Sustainability

MEF seeks to ensure that its investments do not significantly harm its Sustainable Investment Objective by screening potential investments and monitoring existing investments against the principal adverse impacts on sustainability factors (“PAIs”) and applying minimum safeguards as outlined below.

The Fund does not knowingly invest in any MFI which is expected, or is determined, to do significant harm to the Sustainable Investment Objective, and the Fund will seek to actively engage MFIs in order to put in place or monitor the implementation of environmental and social management systems (“ESMS”) that can adequately meet the Fund’s environmental, social and governance (“ESG”) requirements.

By screening potential investments and monitoring existing investments against the identified PAIs, the Fund seeks to ensure that its investments do not cause any significant harm, do not harm the impact objectives, and seek to reach the impact objectives of the Fund. Those PAIs shall be identified, assessed, and, when appropriate, mitigated. The Fund engages its Investment Advisors to identify the potential principal adverse impacts on sustainability factors of proposed investments, recommend mitigation measures and perform follow-up monitoring.

The Fund currently collects the following mandatory PAIs: Exposure to companies active in fossil fuel sector, Share of non-renewable energy consumption and production, Energy consumption intensity per high impact climate sector, Activities negatively affecting biodiversity-sensitive areas, Hazardous waste and radioactive waste ratio, Violations of UN Global Compact Principles and OECD MNE, Lack of processes and compliance mechanisms to monitor compliance with UN GC principles and OECD Guidelines MNE, Unadjusted gender pay gap, Board gender diversity, and Exposure to controversial weapons (anti-personnel mines, cluster munitions, chemical weapons and biological weapons). Following consultation with the Investment Advisors, some mandatory PAIs such as GHG emissions, Carbon footprint, GHG intensity of investee companies, and emission to water have been discovered to be difficult to capture. To this end, the Fund has purchased a data proxy from an external data proxy provider which could help bridge the gap, hereby providing the data which would help the reporting of the above-mentioned PAIs.

As these PAIs are challenging to collect from non-EU MFIs, the Fund is also consulting its Investment Advisors to determine the most relevant additional PAIs to report on. The regulatory and industry standardisation around the methodologies and tools used to perform PAIs assessment is evolving, and the Fund will continue to make its best efforts to accurately assess PAIs related to its investments.

As of due diligence, ESG risk identification and scoring are embedded in the respective tools used by the Investment Advisors and the Fund requests the Investment Advisors to classify their proposed MFIs following IFC risk categorisation for Financial Institutions. Moreover, the compliance with the minimum safeguards (UN Guiding Principles on Business and Human Rights, International Bill of Human Rights, ILO Declaration on Fundamental Principles and Rights at Work), is performed on a systematic basis at the due diligence stage to ensure that no significant harm is done.

Compliance of Sustainable Investments with minimum safeguards as defined in the investment guidelines of the Fund (the “Investment Guidelines”) are assessed at due diligence stage and monitored, ensuring alignment with the UN Guiding Principles on Business and Human Rights including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights.

The OECD Guidelines for Multinational Enterprises do not apply due to the nature of the investee companies of the Fund (micro and small domestic enterprises in emerging markets), however the Fund applies other due diligence principles reflecting the transversal standards of the OECD guidelines such as human rights, employment, environment, combating bribery, consumer interests, through the Fund’s Client Protection and Responsible Finance Principles and the Fund’s exclusion list in line with international standards set forth by development finance institutions.

The Fund aims to support economic development and prosperity globally through the provision of additional development finance to microenterprises and households, via qualified MFIs, in emerging markets. The Fund aims in particular to ensure that financial services are delivered in a responsible and inclusive way through MFIs for the ultimate benefit of its clients, including to rural borrowers, underserved women, women-owned or women-led businesses. The Fund’s vision and mission have been translated into the following strategic impact targets consistent with the investment strategy and social goals of the Fund:

• supports economic development and prosperity globally through the provision of additional development finance to micro-enterprises and private households engaged in entrepreneurial activities via qualified financial institutions,
• observes principles of sustainability and additionality, combining development and market orientations in pursuing its development goal.

To assess the achievements towards its Sustainable Investment Objective, the Fund has been using a social performance assessment tool that is widely used in the microfinance sector, providing data and indicators allowing to measure the achievement of the Fund and the alignment with the Sustainable Investment Objective. Those set of indicators, mentioned in section f) below, are aligned with industry practices and allow streamlined measurement and benchmarking. Considering the Fund’s target regions and specifics of the investment strategy, the Fund has not designated a reference benchmark for the purpose of attaining the sustainable investment objective.

