The historical context of the term “diligence” points towards the underlying aspirations and challenges of due diligence processes today.

In 1841, travel and mobility in Germany took off with the introduction of the so-called “Diligence” — an express stagecoach superior to its predecessors, cutting journey times in half.

The efficiency of this new mode of transport shaped both travel and information flows. The Diligence changed our relationship with space and time: temporal distances shrank, spatial ones expanded.

This is what links the Diligence with the core challenge of sustainability: the impact of economic activities on our ecosystem extends far beyond the “here and now” in time and space — in this context, how can we assess investments with respect to their sustainability criteria? The answer is closely intertwined with the growing importance of “impact due diligence” in infrastructure.

Here, parallels can be drawn with the then-revolutionary Diligence. Until recently, sustainability risks alongside ESG factors were mainly integrated into acquisition and due diligence processes to manage business, legal, or reputational risks to the investment itself.

However, a sustainability assessment in terms of impact due diligence extends far beyond the projected investment period as it considers the impact of the investment on the environment as well as social and corporate aspects over its complete life cycle. This is the fundamental intention of impact investing: linking profitability with environmental and/or social objectives.

The three facets of impact due diligence

Climate impact funds screen investments against three criteria: Firstly, the investment must have a measurable ecological impact and make a positive contribution to climate protection. The second criteria involves an analysis of the compatibility of the investment with other sustainability goals, such as the protection of biodiversity. Finally, compliance with certain minimum standards regarding social issues and governance practices is assessed.

A core challenge lies in defining the specified impact targets as precisely as possible in a measurable way. Climate impact funds primarily pursue the goals of climate change mitigation and adaptation. Thus, the life cycle emissions of the respective investment serve as the benchmark for measuring impact. However, simply excluding fossil fuels is a necessary but not sufficient criteria. For investments in renewable energies, for example, the total amount of green electricity lies at the core of the impact analysis, as does the amount of greenhouse gases avoided.

However, meeting an impact target alone is not enough to qualify as an impact investment. Instead, a holistic sustainability approach towards the investment’s environmental impact is needed. This is covered by the so-called “Do No Significant Harm” (DNSH) assessment. Impact funds are generally guided by the six environmental objectives defined in the EU taxonomy: Climate Change Mitigation, Climate Change Adaptation, Sustainable Management of Water and Maritime Resources, Transition to a Circular Economy, Pollution Prevention and Control, and Protection and Restoration of Biodiversity and Ecosystems.

The goal of the assessment is to ensure that, in achieving one environmental objective, no others are negatively impacted. For example, a hydropower plant with a large dam may contribute towards CO2 emissions-free electricity production, but in some cases may have significant negative influence on local ecosystems and would therefore contravene the goal of protecting and restoring biodiversity and ecosystems. An investment is therefore only suitable for an impact fund if biodiversity is protected and preserved.

Impact-focused sustainability extends also into the areas of society and good corporate governance. These aspects must be given special attention in impact due diligence. Above all, they include social and employee concerns, respect for human rights, and the fight against bribery and corruption. In practice, impact funds assess the company’s own business practices as well as those of business partners, service providers and supply chains in terms of potential social and governance risks.

Impact due diligence in transition

Over the course of the 19th century, the “Diligence” was overtaken by the railway as an even faster and safer means of transportation. Here, too, there are parallels with impact due diligence — after all, the core challenge is to make this particular form of sustainability assessment safer and faster.

Impact assessments depend on both the quantity and quality of available data. The assessment of impact factors is challenging mainly due to existing data gaps. These gaps may further grow or narrow, depending on the industry’s progress on incorporating more comprehensive, accessible and interconnected ESG data — bearing in mind that the depth of data availability and risk-adjusted returns for investors tend to be strongly correlated. 

By Tobias Huzarski, head of Impact Investment at Commerz Real