Big Data and Materiality: Lost in translation?
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Data was the centre of excitement at the GRI Global Conference held in Amsterdam this past May of 2016. Having been part of the GRI process since its foundational days, it has been fascinating to see the movement evolve from the early mission "for sustainability reporting to become as routine as annual financial reporting" to the new mission "to liberate sustainability data from reports". Only in this way can the data be analyzed and integrated in a meaningful way, argues GRI chief executive Michael Meehan.
And while many assume that more data will bring us closer to solutions, wise words at the Conference came from statistics professor Enrico Giovaninni from the University of Rome. He cautioned that data also creates new divides. For one, the data debate tends to be dominated by IT specialists, statisticians and consultants throwing about the latest jargon. It tends to be a technical or expert debate that may very well leave many GRI stakeholders feeling alienated. This brings the challenge of turning complexity into simplicity, an art for which one needs Steve Jobs-type technology visionaries.
As we weigh the opportunities offered by more data, do not forget the old phenomenon of "information carpet bombing". It is one that sustainability thought leaders like John Elkington himself identified in the early 2000s. What is really Big Material in the face of Big Data? During a plenary debate at the Conference someone mentioned that the predictions made by the Club of Rome in the early 1970s are still surprisingly accurate. The global trends and exponential growth in world population, food production and resources depletion as focused on by the Limits to Growth (1972) computer simulation study may indeed leave us with global system collapse by 2050. If they were so accurate and common sensual over fourty years ago, based on data available back then, what more do we really need today? At what point does common sense kick in? What should make us conclude that so much more data in the 2010s will suddenly help us to see the light of day and dramatically transform in a ways we have not been able to do in the last five decades?
During the launch event of the 10th anniversary edition of our report Carrots & Sticks with KPMG, UNEP and GRI, I pointed out that the Sustainable Development Goals (SDGs) can be thought of as a "shortlist" of the key material topics for our globe at this point in time. Despite the interest in these themes, what was coming short at the GRI Conference was making the connection between the SDGs, Big Data and the new GRI standards. Often lacking in plenary discussions on data was:
- Associating the data with the performance of individual organizations (i.e. reporting companies), being entity specific and making the macro-micro link as opposed to a generic discussion on all sorts of data (including Big Data); and
- A lack of appreciation of the mass of contextual data that has been collected by governmental institutions and international public research initiatives since decades. (These include the data collected by institutions such as NASA, the World Bank and UN Global Observing Systems.)
The first above is addressed more or less directly by initial recommendations from the new GRI Technology Consortium on the future of sustainability data, made public at the Conference. One of its five recommendations is the need for a public and open global repository of public sustainability data. One could argue that this is provided by platforms like Corporate Register, which hosts over 75000 corporate reports accumulated since the 2000s. But the Consortium's interest is in making it easier to access, extract and compare data outside of "reports", in a world beyond paper and PDF documents. The easier access and comparability of data also makes the case for more specific GRI standards (on subcomponents of the GRI Guidelines).
The focus on digital information presents all sorts of challenges for old disciplines such as the legal profession as I've argued before (see "Good bye sustainability reports, hello sustainability reporting", May 2014). The Consortium recommendation is also different in that it asks for a public good. This is different from the equivalent information service provided on commercial terms by the likes of Bloomberg and Thomson Reuters to investors. An example of what the Consortium may have in mind is the new Wikirate, a platform profiled in a workshop on "Radical Transparency" hosted before the Conference by the Reporting 3.0 initiative. Wikirate relies on crowdsourcing to compile data and information on various aspects (as per GRI G4 and others) of a company's operations. This includes data reported by the company itself, as well as data available publicly from other sources.
The Wikirate approach reminds of recent reports by Thomson Reuters and BSD Consulting on the GHG emissions of the Global 500, in which publicly available information was used to estimate the GHG footprints of almost 150 of the Global 500 who still do not disclose their GHG emissions. As exciting as Wikirate is, the Berlin-based initiative will be challenged in (a) mobilizing public support (beyond mainly post-graduate students from say Europe) and (b) looking beyond the usual suspects, for example a top 100 companies who report extensively, versus thousands of lesser known, large companies world-wide who in many cases do not even disclose significant sustainability data in the first place.
