How to make the 'S' in ESG more relevant

Environment, social and governance investing is all the rage, but most all investment goes into the "E" and, to a lesser extent, the "G" and not the "S." We neglect social-welfare investment at grave risk and for no good reason. But there is a way to quickly change this by making ESG meaningful for an urgent social good: speeding treatment and even cure for diseases and disabilities.

Even before the pandemic, biomedical research was advancing too slowly and often without regard to critical, unmet needs. Covid-19 has seriously delayed promising research across the spectrum of disease and disability. In just one case, a major study finds that the pandemic threatens "the viability of cancer research as a whole." New financial instruments backed, at least at first, by a federal guarantee can reverse this disastrous trend.

Vast resources are spent caring for the sick, but far too little on the prevention, detection, treatment and cure that reduce needless suffering and grief. One solution to this funding gap would be more public spending and another might be a new philanthropic age, but neither is likely in the near term. As with climate change, private investment needs to be mobilised not just to do well but also good in this most urgent of social-welfare arenas.

Typically, US biomedical funding comes at the basic level from the National Institutes of Health or philanthropy. When a treatment or cure shows promise, it then needs to be tested in clinical trials of increasing size, complexity and cost. At the start of these clinical trials, researchers usually organise a company to protect their intellectual property, getting funding mostly from university tech-transfer operations, philanthropy and – to a limited extent – outside investors. When a trial shows promise, the next step is another clinical trial and the price-tag for advancing the proposed treatment or cure goes up.

One might think that success ensures financial resources, but it takes a lot of expensive trials before the odds of success generally become clear enough to find third-party investors willing to carry promising research through the end-stage trials essential for drug or medical-device approval. The gap between promising early-stage clinical research and the end stage at which big money shows up is known as the 'translational valley of death'. It got this sad moniker because it's in this valley where projects that should be translated into cures sit neglected for years and often wither away.

The valley of death is deep because the equity investors on which biomedical research now depend demand major stakes in high-profile projects with big-ticket drug prices to meet their own market imperatives. Many nations bypass this equity-based, high-cost, high-risk business model with public investment, but the US has never done so in large part due to its historic aversion to direct federal investment in for-profit firms.

Even before the pandemic, biomedical research was advancing too slowly and often without regard to critical, unmet needs. Photo: Bloomberg

As the trillion dollars of green bonds demonstrate, the best way to bridge the translational valley of death is to change the biomedical-funding model from one dependent on equity investments to one that also offers lower-cost debt suitable for research too early in the translational process to have proved its profit proposition. There are many ways for early-stage researchers to demonstrate the ability to repay small loans and still more ways for the federal government and philanthropists to leverage their resources to help them do so. However, building a new debt market for translational biomedical research will take years if we rely solely on private financial institutions to see this light.

The sums translational researchers need are too small and the nature of their organisations too different from traditional commercial ventures to entice sustainable lending until market developments demonstrate viability to more than a few adventurous lenders and securitisation firms. The proven way to create safe, sound, sustainable, and affordable financing for social-welfare priorities is via a limited federal guarantee. This is how green bonds started and how we need to start a new "bio bond" asset class. With this backstop, packages of loans with strong probability of repayment can be originated for packaging into bonds in which risk is dramatically reduced not just via the guarantee, but also thanks to an array of eligibility and diversification requirements. 

These requirements also ensure that guaranteed debt funding isn't soaked up by big biopharma in the form of a new subsidy for still higher profits or as a back-door backstop for venture capital. We know from housing finance and the 2008 cataclysm how important it is to align debt-market incentives with social welfare objectives and this lesson must be reflected in the design of new federal guarantees for under-served biomedical researchers desperate to address unmet needs across the spectrum of disease and disability.

The legislation now pending in Congress shows one way to craft such a guarantee with built-in controls to create a secondary market for high-quality loans to promising scientists suitable not only for local lenders, but also institutional investors such as pension funds and life insurers. Others are possible in the context of broader, "ARPA-H" legislation, where guarantees for new bonds would power up the federal spending also needed to speed translational research.

Adding an 'S' component to ESG offerings is both urgent and possible. The US will unlock billions of dollars for the vital public good of faster cures by deploying well-established loan-underwriting and asset-securitisation practices without adding to the federal deficit.   

Karen Petrou is the managing partner of Federal Financial Analytics Inc., a financial services consulting firm. She is the author of "Engine of Inequality: The Fed and the Future of Wealth in America."

Disclaimer: This article first appeared on Bloomberg and has been published by a special syndication arrangement.