What is Sustainability Reporting?
Sustainability Reporting is a trend that has been gaining traction steadily over the past thirty years. Although it started as a beneficial expedient that companies resorted to in order to improve their communication with stakeholders and persuade potential investors, its importance has now grown exponentially. Today, it is seen as a proof of integrity, transparency, and accountability, as well as a way to demonstrate the commitment of a business to sustainable growth.
In a 2013 Guardian interview, Allen White, co-founder and former CEO of GRI (Global Reporting Initiative), argued that sustainability reporting has evolved from being driven by factors such as corporate accountability and performance improvement to being rediscovered as a transformational instrument for redefining corporate value and value creation:
“In a complex, perilous and uncertain world, reporting is playing a vital role in reframing the meaning of value. The dominance of short-term shareholder value is under more scrutiny than at any time in last three decades. Slowly but steadily, a new definition of value is emerging, one rooted in multiple capitals that encompass human, social, natural alongside financial. In the future, the valuation of a company can and must accord parity to all forms of capital. The planet’s well-being and business prosperity alike are at stake. Sustainability reporting stands to play a leading role in this seminal transformation.”
While sustainability reporting is not yet mandatory, some companies have already reaped the benefits that derive from such a practice. An example of a company that managed to switch to sustainability while keeping its business going strong comes from the multinational corporation Capgemini, which provides consulting, technology, professional, and outsourcing services.
In their 2018/19 report, the company claimed the successful implementation of measures such as having their target validated by the Science-Based Targets initiative (SBTi), the rethinking of business travelling, the installation of solar panels and specific improvements to the energy efficiency of working space, all of which allegedly led to the lowering of car travel and air travel emissions, the reduction of total energy use by 18% since 2015, and the decrease of their carbon footprint in record time. It was estimated that in 2018, two years ahead of schedule, Capgemini reached their 2020 target with a 21% reduction in greenhouse gas (GHG) emissions per employee against 2015 levels.
Conformity Requirements: When Can Targets Be Considered Science-Based?
“Targets adopted by companies to reduce greenhouse gas (GHG) emissions are considered “science-based” if they are in line with what the latest climate science says is necessary to meet the goals of the Paris Agreement – to limit global warming to well-below 2°C above pre-industrial levels and pursue efforts to limit warming to 1.5°C.
ESG reporting and sustainable investments are deeply linked. But why is it paramount to start investing sustainably?
“The Sustainable Development Goals (SDGs) are fully synergistic with our investment objectives.” - Western Asset
A trend that has been taking shape lately is that not just business ventures, but investors, too, are now concerned with measuring the environmental and social impact of their investments. This is what has been observed in studies such as the third Sustainable Signals survey conducted in 2019 by the Morgan Stanley Institute for Sustainable Investing. But the connection between investments and environmental, social, and governance issues, namely the fact that EGS issues can impact investment portfolios directly, affecting their performance, had been acknowledged back in 2006, when the Principles for Responsible Investment (PRI) were first brought forth.
The United Nations-supported PRI grew to be the world’s leading proponent of responsible investment, and its principles continue to help investors materialise and internalise non-traditional financial factors such as climate change- and human rights-related matters. Eventually, they should enable sustainability. In this respect, the most incisive roadmap designed to pave the way for a globally sustainable future is the Sustainable Development Goals initiative (SDG), a collection of seventeen goals launched in 2015 by the General Assembly of the United Nations.
In one of their 2017 papers, the PRI elucidates its reasons why – as investors become more proactive, seeking products and solutions in line with their interests – other investors and companies should also seriously take into account the issue of sustainability. They acknowledge the detriment of some past as well as current business practices aimed at the achievement of business growth, and they condemn blind ambition at the expense of the environment and the people. They also see the potential behind the SDGs as instruments necessary to reach untapped markets and geographies, and to develop innovative financial products:
“The way that past economic growth has been achieved cannot be maintained: it has been responsible for an expanding list of environmental and social burdens. With many of the catalysts of past growth (e.g. use of fossil fuels and rapid urbanization) no longer sustainable in their current form, future growth is likely to be much slower and more erratic over the next 30 years than over the past 30.”
“Inefficiently allocating capital to companies with high external costs, such as those engaged in highly-polluting or socially disruptive activities, can over time lower asset values, reducing returns to investors: one company’s externalities can damage the profitability of other portfolio companies and overall market return."
Investors play a vital role in the achievement of the goals set by 2030, and the need to meet the challenges is undoubtedly urgent. As a matter of fact, the UN Commission on Trade and Development (UNCTAD) estimated that, in order to meet the SDG goals, from 2015 to 2030, the annual budget to be spent on sustainable investments should range between US$5 trillion and US$7 trillion. Yet investors are not even remotely on track at the moment. Out of the US$75 trillion to US$105 trillion required funds, approximately US$1.3 trillion have actually been invested in impact investments by PRI signatories. The thorny issue of insufficient money allocation could have to do with the fact that “only one in six PRI signatories (17%) report allocating capital to environmentally/ socially themed investments (e.g. inclusive finance, renewable energy, clean technology, affordable housing).”4 In spite of investors’ widespread skepticism, their confidence in the long-term benefits of sustainable investing prevails over their perplexities. These long-term (sustainable) investments are becoming even more accepted in the “ClimateTech” world as larger funds, such as Bill Gates’ Breakthrough Ventures, plan to heavily invest in climate hardware with very high upfront costs that differ from the light-weight software-based investments of the period post-CleanTech 1.0. Investors seem aware of the fact that their duty to invest in an ethical manner is also an expression of their need to stay relevant. Therefore, acting in the interest of their beneficiaries is tantamount to acting to their own advantage.