In its latest annual Reporting Awards, Corporate Register (see CRRA 2016) employed "Relevance and Materiality" as one of its criteria. It describes it as focusing on:
- "the report which cuts to the chase and tells us about the material issues (those that are specific to the company performance and sector, the risks and opportunities), clearly and succinctly".
Most will agree that this sounds attractive indeed. Such clarity (or the lack thereof) also has important implications for business model innovation. Being clear on materiality is key for making the business case, having a convincing value proposition and defining a business model that has sustainability built into it. So argued Knut Haanaes, Geneva-based partner of The Boston Consulting Group (BCG) in a recent webinar on their latest annual survey report with MIT Sloan Management Review. The 2016 edition of their Global Executive Study on corporate sustainability highlights that senior executives underestimate the level of interest that senior investment managers are showing in ESG data.
The GRI Technology Consortium members include MIT Sloan. Its survey with BCG hints at a certain skepticism about sustainability ratings today (were they able to predict BP and VW type scandals?) and the possibility that more companies are developing their own benchmarkings in-house. In defence of sustainability ratings, service providers such as Sustainalytics would argue that more advanced rating today has become more dynamic in reflecting changes in the materiality of topics. The new GRI standards approach also recognizes the evolving nature of an ESG agenda and will allow for the formulation of individual topics and indicators to undergo revision on a "when required" basis. Furthermore, agencies such as Sustainalytics would argue that more integrated rating today is also applying more rigorous weighting based on materiality considerations informed by quantitative data analysis. The emerging ESG Ratings Hub of the Global Initiative for Sustainability Ratings (GISR) will provide more transparency about the nature and quality of methodologies applied by rating agencies (including those accredited for applying the GISR principles).
Somewhat data-bombed and lost in translation at the GRI Conference, I attended materiality-focused discussions and two Master Classes on Materiality presented by respectively Deloitte and Sustainalytics. Two themes that struck me was (a) perspectives on the materiality determination process, including how the time dimension is dealt with, as well as (b) making the link between sustainability data and financial data. Let me start with the process.
Materiality process and its value
The master class by Deloitte among others highlighted the apparent disconnect between, on the one hand, (i) a resource intensive process of determining materiality that companies conduct every 1-3 years, involving often diverse stakeholders, and, on the other hand, (ii) the content provided in sustainability reports or content tabled at senior / top management discussions. If a company invests all the effort in determining material topics through an inclusive process, it is puzzling and a missed opportunity if strategic and Board level discussions do not effectively make use of the resultant information. The latest WBCSD Reporting Matters (2015) study found from its examination of 169 WBCSD members' non-financial reports that while 82% of them disclose the use of a materiality determination process, only 30% focus their reporting on those issues they consider to be material to their business.
Talking to South Africa's Mervyn King afterwards, he underlined to me the importance of exposing Board members and ensuring they hear what diverse stakeholders have said. This was echoed in the second Master Class, hosted by Sustainalytics, where Jean-Pascal Gond of Cass Business School (City University of London) argued that the materiality analysis has institutional value in that the matrix tool presents broader societal concerns, helps to renegotiate boundaries and coordinate the actions of people.
Who to involve in the materiality determination process and at what level remains open to experimentation. In the 2000s I worked with AccountAbility in developing The Stakeholder Engagement Manual (2006). Its guidance on how to prioritize stakeholder groups remains highly valuable. Describing its process, ABN AMRO bank highlighted its categorization of stakeholders in four priority groups: clients, investors, employees and society at large. Producing an integrated report based on the IIRC <IR> Framework, it describes its value creation process in terms of the six Capitals. Under Financial Capital, it highlights with respect to inputs its reliance on investor equity and client deposits. Also under Financial Capital, it highlights with respect to outputs the bank's contribution to the national economy by providing debt capital (lending) to households, small businesses and corporates as well as its improving Return on Equity (RoE) to ensure a good dividend paying capacity vis-a-vis its shareholders (investors).
As one of the three biggest banks in The Netherlands, it is no wonder that three of the top material topics reported by ABN AMRO is the privacy, security and stability of digital services to its clients. Another is compliance with legislation and regulations. The new Carrots & Sticks report indicates that financial institutions have received special attention in many new disclosure requirements introduced by diverse instruments (regulations and other) over the last five years. If what is required by law to be included in an annual report (for example a statutory document) were to be material by definition, one cannot help wondering if in some cases what is material may not be strategic.