The Fund aims principally at contributing to the debt financing of MFIs which are institutions that provide microfinance services, including (without limitation) credit, savings deposits, insurance, remittances, and housing loans, to the working poor in developing countries. Such institutions may offer other financial services in addition to microfinance services, and these other services might represent a greater percentage of the institution’s overall business than microfinance services. The Fund promotes a widespread adoption and further deployment and outreach of responsible finance and social performance standards based on industry-wide international principles and practices.

The Fund targets MFIs that serve or intend to serve clients, including underserved women, who manage low-income households, are salaried employees, are microentrepreneurs, or own or lead a micro-enterprise in emerging markets. MFI investments represent the portion of the portfolio of the Fund contributing to the refinancing of MFIs through debt instruments including, but not limited to, senior unsecured loans, secured loans, and bonds or notes, with maturities ranging from six months to three years.

The Investment strategy of the Fund, as well as the types of investments made by the Fund, are further described in the issue document of the Fund.

The Fund requires a set of quantitative and qualitative criteria to be met by eligible MFIs (as further detailed in the Investment Guidelines) to ensure that they follow good governance practices, such as:

• compliance with national laws, including those related to environmental and social performance, health and safety work environment, and microfinance regulations where applicable,
• presence of adequate policies and procedures regarding lending to micro, small and medium-sized enterprises to adhere to the principles of responsible finance and prevent over-indebtedness, and
• adherence to principles of good corporate governance structures, integrity standards and frameworks that ensure responsible ownership.

The investments of the Fund consist of the following investments: (i) mainly MFI investments representing the portion of the portfolio of the Fund contributing to the refinancing of MFIs through debt instruments, and (ii) liquid assets.

Total Sustainable Investments and Socially Sustainable Investments represent a minimum of 70% of the total assets of the Fund. The actual percentage invested will depend on technical, political and economic developments related to the MFIs’ business and environment.

The remaining share (up to 30% of the total assets of the Fund - Not Sustainable Investments) are composed of liquid assets which represent the portion of the non-invested cash that is temporarily placed or deposited in line with the Fund’s policies and derivatives used for currency risk hedging purposes to allow effective de-risking of the Fund’s partner MFIs and their borrowers.

Financial institutions with which the Fund may place or deposit its excess cash are approved by the Board and are major financial partners rated at minima at investment grade level, as defined in the Investment Guidelines.

Also, and to allow effective de-risking of its partner MFIs and their borrowers, the Fund strives to offer local currency financing as much as possible. In parallel, to mitigate open market exposures, the Fund fully hedges the principal of each investment against the Fund’s reference currency (USD) and, to the extent it is economical to do so, the Fund also seeks to hedge local currency interest flows. Derivatives are always related to MFI investments and therefore captured in the MFI investments portfolio.

The Fund preference for local-currency lending reflects both market demand as well as the impact objective of strengthening responsible finance and the financial stability of the MFIs and clients in line with the mission statement of the Fund.

To ensure alignment with its impact objectives, the Fund defined the following key sustainability indicators (the “Sustainability Indicators”): (i) final borrowers reached by the Fund’s funding, (ii) average loan amount per final borrower, (iii) median loan amount per final borrower, (iv) percentage of women final borrowers, (v) percentage of women-led businesses and (vi) percentage of rural final borrowers. These are considered in investment decisions and sustainability data is collected on an annual basis using a social performance assessment tool.

The Investment Committee of the Fund monitors the portfolio and MFI investee performance on an ongoing basis whereby any concerns emerging from the investment proposals prepared by the Investment Advisors are reviewed as they arise.

Monitoring at the level of the Fund furthermore includes the monitoring of the overall portfolio quality and ESG portfolio risks based on the MFI risk categorisation as disclosed in the Fund’s Risk Management Policy. The overall risk level of MEF’s portfolio shall remain low. The Board must be informed in case of a deterioration of the overall level of risk below that standard and shall strive to re-establish the overall level of risk in line with the required standard.

The Investment Advisors monitor impact and ESG aspects on a regular basis and update their assessments accordingly. Any deterioration is brought to the attention of the Investment Committee of the Fund, and, as required, also the Board, to be addressed to ensure sound business continuation.

The Fund also applies for relevant recognized labels (e.g LuxFLAG Microfinance Label) and takes part in international initiatives that aim to ensure transparency across the impact finance industry (e.g. Operating Principles for Impact Management).