“Recent research by McKinsey Global Institute has shown that companies that operate with a true long-term mindset perform better, consistently outperforming their industry peers since 2001 across almost every financial measure that matters.”
“Meta-studies by Mercer and the University of Hamburg and Deutsche Asset & Wealth Management8 provide clear evidence that sustainable business practices lead to lower cost of capital and equal or even better financial performance, but despite higher costs of capital, companies with poor ESG management still have sufficient access to capital and companies providing unsustainable products and services may have relatively good ESG risk management (and vice versa).”
According to “Sustainable Signals”, a survey conducted in 2019 by the Morgan Stanley Institute for Sustainable Investing, not only did almost 9 in 10 respondents (88%) believe that it was possible to conciliate financial gains with social and environmental impact, but they also concurred that their actions could affect climate change and that, socially, they could have positive repercussions on the indigents. The types of impact investment themes that investors showed interest for were plastic reduction (46% indicated a strong interest towards it), climate change (46% indicated a strong interest towards it), and community development (42 % indicated a strong interest towards it).
“Overall, 71% agreed that their investment decisions can influence climate change, up 17% points from 2017, and 84% among the general population agreed that their investments could lift people out of poverty through economic growth.”
Given the evident benefits of long-term sustainable investing, investors now seek solutions that are compatible with their values. Apparently, though many companies are starting to offer an even wider array of products and services, they are still failing to incorporate goods and practices that are tailored to investors’ wants and needs. In turn, investors’ struggle to find alignment with their business priorities causes them to refrain from sustainable investing at all.
This represents a major glitch in the communication system between investors and companies. Companies, however, can align with investors’ interests by developing products which are ideally in line with their values, or at least non-conflicting with their business principles. This tactic could enable them to be the propulsive force behind the closing of the gap between investors’ basic interest in sustainable investing and their actual adoption of sustainable measures. On the other hand, the very purpose of the application of the PRIs* is to better align investors with broader objectives of society, as stated in the preamble to the PRI Principles.
*PRI = Principles of Responsible Investment
Were we to examine the matter from an environmental perspective instead than from a financial viewpoint, we could argue that the demands we are imposing on the planet exceed the available resources:
“In 2016, the Global Footprint Network (GFN) estimated that our demands on renewable natural resources would need 1.6 earths to be met, and more that 80% of people now live in countries that demand more from nature than their ecosystem can regenerate. With the population forecast to reach 8.3 billion people by 2030, we will need 50% more energy, 40% more water and 35% more food.”
Environmental risks could bring about higher costs for ecological damage repair:
“Annual environmental costs from global human activity were calculated at US$6.6 trillion in 2008, equivalent to 11% of GDP, with the top 3,000 public companies – i.e. those that make up large, diversified equity portfolios – responsible for a third of this (US$2.15 trillion).
As far as the social risks are concerned, there are still people who do not have access to basic services such as healthcare, clean water, energy, and sanitation. Aside from the ethical implications of social inequality, it can also lead to political unrest and economic instability:
“Income inequality in OECD countries is at its highest level for 30 years23, and Oxfam estimates that the 62 richest people in the world have the same wealth as half the world’s population. This significant level of income inequality is creating a number of social stresses, including mistrust of governments and business, as well as governance and security-related issues.”
The vexed question of a more dedicated approach to sustainable measures remains open, and the expectation that responsible investment practices will lead to increased profits must be called into question as a major catalyst for the implementation of sustainable measures. The belief that financial returns will be produced as a result of sustainable investing bases its foundation on the assumption that advantageous turnover and sustainability are two faces of the same coin, which is certainly one of the facets of investors’ behavior that needs inspecting. It is not only essential to shed light on the reasons why such an attitude persists, but also to discuss the solutions needed in order to meet the goals in time. Eventually, failure to meet the challenges of the SDG goals could significantly affect the value of capital markets or their potential for growth, and with that, the value of diversified portfolios.
“Undeniably, current responsible investment practices contribute to the ‘broader objectives of society’”, but the contribution is limited and achieving the SDGs through corporate responsibility and responsible investment will require a more dedicated approach. To meet the challenges of the SDGs, responsible investment should not just look at how ESG risks and opportunities affect the risk-return profile of an investment portfolio, but also how a responsible investment portfolio affects those broader objectives of society.”
Sources:
Sustainable_Signals_Individual_Investor_White_Paper_Final.pdf (morganstanley.com)
https://www.theguardian.com/sustainable-business/blog/what-is-purpose-of-sustainability-reporting
https://sciencebasedtargets.org/what-is-a-science-based-target/
https://www.allianz.com/en/sustainability/strategy-governance/strategy.html
https://www.capgemini.com/2019/10/why-sustainability-reporting-matters/
https://www.capgemini.com/resources/group-environmental-sustainability-report-2018-19/
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