Legal best practices in sustainability are not the best companies can do
Making regulators happy is good, making everybody happy is better
TLDR: Many frameworks for reporting sustainability-related performance exist today. Many of them resemble bucket lists: If you tick all the boxes, you might be rated as a top performer. Similarly, many sustainability-related best practices proposed by advisory- and consulting firms are a sophisticated form of a checklist. This is great, but it conceals a key issue: If a company meets the bar across every item on the list, this does not mean that it could not go even higher. Likewise, if two similar companies both tick all the boxes, one might still be outperforming the other. Building basic standards is an important first step, but in the long run, sustainability professionals will need a more granular understanding of a company’s performance and any room for potential improvement.
Companies around the world are facing tough pressure regarding sustainability. In many jurisdictions, corporates need to report their sustainability-related performance, and need to face questions regarding any shortcomings if it is not good enough, or allegations of greenwashing if their performance is too good to be true.
Among the top performers, however, an interesting pattern emerges: With regards to sustainability, they all look the same.
Whether it is a financial company in EU that follows the Sustainable Finance Disclosure Regulation (SFDR), or a company in the UK following the Task Force on Climate-related Financial Disclosures (TCFD), or another company in another jurisdiction following another standard: The top-performers simply tick all the boxes.
Making standards, well, standardized is a good and honorable goal. It also helps with transparency. And, to be clear, many of these sustainability-related disclosure frameworks do not even look like a checklist at first glance. They do look a lot checklists, however, when compared to the actual corporate reporting documents. When evaluating such documents, a lot of the analysis boils down to questions like “Does the company properly talk about transition-related climate risks?” or “Has the company printed a list of the terminology it uses in its report?”
Every company should exceed industry best practices
When it comes to best practices as they are recommended by leading business schools and advisory firms, the checkbox-like nature of them is clear. Harvard Business Review, for example, writes about sustainable business practices:
Partner with a nonprofit organization
Educate your employees
Encourage volunteerism
Rethink your supply chain
All these items are very nice on their own, but beyond whether or not a company has taken these actions, it is hard to use them for a more precise evaluation. Also, these items are not exactly huge: If you are the CEO of a medium-to-large company, chances are that you can start some activities, delegate them to your executives and operational staff, and have the subject off your table in less than a week.
Auditing- and consulting firm Deloitte goes in slightly more detail in its best practices for ESG reporting (ESG refers to environmental, social, and governance-related issues and is often used interchangeably with sustainability):
Identify ESG risks and opportunities, including financial-statement impacts
Incorporate ESG factors into business strategies
Reflect ESG mindset in risk-management processes
Establish appropriate governance structures for ESG-related oversight
Develop indicators to measure progress against milestones
Embed ESG goals in executive compensation
Communicate goals and progress to all stakeholders (not just shareholders)
There is some depth to these recommendations. Particularly the first point, which includes how ESG risks and opportunities might impact financial statements, is rather pertinent for financial institutions. Sadly, the recommendations by Deloitte do not go into further detail, and one can only speculate on how granular (or not) their assessment after this might be.
Finally, the New York Stock Exchange (NYSE) has some best practices on ESG reporting as well:
Identifying the right approach for your company
Identifying stakeholders and evaluating the state of engagement
Assessing materiality
Establishing governance
Integrating ESG into business strategy
Telling your story
Reporting frameworks and standards
ESG research and ratings
The NYSE does go into much further detail on each point. Again, however, it is more or less a box to check. Under point 7, reporting frameworks and standards, they write that the presented information should be accurate, balanced, comparable from one period to the next, and put into the right context. All these are boxes one can tick off — and they are, if one may dare to say so, a rather low bar for ESG reporting overall. If the information presented in a report is not accurate, then why bother writing or reading the report anyway?
Best practices and frameworks only get us so far. They are helpful and necessary, of this there is no doubt. To evaluate a company properly, however, one must do more than count checked boxes.
Might AI help us evaluate companies?
The short answer is: Yes, without a doubt.
The companies themselves are already using AI-assisted techniques to gather data, evaluate it, and present it in a digestible way. Regulators and financial institutions are using large language models to summarize these reports and extract key data. They might also use more methods from data science to further process this information. Wangari certainly intends on doing this.