More on this in Part II of my GRI Global Conference 2016 blog.
Where, when and how do you engage in the climate negotiations?
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As business representative you may have decided to attend the climate convention conference in Paris from 30 November to 11 December 2015. In formal UN-speak it is the 21st Conference of the Parties (COP) to the UN Framework Convention on Climate Change (UNFCCC). It includes a Meeting of the Parties (MOP) which is the term used to refer to the convening of signatories to the Kyoto Protocol, versus signatory members of the overall umbrella convention. You may be wondering how best you can contribute, why you decided to attend in the first place and what your follow up will be as the new year approaches.
I was involved in the climate negotiations during two years leading up to the Kyoto COP of 1997, the conference that delivered the Kyoto Protocol. As multilateral diplomat at the time, I had the envious task of coordinating our South African delegation. For anybody who has been involved in the negotiations at some point, it is amusing over the years how common misunderstandings of the process and what to expect continue to come up in the public debate and media commentaries. Looking back at environmental negotiations 20 years ago and my subsequent research in this field, let me give you some tips:
First, if you convinced your chief executive or were convinced by peers that you need to be there to "influence the negotiations", you are probably in for a big disappointment. The core negotiations are conducted behind close doors and only members of official country delegations are allowed to participate and take the floor in these. This means that, as part of a crowd of what now is over 40.000 people attending the event, you may be able to sit in as observer during plenary statements but you will in all likelihood get nowhere near the core negotiations. The closest you may get, if you are a paid lobbyist, is tackling delegation members with arguments in the corridors when they exit the negotiation rooms, at lunchtime side-events or evening cocktails that your business organisation may have sponsored. Delegation members will see you for what you are, possibly considering you as a useful source of expert knowledge or as an irritating lobbyist making predictable statements. I've seen NGO representatives in plenary walk up to government spokespersons, giving them a piece of paper while encouraging them to make a certain point in response to what was just said. At the later stages in the negotiations, especially late night sessions of the second week, those governmental negotiators may become increasingly agitated by such interferences.
Here is a tip: If you really want to influence the negotiations during such a conference, make sure you become a member of an official governmental delegation. A number of countries include nongovernmental representatives on their delegations, for example an external scientific advisor and a representative from a national business association. Countries that have traditionally included NGOs on their delegations are Denmark, Switzerland and Canada. This allows the NGO representatives to play a hybrid role, compared to different roles such as that of activist, observer, legitimator or monitor. South Africa was one of the few countries to maintain a multistakeholder delegation, including representatives from not only key government departments but also representatives from key industries, the scientific community, environmental NGO and labour unions. Having such openness is good for constructive debate and pooling of national expertise. It can also be nerve-wracking for a delegation coordinator. On more than one occasion I've had to intervene when an opportunistic representative from a polluting industry tried to talk the Minister (head of delegation) into a new position "in the heat of the moment".
Second, if you decided only during the last three months to get involved in the process and/or attend the Paris conference, you may very well have been better off staying at home. Point is that the climate negotiations is an ongoing process of various preparatory sessions held annually in the lead up to the COP in December. In the Kyoto process we had four two-week sessions annually, which meant regular visits to Bonn. If you therefore wish to influence the negotiations, you need to get involved early in the process.
Another tip: The best place to "influence the negotiations" is not Paris or some other city abroad where the next COP is due to be held. Key rather is to influence the negotiations via national processes convened by Government in the country where you are based. In South Africa we created a National Climate Change Committee (NCCC) in the 1990s. Convened by the Environment Ministry, this multistakeholder consultative body included representatives from diverse government departments as well as key stakeholder groups (including industries more obviously impacted). This is where we had heated debates in formulating our national positions, agreed on follow up after convention meetings and decided on national projects with international support. Bottom line is, this is where key positions are shaped, feeding into and responding to outcomes of the international events. So start getting active locally, especially in the country where your business is headquartered.