The Investment Advisors assess each potential investment using their respective internal methodology and/or proprietary rating methodology, and in parallel, investments are reviewed against the due diligence questionnaire of the ALINUS-SPTF social performance assessment when such questionnaire is available. The Investment Committee of the Fund considers these scores and analyses in its investment decisions and gauges the impact potential of an investment based on the IA’s impact assessment of the MFI.

In order to achieve its Sustainable Investment Objective, MEF has established that in the process of choosing an investment the following aspects shall be considered:

• Alignment with the Fund’s sustainability objectives
• Investments’ viability and adequate risk profile
• Alignment with the Fund’s requirements
• Developmental and social impact

These requirements are reflected in the agreements entered into by the Fund with its Investment Advisors and the Fund’s MFIs through Impact and ESG covenants. The Fund also reviews these requirements on a regular basis.

The Fund follows specific Investment Guidelines including impact and ESG criteria to be applied at the level of both the individual transaction and the global portfolio of the Fund, including but not limited to: (i) restrictions on investments in certain sectors and activities, (ii) geographic focus of investments, (iii) exposure limits to certain MFIs, (iv) impact-driven selection criteria for MFIs, (v) key performance indicators to set and measure the impact generated by the Fund, and (vi) ESG risks and mitigants at different stakeholder levels.

The eligible target countries of the Fund only include countries which are not members of the European Union and that are not classified as high-income on the World Bank list.

MFIs are also required to comply with the Fund’s exclusion list in line with international standards set forth by development finance institutions, the Fund’s ESG & Impact covenants, and the Client Protection and Responsible Finance Principles as defined in the Fund’s Investment Guidelines. In parallel, from an impact risk and sustainability risk perspective, MFIs shall comply with the minimum safeguards of the SFDR as mentioned above and be classified by the Investment Advisors according to the IFC risk categorisation for Financial Institutions.

While using its own questionnaire to collect ESG datapoint, starting from 2019, the Fund decided to streamline its social data collection processes using the industry standard SPI4-ALINUS in view of enhancing its social impact assessment though a review and strengthening of the indicators, analysis and reporting, and providing inputs for its annual report. In parallel, the Fund may consider hiring external service providers to: (i) facilitate the implementation, (ii) assess the social performance of its MFI investments and (iii) benchmark its portfolio against other relevant benchmarks when available.

In this respect, since 2018, the Board of Directors has engaged CERISE to coordinate and analyse social performance assessments of the Fund’s MFIs, in close collaboration with the Investment Advisors. CERISE, a global leader in impact measurement, manages the widely recognised social audit tool SPI4-ALINUS aligned with the Universal Standards for Social Performance Management (USSPM).

In addition to market outlook and portfolio development aspects, the impact reporting of the Fund is based in large parts on financial, developmental, outreach and social indicators reported by the MFIs. The aggregate responses on aspects such as outreach, products and services, or on the range of social performance indicators provide a yearly “snapshot” of the MFIs in MEF’s portfolio.

The impact reporting captures how the Fund, as a whole, performs based on traditional microfinance indicators and assesses the social performance of its MFI investments as well as benchmarking its portfolio against the universe of MFIs. However, for a global fund such as MEF, capturing the impact and benchmarking across various investees profile such as low-income households, micro entrepreneurs as well as small enterprises requires a more nuanced approach. For this purpose, selecting adequate indicators and adjusting the ESG and Impact initial assessment and monitoring requirements according to the profile is key.

It is to be noted that the datapoints are reported directly by the MFIs and/or the Investment Advisors on the SPI online platform, with the Investment Advisors confirming the datapoints reported. Prior to conducting an in-depth analysis of MEF portfolio companies, CERISE runs a series of checks on the collected data to identify potential reporting errors and inconsistencies. To complete the reporting and benchmarking work on time so that the annual report can also be published in a timely manner, the analysis might not be based on the entire portfolio. All sample and benchmarking information are described in the annual report. Reporting on Sustainability Indicators is based on more than 95% of portfolio coverage, while PAIs are expected to cover at least 80% of the portfolio.

The Fund currently collects the mandatory and two additional PAIs. Following consultation with the Investment Advisors, some mandatory PAIs such as GHG emissions, Carbon footprint, GHG intensity of investee companies, and emission to water have been discovered to be difficult to capture from the MFI. To this end, the Fund has purchased a data proxy from an external data proxy provider which could help bridge the gap in an approximative manner, hereby providing the data which would help the reporting of the PAIs mentioned in section b) above. Such data proxies constitute a limitation to the methodology of MEF.

