Business Sustainability Has Lost Its Way

The bright lights of ESG are distracting us from the primary purpose of business sustainability.

The Ledger: ESG Funds and SDGs

ESG Funds

From an investor’s point of view, it’s going swimmingly. ESG funds are potential money makers. As COVID-19 hit us in the first half of 2020, ESG portfolios weathered the storm best, with 40% of ESG funds making top quartile financial returns.[i] The MSCI ESG Universal Index (global stocks with a robust and improving ESG profile) made a total return of 5.31% compared with the MSCI World Index return of 3.64%.[ii] Ergo, ESG marketers are gushing about ESG alpha and funds are gushing into ESG investments. Global inflows exceeded US$150 billion in Q4 2020; ten times the inflows in Q4 2018.[iii] Global ESG assets are expected to exceed US$53 trillion and represent more than one third of total assets under management by 2025.[iv]

Sustainable Development Goals

On the sustainable development side, it’s not going so well. An advance version of the UN Secretary-General’s annual report on SDG progress, released last week, warns that:

• the goal to end poverty by 2030 is out of reach due to COVID-19, conflict and climate change
• tens of millions of people were pushed into chronic hunger in 2020
• health services are disrupted in 90% of countries
• the pandemic has been catastrophic for children’s learning
• violence against women and girls has intensified
• refugees in 2020 were at the highest number on record
• unsustainable production and consumption is driving three planetary crises: climate, biodiversity and pollution
• human rights have been shattered in some countries
• and foreign direct investment is expected to drop by 40%, inhibiting recovery.[v]

UNEP reported this week that the world is on course to fall short on the environmental SDGs. [vi] It was reported in March that the Asia-Pacific region is on track to achieve less than 10% of its SDG targets (for which there are data) and has regressed on climate action since 2000.[vii] It is estimated that achieving the SDGs will require an increase in funding of US$2.5 trillion per year.[viii]

Imbalance

On the one hand, we have a massive upsurge in ESG funding. On the other hand, sustainable development is underfunded and we are drifting further and further from success on global sustainable development goals. Theoretically, ESG funding and sustainable development should enjoy mutual success - isn’t that what the ‘financing green’ and ‘greening finance’ revolution is about? Yet, one is booming while the other busts.

The Enabler: Business Sustainability

Purpose

Both ESG funding and the sustainable development agenda rely on business performance on sustainability criteria. But if business sustainability is working well for ESG investors, why isn’t it working for sustainable development? After all, the primary purpose of business sustainability is to help business contribute effectively to sustainable development.

There is no doubt that businesses have reshaped their ambitions and transparency on key concerns: employee health, safety and wellbeing, diversity and inclusion, energy consumption, water use and carbon emissions, with nature loss and modern slavery entering the conversation. Certainly, the pandemic has highlighted the need for corporate resilience and the value of social licence.

Climate Ambition

Corporate ambition on climate resilience, in particular, has grown spectacularly. Best practice recommendations for climate risk reporting, ie TCFD, were introduced only in 2017 and by FY20 had been picked up by 37% of the top 250 businesses by revenue globally, including about half of those in the oil and gas, automotive and financial services industries. A key part of business climate resilience is ensuring that a company reduces its carbon emissions in line with stakeholder expectations. Two thirds of the top 100 businesses by revenue per country and three quarters of the top 250 businesses by revenue globally now have carbon emissions reductions targets, and 23% and 39% of their targets, respectively, are linked to the Paris Agreement. 

Sustainability Reporting

Sustainability reporting, too, has skyrocketed, with 80% of a sample of listed companies worldwide producing some kind of sustainability report, up from 73% in 2015. This is consistent across all industries, with only retail slightly lagging all others. Two thirds of the top 100 businesses by revenue per country and three quarters of the top 250 businesses by revenue globally use GRI sustainability reporting standards, which encourage businesses to focus their reporting on their most material sustainability topics.[ix]

The Distraction: ESG Reporting

In the past year, there have been three major proposals to further corporate transparency on business sustainability. A white paper from the World Economic Forum International Business Council is aimed at simplifying disclosure down to just 21 core business metrics to overcome business reporting ‘pain points’.[x] The proposal from the International Financial Reporting Standards Foundation is aimed at meeting the needs of investors, with a focus on climate matters.[xi] The European Commission’s proposal is aimed at directing investment toward more sustainable activities to support the European Green Deal.[xii] So, we can be sure that business sustainability practice in the foreseeable future will be focused on producing less painful, common, internal business metrics that help asset managers build better ESG portfolios.

Transparency is a good thing, but our direction of travel on ESG reporting is not going to help responsible investors, or any other stakeholders, understand how much a business is contributing directly to, say, the eradication of poverty, which is the primary goal of the 2030 Agenda for Sustainable Development.[xiii]

The Call: Refocus Business Sustainability

Evaluate Actual Impact

Global success on the 2030 Agenda for Sustainable Development, which all 193 member states of the United Nations unanimously adopted in 2015, requires a critical mass of businesses to take responsibility for measuring, managing and disclosing their biggest absolute harms and contributions to sustainable development goals, not as measured inside the business, but as experienced outside the business.

