FI's & Corporate's Transition for Sustainability & the Arts or Maths of Universal ESG Metrics
Basics first - E S G metrics are the measurements of Environmental, Social & Governance aspects of a business’s performance. To recollect, when did we begin discussing this? You won’t disagree that no one was talking about ESG measurements earlier than just 3 to 4 years from now. At that time, credit risks and investment decisions were purely based on financial performance. The basis of credit ratings was blind to everything other than the financial numbers. Covid-19 came and probably shacked the system. But by then, distinguished people were already raising the problem in the system or the larger economy. Multi-stakeholder Capitalism was the central topic in WEF Davos Agenda 2020. Mr Klaus Schwab, the Founder and Executive Chairman of the World Economic Forum has been an advocate of multi-stakeholder capitalism since the beginning and published his book Stakeholder Capitalism: A Global Economy that Works for Progress, People and Planet along with Peter Vanham in Jan 2021. Parallel to this, the dimension of Purpose in businesses was already gaining strength. People were recognising the growing problems in the world, starting from Environment to Nature loss to poverty and inequality. This conversation became centre stage with Covid’s impact on the entire world, disrupting every corner of our lives. Covid forced us to retrospection, which probably was possible due to the lockdowns. There was a unanimous voice for change. The post-Covid world must be different. Some called it Build Back Better. And an opportunity came for a systemic change. Because our lives were disrupted at a systemic level, the new could be different at a systemic level too. Various initiatives at the international level including the Glasgow Financial Alliance for Net Zero (GFANZ), and Global Gateway initiated by the European Commission are on today.
The financial system realised its responsibility and the opportunity to steer this change in the economy. For the first time, the creditworthiness of businesses was not determined by financial numbers alone but additionally considering another set of measurements called ESG metrics which looked into the Environmental, Social & Governance aspects of a business’s performance. It was like a gold rush. Suddenly everyone realised the huge opportunity that had come and how meaningful it was. In other words, ESG risks became material. Something that sat in the Corporate Social Responsibility (CSR) bucket had become centre stage, and doing good while doing business seemed the most sensible thing. Was it Covid, or the extreme weather events or growing social unrest seen through migration, social conflicts & war that fuelled this shift? Possibly it was all of these. Time is running with climate change being experienced at a first-hand level by people across the globe. Was the pandemic the result of this changing environment? No one knows that, but no one can deny the possibility.
So business’s creditworthiness was looked at through a new lens by the financial sector. They wanted measurements on ESG aspects, started creating new rules for investment decisions and corporates started showing how good they were on ESG aspects. Everything suddenly turned green. It was like a switch. Something that sat in the CSR bucket became the centre stage, and in no time, businesses started disclosing how they were meeting the requirements. Then there came the rush from the standard-setting bodies who came with sets of metrics to be disclosed by businesses. This led to a number of standards that businesses could adopt. The industry referred to the situation as an alphabet soup. The investment community faced the challenge that it could not compare the sustainability-related disclosures by businesses for any sensible investment decision-making.
So each party was focused on their immediate requirement - for FIs, it was how to make investment decisions; for the corporates, it was how well they could display performances on ESG aspects; for the rating agencies it was how to rate businesses on ESG aspects; and the standard-setting bodies competed for making their requirements more comprehensive than the other.
In all of these, a very basic fact was missed out. Corporates and FIs needed to transform to bring their focus to ESG aspects before corporates could start portraying how green they were, and FIs could start judging investment decisions based on those disclosures.
Something non-existent could not be centre stage in no time and ready for measurements and investment decisions based on those measurements. This hasty move by each participant has led to a situation where confidence in the ESG related outcome is very low - be it FIs ability to make investment decisions, ESG ratings by the agencies, or the situation of an alphabet soup by standard-setting bodies or the disclosures by the corporates themselves.
The net result of this is the appointment of the International Sustainability Standards Board (ISSB) today, which is entrusted with coming up with a global Sustainability Standards that could lay down the requirements for sustainability-related disclosures by corporates. These disclosures would enable comparability on ESG aspects of a business’s performance.
So maybe we need to step back and fix the basic problem of transformation first that would make the corporates deliver towards the Environmental, Social and Governance aspects with a high focus.
Once the strategy and the entire process is focused on this goal and the organisation embarks on a journey that is delivering results, every other party in this system can work around this but nothing before that.
So the most crucial thing is the transformation of businesses to make the Environmental, Social & Governance issues their centre of focus and the same for the FIs. To appreciate ESG, FIs need to transform and bring ESG to the centre stage from the CSR bucket and monitor their portfolios.
If this transformation could be executed through a consistent and repeatable methodology, that would become the foremost action by corporates and the FIs. Measuring the quality of this transformation methodology would become a clear indicator of an organisation’s ESG oriented performance partly. But what this transformation methodology could look like?
Environment, Social and Governance focus do not originate from a profit mindset but a desire to do good across stakeholders.
Organisations need to have a purpose, a higher purpose beyond just making a profit.
A higher purpose would become a north star that would steer the organisation and nudge it to make positive impacts across stakeholders. Focusing on purpose does not mean the business will be impacted on profit in the long run. It will not only enable profit at the same or with better results but also make the businesses harmonious and inclusive across all stakeholders - the customers, employees, suppliers, environment, society and the shareholders. It is the robustness of businesses that will make them last for a very long period of time and be truly sustainable. It is a win for themselves and a win for the people, society, and the planet.
