ESG investment, corporate reporting and sustainable markets initiatives launched at the World Economic Forum will influence the regulations, standards and stakeholder expectations around the corporate response to climate change.
One of the lasting images of last week’s World Economic Forum (WEF) in Davos – a gathering of industry leaders and politicians – was of a meeting between a British royal and a 16-year-old activist. HRH Prince Charles and Greta Thunberg had each delivered impassioned pleas (and admonishments) that those industries and governments need to do more to combat climate change.
The issue was the central theme of Davos 2020 and dominated the WEF’s 2020 Global Risks Report, with environmental issues making up three of the top five identified risks in terms of impact and all of the top five risks in terms of likelihood.
All this is a far cry from 10 years ago, when the top five risks were dominated by economic factors such as asset price collapse and the slowdown of the Chinese economy, with environmental risks entirely absent.
Beyond the rhetoric, Davos saw the launch of several white papers and initiatives intended to have a direct impact on shaping policy and corporate practices.
Unlocking capital markets
The United Nations was warned that there is a persistent $2.5 trillion gap in the financing needed to achieve its 17 Sustainable Development Goals (SDGs) which include environmental objectives in areas such as climate action, affordable and clean energy, responsible consumption and production, and sustainable cities and communities. Closing this gap requires 3% of global GDP to be invested in sustainable development.
An interactive ‘Sustainable Development Transformation Map‘ charts the interconnections between the diverse challenges and issues around sustainable development. One particular area of focus, as set out in a recent white paper from the UN Secretary-General’s Taskforce on Digital Financing of the UN SDGs is the role that capital markets can play in making a positive difference, through supporting sustainable investment.
“Some of the brightest minds in capital markets are bringing key tools and innovations to sustainable investing and achieving the SDGs. We are confident the best is yet to come” Taskforce on Digital Financing of the UN’s SDGs”
The taskforce’s report identifies two major challenges in financing the SDGs:
- There is no common definition of material information that includes SDG-linked disclosures for valuation modelling and risk management purposes.
- The lack of consensus on a shared definition of “impact” and associated measurement criteria.
Standardising reporting requirements and metrics would help all stakeholders in relation to SDGs or environmental, social and governance (ESG) factors(the report acknowledges that there is a close link between the concepts of ESG and the SDGs, although the two are distinct). Investors need to be able to demonstrate the ESG/SDG credentials and returns of their investments; businesses need to understand the metrics on which they will be judged by investors; and civil society groups have an important role in assessing the impact of ESG/SDG investment.
The European Union is making progress on addressing these challenges. Its sustainable finance action plan includes a Taxonomy Regulation, to introduce an EU-wide taxonomy of environmentally sustainable activities, and a Disclosure Regulation, which would impose new transparency and disclosure requirements on certain firms. Both regulations are currently progressing through the EU legislative process. Other regions (including the UK, post-Brexit) may look to the EU model to encourage impact investing as a way of driving positive change.
Beyond financial reporting
The availability and standardisation of ESG-related information is not just an issue for investors. Towards Common Metrics and Consistent Reporting of Sustainable Value Creation is a discussion paper prepared by the WEF, in collaboration with each of the ‘Big Four’ accounting firms, for the WEF International Business Council, which addresses the provision of non-financial information in the corporate reporting process.
“ESG and other factors relevant to sustainable value creation … are increasingly material to business performance. As such, they should be addressed in the mainstream report and proxy statements and integrated into core business strategy and governance processes. By reporting on these factors on a consistent basis in its mainstream report … a company demonstrates to its shareholders and other stakeholders that it diligently weighs all pertinent risks and opportunities in running its business, conducting its governance processes and contributing to broader economic and social progress…” Towards Common Metrics and Consistent Reporting of Sustainable Value Creation discussion paper”
The report proposes two sets of metrics, based around four “pillars” (principles of governance, planet, people, and prosperity):
- Core metrics: the core metrics are intended to be well-established data that the organisation should be able to provide of its own accord, such as: annual greenhouse gas emissions, land use, freshwater consumption, climate risks, statistics on anti-corruption training and instances of breach, wage-level ratios and diversity statistics, and investments made in the community.
- Expanded metrics: these are less well-established metrics that tend to extend across a wider value chain and “convey impact in a more sophisticated or tangible way, such as in monetary terms”. Examples of expanded metrics include: the organisation’s approach to stakeholder engagement, the societal impact of greenhouse gas emissions across the value chain, the impact of air pollution in urban areas, and current wages against the living wage for employees, contractors and suppliers.
The ethos behind the metrics is that they should be consistent with existing frameworks and regulatory requirements; be widely applicable and based on widely-available data; and be linked to long-term value creation for stakeholders.
The report was produced for discussion and consultation with International Business Council (IBC) members, with the intention of finalising the reporting framework over the next few months. Once it has been finalised, businesses – particularly IBC members, but it will be open for others to follow voluntarily – will be encouraged to report on at least the core metrics during their next financial year, as part of their annual corporate reporting. The intention is for these metrics to be adopted formally as a generally accepted international accounting or other reporting standard, on a “comply or explain” basis.
The IBC’s 2017 “Compact for Responsive and Responsible Leadership” has been signed by the CEOs of more than 140 corporations worldwide. If the majority of those companies decide to include the proposed metrics in their corporate reporting, this could create the direction and momentum needed to establish standardised, comprehensive ESG corporate reporting requirements for other businesses to follow.
In contrast to the detailed and specific remit of the IBC proposal, the Sustainable Markets Initiative (SMI) was launched with the lofty goal to “accelerate the transition to sustainable markets”. A collaboration between the Prince and the WEF, the SMI is a platform for business leaders. The initiative set out a five-point plan to achieve its aims:
- Pathways: outlining responsible transition pathways to decarbonise and achieve net zero.
- Policy: aligning policies, regulations, taxes and incentives to create the enabling environment.
- Prices: embedding positive and negative social and environmental costs into goods and services to ensure sustainable options are the attainable option.
- Standards: adopting common standards and comparable metrics so consumer, investors, shareholders and the public are better informed to make decisions.
- Platforms: connecting investments to investables using platforms that can rapid scale solutions.
It remains to be seen how these high-level aims are translated into specific actions, commitments or lobbying, but with a council that includes the CEOs of major multinationals such as Bank of America, HSBC, AstraZeneca and KPMG, as well as the Prince, the group has the potential to have an influential role in shaping policy and market-driven initiatives. This may take the form of signing up to common commitments, voluntary certification schemes or self-regulation in certain areas.
Each of these reports and initiatives has the potential to introduce significant change to reporting requirements, investor decision-making and commercial behaviour across a range of regions and sectors. But perhaps more significant is the cumulative impact on policy agendas and stakeholder expectations of the attention that is being given to ESG considerations that are moving from aspirational to essential.