Business internal ESG performance, even on material issues, is not a proxy for impact.

• Climate impact is the social cost of total GHG emissions (minimum US$50 per tCO2e) in a business’s supply chain (the counterfactual being zero, as if the business did not exist). Climate impact is not the reduction in carbon emissions in business operations.
• Water impact is the effect that a business has on the people (health issues) and environment (loss of biodiversity) within its water context (the counterfactual being zero, as if the business did not exist). Water impact is not the reduction in water use in a business’s operations or the reduction in fertiliser per hectare in its supply chain.

Look at SDG Targets

Businesses say that they struggle to understand how the SDGs apply to them or how to work them into business goals. Hmmm, businesses seem to be able to overcome such challenges when investors and governments show an interest. Five years ago, it was a rare business that understood anything about CO2 emissions; now, 21% of the world’s 2,000 largest companies have net zero targets and more than 9,600 businesses submitted data to CDP on carbon, forests and water in 2020.[xiv] [xv]

The 17 SDGs are abstract, that is true, but there is a lot more to them than meets the eye. Behind them sit 169 targets that are highly relevant to the business sector. Yet, businesses appear to suffer from imposter syndrome in this space, crowding around SDG 8 Decent Work and Economic Growth (prioritised by 72% of high revenue businesses), SDG 13 Climate Action (63%) and SDG 12 Responsible Consumption and Production (58%), while several others are barely supported, including SDG 2 Zero Hunger (22%), SDG 14 Life Below Water (18%) and SDG 15 Life on Land (9%).[xvi]

There is so much that businesses do, or could do, to directly affect achievement of the SDGs.

Does your business produce or distribute plant food? Then, consider whether your business or its supply chain are harmful or helpful toward maintaining the genetic diversity in food production, and try to evaluate the effect.

Does your business design, build, finance or manage infrastructure? Then, consider whether your business is contributing to building resilience to environmental, economic and social disasters, and try to evaluate the effect.

Does your business operate in developing countries? Then, consider whether your business is contributing to offering special and differential treatment to developing countries, and try to evaluate the effect.

Use the Tools

There are numerous resources to help businesses better understand how they contribute to sustainable development and how to disclose their contribution, including:

• SDG Compass Inventory of Business Tools (for assessing impacts on SDGs)[xii]
• SDG Matrix (examples and ideas for corporate actions on SDGs)[xviii]
• UN Global Compact (links to platforms and tools to support SDG implementation)[xix]
• Future Fit Business Benchmark[xx]
• Sustainable Development Goals Disclosure Recommendations[xxi]

Conclusion

Business sustainability exists to help business contribute effectively to sustainable development, whose primary concern is overcoming global wicked problems, including poverty, hunger, gender violence and a lack of opportunity among billions.

Do say, we’re here to help. Don’t say, ESG alpha matters too.

References

[i] https://www.trustnet.com/News/7464986/has-it-been-worth-holding-an-esg-fund-in-2020/

[ii] https://www.trustnet.com/news/7466122/esg-funds-beating-their-conventional-rivals-in-most-sectors-this-year

[iii] https://www.reuters.com/article/us-global-funds-sustainable-idUSKBN29X2NM

[iv] https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/

[v] https://sdg.iisd.org/news/secretary-generals-sdg-progress-report-recaps-pandemic-impacts-on-17-global-goals/

[vi] https://www.unep.org/news-and-stories/press-release/world-set-miss-environment-related-sustainable-development-goals-un

[vii] https://www.unescap.org/sites/default/d8files/event-documents/APFSD8_2E.pdf

[viii] https://www.un.org/press/en/2019/dsgsm1340.doc.htm

[ix] https://assets.kpmg/content/dam/kpmg/xx/pdf/2020/11/the-time-has-come.pdf

[x] https://www.weforum.org/reports/measuring-stakeholder-capitalism-towards-common-metrics-and-consistent-reporting-of-sustainable-value-creation

[xi] https://www.ifrs.org/projects/work-plan/sustainability-reporting/#about

[xii] https://ec.europa.eu/commission/presscorner/detail/en/qanda_21_1806

[xiii] https://sdgs.un.org/2030agenda

[xiv] https://eciu.net/analysis/reports/2021/taking-stock-assessment-net-zero-targets

[xv] https://www.cdp.net/en/articles/media/companies-worth-15-trillion-revealed-on-cdp-2020-a-list-of-environmental-leaders

[xvi] https://assets.kpmg/content/dam/kpmg/xx/pdf/2020/11/the-time-has-come.pdf

[xvii] https://sdgcompass.org/business-tools/

[xviii] https://www.unglobalcompact.org/library/3111

[xix] https://www.unglobalcompact.org/sdgs/17-global-goals

[xx] https://futurefitbusiness.org/sdgs/

[xxi] https://sdghub.com/project/sustainable-development-goals-disclosure-sdgd-recommendations/