This, however, slightly misses the point. If we use AI on checklists, it will learn to present us with checklists. If we use AI to build a more granular understanding, it will serve us that. If we use AI to inspire not best but optimal practices, it will help us make this happen.
Instead of spending too much time on thinking about how to get over the low bars that most checklist-style standards set, executives and their financiers should be thinking about what the best way would be for their company to:
Bring financial and sustainability-related concerns into alignment, and
Excel both financially and with regards to sustainability.
In the very long run, financial and sustainability-related concerns are of course aligned: If a company has burned up the planet and no human can perform any more work for them, or buy any goods and services from them, then the company will face bankruptcy. If, on the other hand, a company has invested in a livable environment and the wellbeing of all humans involved with the company, it has high chances of thriving financially.
In the mid- to short term, however, these two objectives can work against one another. A major oil producer might choose to decarbonize its production chain (15 percent of all greenhouse gas emissions result from operating oil and gas, which does not include burning it by consuming it as a fuel). This, however, will raise costs in the short term and set this oil producer financially back against its competition.
Working out a strategy — or industry-wide agreements like what had been negotiated at COP28 — to make short-and-long-term, financial and sustainability-related performance align, can be a lot of work. Once such a strategy is established, companies must execute wisely to make it work. Making nice pledges and feel-good plans that only get half executed is not a good look — honest ambition must be the driving force from start to finish.
Building, executing, and reporting in an ambitious way does not make lower bars disappear. Lower bars are still necessary to protect against major mishaps. Ambitious companies, however, likely already satisfy all or most lower bars, and will find it easy to tick any remaining boxes. Less ambitious companies, on the other hand, risk being flummoxed every time that a new checkbox gets introduced.
Best practices are great, optimal practices are better
What can financial institutions learn from ambitious companies? For one thing, they can become ambitious themselves. For another, they can build their capabilities to properly analyze and value such top-performers. Two companies of the same industry that both tick all the boxes of a given framework might look very different: One might work diligently to tick off one box after another, the other might be ticking the boxes as a side-effect of a much bigger plan and some excellent execution.
Building data capabilities to truly identify and value such companies is not easy. Wangari is currently creating a software tool that identifies such companies in order to bring them to the attention of asset managers, banks, and other investment firms. This allows ambitious companies to prosper and their investors to make above-market returns. A prototype should be ready by late spring.
In business it is like in life: If you only try to satisfy whatever expectations others put before you, your odds of outstanding success are small. If you really stretch yourself, set ambitious goals, and go for them, you might still fail. But your odds of outstanding success are a lot larger.
The best part about being ambitious is that you will likely not regret it. Ambitious companies certainly do not.
What we’re reading at Wangari
More than half of all produced energy is lost. As
points out in Broken Promises?, the way to reduce this inefficiency is by decentralizing the power grid. The article focuses on the UK, but many parallels can be drawn to other countries.Scientists have proposed a category 6 for extremely intense cyclones (up to now, the categories range from 1 to 5). The reason is that climate change is increasing the chances of exceptionally strong storms, writes
in a short-but-sweet piece called Brace for impact: The case for Category 6 hurricanes.An important reminder that rising sea levels will not go away, penned by
in his piece The Rise and Fall of Sea Levels. Spanning the last billion-or-so years of the history of our planet, the author shows how sea levels have always fluctuated over time. Unfortunately this makes them no less threatening to humanity.In a data-driven piece,
argues that Global energy demand could be lower in 2050, despite the world getting richer. The key here is electrification: It turns out that burning fossil fuels is an inefficient way to get energy, hence we need to burn lots of it. With more and more vehicles and homes turning to electricity for power, people will get richer and, simultaneously, become energy-efficient.Very relevant to Wangari,
concludes in Energy ETF Showdown: Comparing Performance of Different Energy Sources that an oil and gas ETF has outperformed wind and solar ETFs in 8 out of 15 past years. Nuclear has outperformed wind and solar in 5 out of the 15 past years, notably in the past three years. It will take a while for oil and gas to become un-lucrative.