On the heels of the 2015 Paris climate agreement, environmental, social, and governance (ESG) standards exploded onto the scene as a way for companies to focus on sustainability in business decisions and for investors to prioritize socially responsible companies. In the years that followed, trillions of dollars poured into ESG funds. But cracks started to emerge, underscoring the importance of redefining catalytic capital.

As journalists looked under the hood of ESG funds, they found investments in oil and gas majors. In 2021, Tariq Fancy, former chief investment officer for sustainable investing at Blackrock, the world’s largest asset manager, penned a scathing essay that the ESG label was being used to dupe the American public with greenwashing. Backlash against the consideration of social factors in investments also began to grow; in recent years, 19 US states have passed 42 anti-ESG laws preventing public fund managers from taking social considerations into account.

At its core, ESG’s problem stems from a lack of clarity, demonstrating the need to redefine catalytic capital. There are, of course, innumerable instances of ESG-focused funds leading important change globally. Many have helped reform operational and governance standards within corporations, and forced internal dialogue and measurement efforts to gauge social progress. But in the absence of clear, value-based standards, it’s often just a buzzword. Its loosely defined, “yes and” posture allows companies and investors to toss it around to validate their commitment to social good without having to meet specific requirements. Companies’ loquacious race to classify themselves as “ESG-approved” has led to justified attack, with shareholder support for ESG declining and institutional investors citing ESG fatigue.

The ESG movement may be too far gone to revive. But its fate can help shape the development of another type of impact financing: catalytic capital. A sharper, shared understanding of this form of risk-tolerant investment, which takes on risk to validate a new business model or market with the aim of ultimately drawing in more capital, can dramatically increase the volume and scope of funding for social impact.

Read the full article about redefining catalytic capital by Savannah Baum, Olivia Rosen, Sean Sellers, and Billy Silk at Stanford Social Innovation Review.