MEF also recognises that developmental effects at the outcome level typically cannot be captured by portfolio or MFI reporting alone. The Fund is therefore considering how best to address this, such as through impact studies or evaluations, to support the impact narrative as well as to assess any unintended effects. To strengthen its reporting, MEF is furthermore assessing the possibility of applying a model developed by the industry to the entire portfolio, which will serve to provide an estimation of impact effects at the portfolio level.

Notwithstanding the care given to data checks, certain discrepancies and reporting errors may remain, which however have no consequences on the global analysis and reporting for MEF.

Finally, the collection of datapoints from MFIs in developing countries is challenging and the Fund applies best efforts to ensure adequate data monitoring as already described above.

The Investment Advisors are required to perform mandatory due diligence on prospective MFIs. Such due diligence includes the identification and evaluation of social and governance aspects as well as risks and opportunities. The pricing of investments shall reflect market conditions, risk profiles, and each prospective MFI investment is first screened by the investment committee of the respective Investment Advisor. Final proposals of all potential MFI investments are then submitted to the Fund’s Investment Committee for decision-making, and as the case may be, to the Board.

Investment Advisors are required to monitor and provide timely reporting and, as the case may require, escalation regarding external ESG factors with respect to any MFI, or their underlying clients, that could reasonably materially impact the MFIs’ compliance with the Fund requirements and/or the MFI’s profitability and risk profile. ESG risk identification and scoring are embedded in the respective tools used by the Investment Advisors.

The Investment Advisors shall:

• Ensure MFIs’ ongoing compliance with all relevant laws and other standards and regulations
• Support and encourage the MFIs to work towards continuous improvements in their ESG process through trainings and the continuous involvement of management and staff
• Monitor, record and report any serious incidents involving the MFIs

MFIs are also required to comply with the Fund’s exclusion list in line with international standards set forth by development finance institutions, the Fund’s ESG & Impact covenants, and the Client Protection and Responsible Finance Principles as defined in the Fund’s Investment Guidelines. In parallel, from an impact risk and sustainability risk perspective, MFIs shall comply with the Minimum Safeguards of the SFDR and be classified by the Investment Advisors according to the IFC risk categorisation for Financial Institutions.

The Fund aims to ensure that its investments do not cause any social or environmental harm. As such, MEF carefully filters potential MFIs and systematically assesses ESG risks.

As mentioned above, the Fund also applies for relevant recognized labels (e.g LuxFLAG Microfinance Label) and takes part to international initiatives that aim to ensure transparency across the impact finance industry (e.g. Operating Principles for Impact Management).

MEF engages its Investment Advisors, each a signatory to the Operating Principles for Impact Management (OPIM; www.impactprinciples.org), to identify the potential adverse sustainability impacts of proposed investments, recommend mitigation measures, and perform follow-up monitoring.

MFIs are required, in their respective agreements with the Fund, to make ESG representations towards the Fund, meet the Fund’s ESG requirements at the level of such MFI, and provide a copy of their environmental and social management system (“ESMS”), all commensurate with the MFI’s risk profile, and to notify the Fund of any amendments to their ESMS. Whilst the Fund does not exclude MFIs that do not yet have a full ESMS, it actively engages its MFIs to ensure that they have minimum standards in place, assesses the ability of the MFIs to comply with the Fund’s ESG requirements, takes corrective actions to the extent applicable, and puts in place or monitors the implementation of ESMSs in accordance with agreed schedules. The social performance of the Fund’s investment in MFIs is periodically evaluated based on evolving social performance standards.

Investment Advisors are also required to monitor and provide timely reporting/escalation regarding external ESG factors with respect to any MFI, or their underlying clients, that could reasonably materially impact the MFIs’ compliance with the Fund’ requirements and the MFI’s profitability and risk profile. The loan covenants between the Fund and the MFIs notably require MFIs to implement corrective measures in case underlying client activities are inconsistent or in breach of the Fund’s ESG requirements. If an MFI fails to engage its underlying client to take corrective measures, such MFI is required to take commercially reasonable steps to exit from such underlying client activities. Ultimately, a breach of the Fund’s loan covenants may be deemed to be an event of default, giving rise to the Fund’s recourse to call the loan due and accelerate repayment of principal and interests, as well as penalty interest as the case may be in accordance with the relevant agreement with such investee.