Hello and welcome to the 2nd monthly CEO Report!
The first 2 and a half months of 2021 have been a whirlwind for the global community of Social Value International. Across the world, interest in social value and meaningful social impact measurement and management continues to increase, with more and more sectors, industries and individuals seeing the need to expand our global definition of value and protect people and the planet.
In this month’s report, I dive deeper into ESG – a concept we cannot move without hearing right now – as well as highlighting to you a couple of important global developments that highlight that ever so critical principle of materiality:
The phenomenon of E, S and G
It’s hard to move at the moment for commentary, analysis or pure hyperbole that uses the three letter acronym of ESG. My team is often asked: “can SVI help determine the ‘S’ in my ESG? The S standing for ‘social’ so – of course! This month I want to address this by unpacking these three letters: E,S and G and how it relates to the work of Social Value International.
Firstly, let’s be clear that “ESG” is not a standard, it’s not a framework or anything other than three words put together: Environment, Social and Governance. It is used mainly within the context of corporate sustainability reporting and mainstream financial markets to simply describe a set of environmental, social or governance issues that relate to a business (or investment) and should be reported.
Before I get my scalpel out to dissect and critique, I will put on record that I am delighted that mainstream investment and multinational corporations are using the term so much. The new Biden administration in the USA is clearly building sustainable finance and ESG into its identity. This all shows how the world is changing. Every day we can see that our perception of value is expanding beyond purely financial metrics.
But before we get too excited, I do want to make a few technical observations and highlight two major recent developments to show that these 3 letters alone are not enough to change the world – or at least not as much as it needs to in order to tackle climate change and rising inequality.
Some technical points to show the limitations of typical ESG metrics: On the whole (and let’s remember there is no standard here) ESG metrics are almost always at the “output” level. This means that they do not capture outcomes – changes in people’s lives. At best they are proxy measures for what might lead to outcomes and impacts for people. A typical S metric might be: “number of reported accidents in the workplace” or “gender diversity in the workplace”. In reality, none of these provide meaningful insight into changes in wellbeing or actual impact on people. Take a look at SVI’s second principle: “Understand what changes”.
Even if these metrics were measuring outcomes rather than outputs, rarely do ESG metrics have any weighting or value assigned to them, which means that all issues must be taken as equally important. This makes it impossible to make decisions about optimising value creation. That is what makes the principle of valuation so important to SVI’s mission.
My last technical gripe (for today!) is that the process for deciding what ESG issues are reported is (almost) always based on what issues pose a risk to financial profit. This brings us to SVI’s fourth principle of ‘Only include what matters’. But what matters for whom and why? To use technical but more zeitgeist phrases; ESG metrics adopt a ‘single materiality’ lens or an ‘enterprise value’ focus. At its simplest, ESG metrics are presenting what matters to investors (shareholders) where they pose an immediate risk to short term financial gain. If there are ESG factors that affect people or the planet but won’t affect immediate financial returns they can be deemed immaterial and not reported or managed. Reduced biodiversity and increased social inequality probably won’t affect next quarters profits and so won’t often be captured in ESG metrics.
This discussion could become very long if I wade too deep into the fierce materiality debate that is raging. In the previous paragraph my example may be slightly exaggerated to make a point. Of course, the nuances are real. I hasten to balance the debate by highlighting the phrases ‘double materiality’, ‘inside-out materiality’ and ‘dynamic materiality’ that are getting equal air time and they reflect a slightly opposing view, held by many (businesses and investors), that impacts that matters to people and the planet are always going to affect the profit of a business in the long(er) term and so more should be included. SVI have had a clear position on materiality since 2007; where stakeholders experience impacts that matter to them, they should be accounted for and managed. This is part of accountability and maximising value.
Two important recent developments: The tectonic plates that underpin capital markets, financial reporting and corporate disclosures are shifting fast. In the last week alone two developments are worth highlighting and lay bare the battle lines around this critical principle of materiality:
- Firstly, the IFRS confirmed their intention to create a Sustainability Standards Board that will focus on information that is material to the decisions of investors, lenders and other creditors but interdependent from value creation for society and the environment (a single lens of materiality).
- Secondly, the next day, the European Financial Reporting Advisory Group published a roadmap for the development of a set of EU sustainability reporting standards and reforms to EFRAG’s governance structure to ensure that future EU sustainability reporting standards would be developed using an inclusive and rigorous process (most likely a double materiality lens).
I point you all to this short and beautifully to the point blog by Professor Carol Adams that compares these two big developments. This matters to us all, these developments that may seem dry and technical but are actually the key to reforming what information gets measured and subsequently, as we know; what gets managed!
For those that can’t get enough of this and want extra homework, I point you to this excellent document that shows how reporting disclosures can be aligned to SDGs: Sustainable Development Goals Disclosure (SDGD) Recommendations.