So the transformation would be such that it will result in making the corporate or the FI sustainable for the long term.
A consistent and repeatable transformation methodology for sustainability (e.g Change thru Movement (CTM) by SEEM) that underpins the organisation has purpose beyond just making a profit would result in projects delivering toward the organisation's Purpose, which also means the outcomes would align with one or more Sustainable Development Goals (SDGs).
These projects' results would be the outcome of innovations. They would not be BAU activities. Hence the risks inherent in those projects would be very different and possibly cannot be identified when looked at through the traditional lenses of the BAU type of work model. The transformation methodology for sustainability probably needs to be built on a management philosophy which is not of Command and Control.
The philosophy required would be of believing in people, giving them Purpose and letting them innovate - Engage, Empower & Mobilise.
Unlike Command and Control type of management processes where the goal is already known for each task, it is not possible in the case of something new that is yet to be created. Innovation requires space, and that space cannot be already defined by specific goals, risks and tasks. Yet the journey of innovation would have processes and controls but somewhat different. The repeatable transformation methodology for sustainability (e.g CTM) must have a governance structure embedded inside it, disclosing this standard Transition Plan and then measuring the quality of its deployment would become a clear indicator of an organisation's ESG oriented performance partly. These measurements would become part of the ESG metrics, and they would be universal as they are not dependent on the type of organisation or industry in which the transformation methodology is deployed.
Let's now talk about the other part of the universal ESG metrics and the mathematics of it.
The transformation journey would result in projects with outcome measurements that would be quantitative. So to give projects a pathway to align with, the organisation would declare its %impact distribution across the 17 SDGs and revise the same at a fixed interval, say annually, looking into its strategy and goals. In addition to this, the project review process and guidelines would state the org level targets, which could be based on the science-based targets or any other standard for the specific industry as chosen by the corporate. The projects' quantitative outcomes could then be translated into their weighted %impact distribution across the 17 SDGs.
The beauty of this method is that the projects are self-initiated. Initially, it does not matter how much in absolute numbers the outcomes are, but if these projected outcomes are towards SDGs and what are their distribution. The process through which the projects need to go through must ensure that the project's impact is at the centre of discussions and all decision making. As the projects mature and reach their final stage, their data would then qualify for org level consolidation only when the project demonstrates impacts and tangible outcome measurements as applicable and qualifies all the review stages.
Now, the gap between the org level declared %impact distribution and the actual org level %impact distribution arrived at through consolidation of qualified project's weighted %impact distribution across the 17 SDGs can be easily interpreted for the organisation's transformation outcomes vs its intent. Two teams with key responsibilities in this aspect would be the Organisation SDG Alignment group and the Project Review Board.
This methodology of transformation would guarantee positive outcomes through innovations carried out by self-initiated projects.
The project’s weighted %impacts distributed across the 17 SDGs will collectively give a clear result of the organisation’s transformation so far. So the process metrics designed into the transformation methodology (CTM) and the difference between the org level declared %impact distribution across the 17 SDGs and the consolidated project outcome metrics translated into weighted %impacts across the 17 SDGs at org level would become universal as they are independent of the organisations and their industries. They are simply the measurements based on the transformation methodology (CTM) and the normalised value of declared and actual %impacts across the 17 SDGs at the org level.
Another advantage of this transformation methodology (e.g. CTM) is that it does not focus on any area like climate or biodiversity or inequality, etc. Purpose encompasses all areas of impact. So when the transformation would be while keeping Purpose as the North star, it would result in positive outcomes across all the areas the organisation influences, which also means one or more SDGs.
So the same sustainability standard that incorporates the universal metrics originating from the quality of the transformation methodology and measurement calculated from the difference between the org level declared %impact and org level actual %impact distribution across the 17 SDGs arrived through weighted %impact data from qualified projects would cover all areas of impact.
There would be no need for a separate sustainability standard for climate, biodiversity, inequality, etc. Any target value specific to the sector could be mentioned in the single sustainability standard in different sections for each area of impact.
Now the transformation for sustainability is not for the businesses in the real economy only. The FIs need to transform to become sustainable for the long-term and bring ESG focus at the centre of their businesses too. The same standard transformation methodology for sustainability (e.g. CTM) would apply to FIs and they would disclose their Transition Plans just like the corporates in the real economy. In the case of FIs, the transactions would be equivalent to projects and the quality of the portfolio company’s Transition Plan and regular outcomes would become project outcomes. They would declare their org level portfolio’s targets wrt emissions, and all other goals in the transaction review process and guidelines document. So instead of a project review board, there would be a Sustainability related Transaction Review Board and Org SDG Alignment group with key roles and responsibilities.
Therefore, keeping the transformation at the forefront of all actions by businesses and FIs before ESG could be considered being integrated into companies and ESG metrics could be considered by FIs for any investment decisions would be a sensible proposition. With this approach, we will be able to derive universal ESG metrics that will solve the challenges of comparability faced by the Investment community and make FIs truly sustainability focused, thereby enabling rapid progress towards the goals of net-zero and many other issues faced by the world today. It will also restrict most of the greenwashing issues found across sectors.