Third, you have decided to attend Paris and wonder how to make the best of the situation. Irrespective of the negotiations, the event is a fantastic networking opportunity where hundreds of experts in climate science, climate economics, climate finance, climate friendly technology etc meet up annually. There are other international events where similar networking happens, but this one is particularly effective in convening climate networks. It remains the case even if that networking is happening "off site" at external venues where for example special business and research events are held. Compare the Sustainable Innovation Forum and the Caring for Climate Business Forum convened by the UN Global Compact and others in Paris this December, and the Business & Climate Summit held in Paris during May 2015.
Tip: If you are trying to make sense of what is really happening with the negotiations other than what you take from the political gossiping at cocktail events and what you read in the daily Earth Negotiations Bulletin, do consider the following. In the midst of the negotiations, various chairman contact groups and informal negotiation groups are convened. At the same time parallel discussions are held in the main convention bodies, notably the subsidiary body for scientific and technological advice (SBSTA - incl the latest IPCC science and tech solutions) or the subsidiary body for implementation (SBI - implementing schemes such as emissions trading, verification and financing). All of this means that at any point in time during the circus, no single person knows exactly where things stand and what the final negotiating text will look like. The ones most informed on this are the Ambassador / Minister chairing the overall negotiations, the head of the UNFCCC Secretariat, and the supporting event Bureau with elected governmental representatives. The secretariat has to consider how best to "manage" the process. For 2015 they and the French hosts have done an impressive job in seeking to have the most difficult issues agreed in advance of the December COP.
In the aftermath of the failed Copenhagen COP of 2009, research by IR specialists Gunnar Sjostedt and others have highlighted stumbling blocks to overcome. These are structure-related ones (external context and internal factors such as the structure of the conference and its negotiating bodies), issue-related stumbling blocks (consider the transboundary nature of the problem, exceptional uncertainty, extreme values at stake, extreme complexity, immeasurability and horizontal linkages with other issues such as trade), actor-related stumbling blocks (such as the need to win over brakemen, negotiating capacity and leadership problems) and process-related stumbling blocks (including tactical facilitation and the behaviour of individuals who have been involved in the process for many years).
Fourth, do not be misled by superficial arguments commonly repeated in the public discussions and daily media reports. These are statements such as "developing countries will not commit before developed countries show commitment, and vice versa" or "governments cannot agree because they and their lobbyists do not understand climate science or the urgency of the situation". In many multilateral environmental agreements of the last 30 years the assumption has been that developed countries take the lead in addressing industrial pollution issues (ones they have been most responsible for causing), and that developing countries are given a grace period of often 10 years before they take on similar commitments.
In the climate case, it was therefore always known that it is only a matter of time before developing countries (Non-Annex I Parties to the UNFCCC) will need to take on binding GHG reduction commitments. The fact that they have not taken on these in the 1990s is no excuse for developed countries not to speed up implementation of their own commitments. Also, it must be added, developing countries are late in taking on their binding targets under the climate regime - way back the expectation was ten years after Kyoto i.e. 2007. So it is high time for both sides to take on new binding commitments and not play the game of chicken, even though the binding status of the expected Paris agreement (for example a new protocol under the umbrella convention) is still uncertain. The new Paris agreement will also require further fine tuning. It took a decade for the Kyoto agreement to get to implementation stage.
My final tip: The fact that major governments involved cannot agree is not because their representatives are ignorant and don't get climate science. Even if all understood it and the urgency of the matter, this is no guarantee of an easy global agreement. Back in Kyoto 1997 most of us knew that what was agreed was not enough. The agreement to introduce a market mechanism (emissions trading and joint implementation) at international level was historical, but the GHG reduction targets were more political than science-based and simply not ambitious enough. What will come out of Paris will not be enough as well. Scientific research suggests we are heading for 3 degrees Celsius change - failing to stay below the 2 degrees Celsius temperature change above pre-industrial levels. Paris will produce a long list of individual, voluntary country pledges (plans) that from an implementation point of view makes for a shaky start.
Why this failure to come up with timely, effective and sufficiently ambitious agreements at global level? It is the problem of collective action. Even if you know what would have been the better option, you take a suboptimal decision since you fear that your peers or competitors will not take the optimal decision. It is the equivalent of a Prisoner's Dilemma, where the logical (rational) decision for each side is to defect and end up with a second best, suboptimal outcome. It is maybe not the worst outcome, but it is second best. And with so many players involved, despite the learning opportunities of game repetition, it is simply too tempting to be overcome with a certain fear. It is the fear that if you did what is really required, you may be left out in the cold since others do not do the same as well. The UNFCCC secretariat may be trying its best to have players focus on the bigger picture (sense of being in the same boat). Yet the pressure of global economic and trade competition results in a play of almost 200 countries unable to get themselves collectively to accomplish the scale of transformative action required.
