Earlier this year, two annual reports were released that both address the role sustainability is playing in business. The first, from MIT’s Sloan School of Business and Boston Consulting Group, focuses on the emergence of what they call “Sustainability-Driven Innovators,” those companies that profit from their sustainability initiatives by changing their business model. The second report, The State of Green Business, from GreenBiz Group, zeros in on key sustainability trends for 2013. Chief among those trends is the increasing use of technology and data to drive sustainability and financial performance.
Throughout both reports, there is a common refrain—approaching sustainability from a strategic, integrated, data-driven standpoint is imperative for businesses that want to stay profitable and competitive. And now it appears that two major sustainability standards organizations are joining the chorus by focusing on financial and non-financial integration and using materiality—a way to determine just how much environmental, social and governance risks may threaten the financial health of a company—as a tool.
Not everything that can be counted counts, and not everything that counts can be counted. – Albert Einstein
Conventional wisdom has held that sustainability investments require trade-offs in a company’s financial performance. This has often been true as long as companies have taken a project-based approach to sustainability, blindly throwing money at renewable energy or waste reduction or carbon-cutting projects with little or no connection to an overall strategy. These projects, while they are certainly worthwhile and possibly yield some quick savings, may still be irrelevant to managing risks and costs associated with unsustainable practices at a business’ core. And these risks can jeopardize the long-term financial viability of a company and scare away investors. But it doesn’t have to be that way. By adopting a strategy that focuses on environmental, social and governance issues that are most material to an organization’s value, companies can drive both sustainability and financial performance.
The concept of materiality as it relates to sustainability is a way to determine if external risks and costs of doing business really matter to an organization’s long-term economic health and general viability. But here’s the catch with materiality–it can often be tricky to determine which environmental, social and governance (ESG) risks are actually material to one’s business. Even once you’ve identified what’s material, those externalities can be difficult to quantify. Difficult, yes, but not impossible. (We know because that’s part of what we help companies do.)
Luckily, help is on the way for companies struggling to determine what’s material and how it relates to financial performance.
First, the Sustainability Accounting Standards Board (SASB), a non-profit modeled on the Financial Accounting Standards Board (FASB) that is developing industry-specific standards for publicly traded companies to incorporate ESG issues in their annual financial filings, recently released their first set of guidelines for the financial sector. For seven different industries within the sector, these guidelines identify a list of potentially material ESG issues and rank them by how material they are for each individual industry. SASB plans to develop these guidelines for 89 industries in 10 different sectors.
To determine how material an issue is, SASB evaluates three different areas: evidence of interest, evidence of economic impact and a forward-looking adjustment. The evaluation of interest reveals how often a specific issue arises in each industry, the evaluation of economic impact shows whether mismanagement of the issue will affect traditional value parameters (i.e. return on capital), and the forward-looking adjustment may change the level of materiality if an emerging issue has a high likelihood to create a big impact on outside stakeholders.
The second recent big release was from the International Integrated Reporting Council (IIRC), which published a draft framework for integrated reporting. Integrated reporting sits at the intersection of financial and non-financial reporting and ties together financial and non-financial performance measures to provide a more accurate picture of corporate value. It’s designed to help investors and other stakeholders better understand how financials are impacted (positively or negatively) by things that haven’t typically been quantified in the past in a financial report–things like employee retention, community outreach and resource efficiency.
The IIRC defines six kinds of capitals that a company should evaluate and then report on the degree to which they are creating, compromising or eliminating value in these categories. The six capitals are: financial (self explanatory), manufactured (physical assets), intellectual (branding, reputation and intellectual property), human (people, such as employees), social and relationship (with communities, NGOs or other outside groups) and natural (air, water, land, biodiversity).
The good news is that these guidelines help clarify for companies what they should be measuring. After all, there are no benefits to measuring something that provides you with no real information or doesn’t impact your overall strategy–be it financial, environmental or otherwise. As Einstein once quipped, “Not everything that can be counted counts, and not everything that counts can be counted.”
As companies become more savvy and realize that they need not just a series of ad-hoc projects, but a real sustainability strategy, it becomes increasingly difficult to measure performance in a meaningful way and ensure that they’re focusing on the right things. Assessing materiality is one way to define what’s important, but as standards begin to emerge, they also help companies focus their efforts on quantifying the ESG issues that will truly impact financial performance and long-term health of the business. And in our new era of big data–where you could measure everything and learn nothing–it sure is helpful to have some tools in your belt to focus your time and resources on measuring the right things.