70 Source : Monitor Institute
A nascent industry … Impact Investing may have reached a transitional moment in its evolution : poised to exit its initial phase of uncoordinated innovation … ?
?
71 Source : Monitor Institute
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Socially investing : a wide offer
basic SRI funds - actions / bonds
- theme funds : water, renewable energies …
« Alternative » social investment - micro-finance/insurance -impact investing
- revenue-sharing funds (fonds de partage)
Philanthropy - contact with projects / CSOs - set up of suitable invest. vehicule
Low / medium
level of social
engagement
Medium /
high level
of social
engagement
Ultra-high level
of social
engagement
To each customer’s expectation … A SPECIFIC FINANCIAL SOLUTION
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The scope of challenges facing society today can no longer be solved with a purely philanthropic approach (capital accessible through fundraising for philanthropic activities is in no way sufficient to address all the local issues in society) : - threat of possible climate change, as well as poverty leading to major political instability,
human rights issues in supply - change management, the scarcity of primary resources, and demographic challenges
In the light of the dominance of capitalistic socio-economic models in our societies – and the lack of credible alternatives
the challenges of sustainability can only be overcome
if they are integrated into market logic
The “Missing Middle”, SME financing needs
Source : International Finance Corporation, The SME Banking Knowledge Guide”, 2010.
75
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