One can think of alternative forms of global problem solving that may produce more optimal results. For example organising two separate conferences, one focused on mitigation and one on adaptation. Involving in each only the key players implied in both cases may result in more focused discussions and agreement. Also, consider that it is really a small group of countries and industries that are most responsible for GHG emissions. You may find that ten countries and ten industries produce the greater part of global emissions. If a mitigation negotiation were to involve only the leaders of these main countries' governments and largest companies of the most implied industries, plus additional representatives from internationally recognised science & technology bodies and international NGOs, such a smaller, multistakeholder group of key players could be tasked to negotiate a solution. Subsequently their agreement could be presented for approval to the rest of the world. My guess is that the smaller group of key players would come up with a much more accurate agreement, one that few would be able to argue against convincingly.
This approach requires going beyond conventional International Relations as maintained by UN institutions and International Law as defined by Delft's Hugo de Groot. It requires a willingness to experiment with global governance that is multistakeholder, engaging only the big players most implied in a problem, and taking on an agenda that is functionally needs-driven and timely. It is the type of approach that organisations such as the World Economic Forum may experiment with. It does not imply a global elitism and dominance by big business. It simply recognises the need, at a certain (e.g. global) level of governance, to engage those players most implied in a problem and its solving. It is the very contrast of endless plenaries with long, repetitive statements by smaller players simply intent on slowing the process as much as they can - something of which I have seen far too much by the likes of OPEC member states.
Integrated Reporting: I think integrated, therefore I am…
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"Integration" again found itself in the domain of popular terminology in recent years as managers, policy makers and others contemplated ways of dealing with mainstreaming, fragmented information and inconsistencies as demonstrated in the market failures of financial crisis. Integration is a beautiful word, bringing to mind images of integral whole, unified pattern and harmony. Who would not want to be integrated, at least in thinking? What would be the alternative? A fragmented, incoherent enterprise?
In developing its International Integrated Reporting <IR> Framework, the International Integrated Reporting Council (IIRC) has considered various interpretations of "integration", including reference to a "process" of reporting, a way of "conducting management", linking various streams of information, as well as a "philosophy" of integrated thinking. Its <IR> standard defines "Integrated Reporting" as a "process founded on integrated thinking that results in a periodic integrated report by an organization about value creation over time and related communications regarding aspects of value creation".
And while the integrated report is meant to be a concise document that builds on annual financial and sustainability reporting, it is supposedly more than just an executive summary of information found elsewhere. Rather, it is meant to make explicit "the connectivity of information to communicate how value is created". One of the guiding principles of <IR>, "connectivity of information" refers to "a holistic picture of the combination, interrelatedness and dependencies between the factors that affect the organisation`s ability to create value over time".
When one then examines the integrated report of an enterprise, one would expect common sections such as the CEO Statement, company profile and strategy, financial and sustainability performance highlights, overview of risks and opportunities, and corporate governance disclosure to show a certain consistency and common thread. But instead, many so-called integrated reports still reflect the lumping together of a conventional annual report (including financial statements) with sustainability reporting content (including environmental and social sections). They display little integration, certainly not between sustainability performance and financial performance.
Attempts to integrate lists of sustainability risks and business risks often result in an odd mix of some top material issues such as climate change with a legalistic boilerplate description of conventional categories of business risks (e.g. operational risk, market risk, financial risk). The lumping together without real integration of financial and sustainability information components have been most evident in early versions of lengthy "integrated" or rather "combined" reports by corporates from South Africa, where <IR> is a listing requirement of the Johannesburg Stock Exchange (JSE). Being an early mover can involve making blatant mistakes, but also provides the opportunity to lead in fixing them and defining innovative solutions.
