BUS604: Innovation and Sustainability

Research shows that companies managed with a long-term ESG-friendly approach and a clear focus on sustainability perform better financially than those that aren't. A study by Harvard and London Business Schools found that a dollar invested in 1993 in a value-weighted portfolio of high sustainability firms would have grown to US$22.60 by 2010, compared with US$15.40 for low sustainability firms. Growing numbers of financial sector leaders recognise the investment case for sustainability. Signatories to the UN Principles for Responsible Investment accounted for US$59 trillion of assets under management as of April 2015, a 29 percent year-on-year increase. 

Many institutional asset owners – particularly pension schemes and insurance companies – are alive to the potential of their money to influence the wider economic system. For instance, in late 2016, HSBC placed £1.85 billion of its UK employees' pension savings into an environmentally-friendly fund. The HSBC pension fund's chief investment officer described taking action on climate change as "the new normal" for investors.

However, it isn't easy for investors to discover which investments will have the most impact on sustainability. If all companies financed by the system were paying "real" prices reflecting the true costs of externalities (see Section 3.7), then investors and their financial intermediaries would be able to compare companies' sustainability performance by comparing their financial performance. But achieving accurate prices across the economy will take time. Until then, investors rely on companies' ESG reporting to compare their sustainability performance. Unfortunately, there are as yet no agreed standards for measuring sustainability performance equivalent to international accounting standards, and no publicly available or recognised league tables, making that comparison difficult. 

The past 15 years have seen significant growth in disclosure of corporate performance on sustainability. There has been a huge rise in interest in responsible and sustainable investment among asset managers and owners and rapid growth among companies providing ESG analysis, such as Vigeo, EIRIS, MSCI, and SustainAlytics. Now 92 percent of the world's 250 largest companies report on sustainability. 

Most fund managers now claim to include assessing ESG performance in their investment process. However, even the largest institutional investors with teams of 30-40 professionals in their ESG units, can only cover ESG for 1,000 companies in any serious way, in an investable universe of up to 30,000 companies. The challenge is an order-of-magnitude higher for smaller investment houses.

The lack of a standardized system for reporting on ESG performance is the main reason ESG analysis is time-consuming and expensive. In its absence, different companies use different reporting standards. There's the international Global Reporting Initiative, country-specific schemes like the UK's Connected Reporting, and principles ranging from the UN Global Compact to the OECD's Guidelines for Multinational Enterprise. There are also quality standards, like ISO 26000 on social reporting; issue-specific standards like those of the Carbon Disclosure Project; reporting frameworks that focus on materiality, like the Sustainability Accounting Standards Board's; and ones that focus on broad brush strategy, like the International Integrated Reporting Council's approach.

This profusion of frameworks is a headache for investors, 79 percent of whom say they are unhappy with their ability to compare sustainability reporting between companies in the same industry. CEOs lose out too. When everyone uses different frameworks, there's no way to benchmark performance against competitors, or use high performance scores to build trust among customers, staff, and the public. And it is harder to make the quantitative case that investing in sustainability brings better returns. 

Moreover, much of the existing analysis of relative corporate ESG performance remains inaccessible to individual asset owners and civil society because of high paywalls, lack of transparency in methodology, or the complexity of reporting. As a result, individual investors and civil society cannot hold companies effectively to account for investing in and promoting good corporate performance on sustainable development. And companies have insufficient motivation to improve on their corporate sustainability performance. 

The Commission believes that publicly listed companies should decide on simple, clear metrics to report annually to stakeholders. These metrics should be standardized across industries and geographies to allow for easy comparison by investors. We will advocate to investors to monitor progress in this direction and to build these metrics into their ESG assessment of companies. We urge other business and financial service leaders to do the same.

We strongly support the creation of corporate Global Goal benchmarks that harmonize and build on existing corporate reporting requirements and frameworks. Once companies report consistent data over time, comparable with others in their respective sectors, benchmarks can be developed. From this position, it is a short step to compiling "league tables" of company progress towards alignment with the Global Goals. Such tables would for the first time enable the leaders and boards of companies, policymakers, civil society, and retail investors to quickly and easily compare the relative performance of companies within a sector, over time, on a range of Global Goals relevant to the sector. This process would need to be governed by an independent, non-political institution, to ensure no conflicts of interest from the private or public sector.

The greater the number of companies in a sector participating in and leading this process, the more relevant the Global Goal benchmarks will become to all the companies in the sector. A well-designed benchmarking process allows individual companies to decide for themselves how to develop sustainably, in line with the Global Goals, while at the same time setting them all on a competitive "race to the top". The global insurer, Aviva, has proposed such a concept and its proposal has been endorsed by the UK government. (See Box 8: Transparent reporting starts a race to the top for a forerunner in the pharma sector).

Box 8: Transparent reporting starts a race to the top

The Access to Medicines Index provides a model for benchmarking performance related to Global Goals. The index, published every two years by non-profit foundation Access to Medicines, analyses the performance of the top 20 pharmaceutical companies on improving access to medicines, vaccines, and diagnostics in low- and middle-income countries. Making this sector data transparent motivates all the companies in the group to make their products more accessible. In effect, it has started a "race to the top" on the issue in the sector.

More broadly, financial actors can strengthen sustainability teams and make sure sustainable development is at the heart of their dialogue with business leaders, not just the "back page". Businesses leaders can help to clarify this dialogue by making statements of their strategy for long-term value creation and describing in explicit, quantitative terms how their investments in new business models, products, and value chains related to Global Goals will drive improvement in the bottom line, reduce risks and improve the quality of earnings. Business leaders should also educate and encourage stakeholders to look beyond some of the quarterly reporting items and focus on the basis of the business's longer-term sustainability. More boldly, some business leaders may choose to end the practice of issuing earnings guidance and quarterly profit reporting altogether.

Lastly, driving progress in this direction would be an appropriate responsibility to give to a non-executive board director accountable for implementing a company's strategic alignment with the Global Goals (see Section 3.5). Investors can directly support the appointment of a director with this responsibility wherever they have a vote in the election of board directors. Corporate Governance Codes, in particular, the G20/OECD Corporate Governance Principles, could also advocate this approach to leadership responsibility for advancing sustainable investment.