Are you an organisation that needs to report on its environmental and social performance? And is this exercise simply another regulatory burden or does it help you succeed in the marketplace?
This post looks at the state of sustainability reporting in the world and what needs to be done to make sure that the value created by sustainable companies is fully recognized by investors and financial markets.
Assessments of corporate sustainability have been around for decades. RobecoSAM, a leading investment specialist, questions over 3,400 companies every year on the economic, environmental and social factors that contribute to their success.
The Dow Jones sustainability indices are based on RobecoSAM’s methodology. So, how well does the sustainable index do when compared to the rest of the market?
Not that well, it turns out. Since 2012 the S&P 500 index is up 85% while the Dow Jones sustainability world index composite is up 30%.
It might not just be about performance, but you could have gained almost 3 times as much by not worrying about sustainability.
Not everyone is interested just in financial returns.
Some organisations such as churches and environmental groups may not want to invest in anything that they see as “bad”. This might include alcohol, tobacco and guns. Some may include or exclude nuclear power depending on how good or bad they see that technology.
Some investors see a future where companies that have sustainable practices will do better than those that don’t. For example, socially responsible retailers might be expected to take market share from those that don’t demonstrate such behaviour.
Other investors might see certain sectors as being more exposed to risks from climate change. For example, they might want to avoid banks that hold stranded coal plants or insurers that have flood risk liabilities.
Still other investors may simply prefer sustainable companies to non-sustainable companies as long as the returns don’t diverge too much from expected market performance.
Sustainability is increasingly mainstream
1300 organisations controlling over $59 trillion in assets have signed up to the United Nations Principles for Sustainable Investment.
Some of the largest companies in the world including Google, Walmart and Apple are taking significant steps to make their operations and supply chains more sustainable.
A crucial element of sustainable development is the use of robust sustainability reporting frameworks.
In the United Kingdom and Europe some companies and many public sector bodies have a mandatory requirement to report on the environmental and social impact of their organisations.
The legislation is designed to not be onerous, using existing systems and data collection where possible and leaving it to the discretion of the companies to choose what they include in their annual reports.
Internationally the number reporting standards is increasing
The Global Reporting Initiative (GRI) is the oldest such standard and tries to bring in a common language so organisations can communicate their economic, environmental and social impact and help stakeholders understand more about them.
The GRI standards are interrelated documents that help companies prepare a sustainability report focused on material topics in a form that follows the reporting principles set out by the GRI.
There are three main problems with existing sustainability reporting.
First, there is confusion over what is meant by sustainability. Does it cover just the carbon impact of an organisation’s operations or should include its supply chain? Should larger organisations be held to a more stringent standard?
Secondly, what are investors looking for? Not all investors are the same and is it possible for one single report to meet the needs of different types of investors?
Thirdly, the way in which metrics are calculated have methodological weaknesses. Given this, is it appropriate to compare companies on the basis of the metrics reported or do investors need to carry out more investigation?
It is worth understanding the types of investors out there in more detail
Socially responsible investors will invest in sustainable companies and exclude “bad actors” from their portfolio on principle, even if they have to accept worse returns.
Investors looking for a social return on their investment will take factors such as the community benefit of projects into account in addition to the financial return on investment.
Investors looking to avoid risk will tilt their portfolio towards companies that they feel will not be disadvantaged by the impact of climate change.
Investors looking to green their portfolio will choose, all else being equal, sustainable companies instead of non-sustainable companies.
Finally, investors looking to profit from a decarbonised economy want to select sustainable companies that they feel will outperform the market.
How should organisations appeal to these different kinds of investors?
Many ESG metrics are based on reputational measures such as feedback questionnaires or social media research. Could organisations use more operational measures that allow for better comparisons?
Most companies focus on the impact of their operations measured in terms of their carbon emissions. It may be better, however, to focus on whether products and services contribute to sustainability. In other words, is their carbon handprint bigger than their carbon footprint.
ESG metrics are almost invariably backward looking. This might mean some companies are excluded because of their history.
For example, Volkswagen is currently under pressure for its role in diesel emissions fraud. The company, however, will have to radically transform itself in order to recover from the scandal and may actually be a good choice from a sustainability point of view in the future.
It is still hard to see any clear links between the sustainability metrics collected by organisations and their success in the marketplace. Are organisations collecting the right information?
There is still much research that needs to be carried out to determine which metrics are material and will link sustainability and organisational performance.
Finally, investors may need to select metrics that are appropriate for the kind of investing philosophy that they follow. A broad approach may be less effective than a narrow one where a set of robust comparable metrics are used to evaluate similar companies.
Make sure the data is good
Effective data collection underpins good sustainability reporting. Wherever possible data needs to be based on measurements rather than assumptions, and should be verified.
To be useful, data needs to cover a long enough time frame so that patterns and trends can be identified.
Where there is missing data, as is often the case, methods used to fill gaps must be transparent and robust.
It may be necessary to normalise data before it can be compared. Once again, the method used to transform the dataset must be robust and transparent.
Finally, updating information once a year may not be sufficient for investors. It may be necessary to provide guidance and enter information sooner, for example using quarterly reporting.
In summary, as more companies commit to becoming more sustainable there will be a greater need for good quality sustainability reporting.
Investors and financial markets will pay more attention to good reports and should reward companies with greater success in the market.