Examining integrated reports of South African corporates of 2011, Deloitte highlighted some progress in the "integration of economic, environmental and social goals into the overall business strategy" - which was evident from the reports of about half the top 100 JSE listed corporates. At the same time, it noted "continued difficulty in addressing the sustainability / development agenda", which remained the lowest scoring element of its analysis of the integrated reports (Deloitte South Africa, "Navigating your way to a truly Integrated Report", 2012). One of the better examples of "integration" has come from power utility Eskom, surprising for a state-owned enterprise not normally known as a leading innovator. It lists various business risks "related to" its listing of material topics as identified through stakeholder engagement (Eskom Integrated Report 2014). This means that the listing of material issues is linked with the listing of business risks and opportunities, an exercise in which companies display varying degrees of well thought-out integration.
So what is the ideal type integration that a quality enterprise is expected to display? The following types of integration are at stake:
- Organisational integration: displaying integration in the internal value chain through collaboration and alignment between different departments, or in the external value chain through various degrees of integration with partners upstream (suppliers) and downstream (e.g. clients, customers).
- Issue integration: displaying a balanced, systematic and holistic approach to a range of sustainability (ESG) issues, able to deal with trade-offs (e.g. the water-energy-food nexus) and seeking to optimize mutually supportive economic, social and environmental outcomes.
- Financial Non-financial integration: displaying an ability to make the connection between financial and non-financial information, having aligned business financial and sustainability accounting systems that facilitate the translation of sustainability performance metrics into financial performance metrics.
The first of the above is the oldest and most known problem in large organizations. The second is a challenge companies have been grappling with since the 1980s with the advent of the social responsibility debate in its current form. It remains an ongoing challenge, today framed in terms of integration involving not only "three pillars" but "six capitals" as included in the IIRC Framework.
The third of the above types of integration is a more recent addition and one most critical in capturing the interest of the providers of financial capital (banks, insurers, investors). Slow progress with this type of integration is symptomatic of the fact that often regulations do not exist to ensure that externalities are adequately priced and thus automatically find their way into corporate balance sheets. The result is an endless experimentation in innovative ways to best capture the value of various forms of capital (e.g. natural, social) in financial terms. In the absence of this type of connected information, many integrated reports still fail to disclose the inter-connectivity between the different capitals as highlighted by Ernst & Young in its 2014 Excellence in Integrated Reporting Awards in South Africa. For example, if a process uses 10% less water, what are the financial consequences? What is the effect in terms of risk exposure?
Cross-referencing financial and sustainability performance information can be illustrated with the below Green Business Case Model. I developed this based on research I did for UNEP two years ago, examining leading research papers and business publications on "the business case" published from 2002 to 2012. The analysis showed a collection of indicators typically employed in business case analysis, ones that can best be categorized in three groups that refer to "sustainability action areas" (input), intermediary or lead indicators (connectors), and their impact on "financial value drivers" (output, impact on financial performance). The seven financial value drivers listed in the business case model are well known to financial analysts and investors, having been defined by scholars working on shareholder value in the 1980s.
Based on the Green Business Case Model, each row of indicators can be captured in a hypothesis that illustrates a suggested cause and effect (if a + b à c) relation, making the integrational link between sustainability performance and financial performance. The ideal type hypotheses would read as follows:
Argument 1: As market and regulatory demand for sustainability grows, the business that (i) makes effective use of design for sustainability and delivers greener products and services will be in a position to (ii) boost its innovation ability and attract more customers, which (iii) will show positive results in its growth of sales.
Argument 2: The business that (i) introduces greener goods and services in the market, backed up consistently by recognised standards and labels, will (ii) reap the benefit of greater brand value and reputation, which again will (iii) enable the business to sustain a good growth of sales with longer duration.
Argument 3: Through (i) the use of recognised standards and cleaner technologies in its own operations to use resources more sustainably, plus advancing those through its supply chain, a business can (ii) improve its operational efficiency - its ability to turn inputs into productive outputs in a cost-effective manner - as a result of which (iii) it will improve its operating margin or net profit margin and optimise its capital expenditure.
Argument 4: (i) Use of recognized environmental (and other) standards, combined with proper education and training in the use of such standards, and promotion of such training among suppliers, enables a company (ii) to improve its attractiveness to employees and the productivity of its employees and those of its suppliers, which (iii) serve to boost operating margin and optimal capital expenditure. Better trained employees manage fixed assets more efficiently, operating under better environment, health and safety conditions.
Argument 5: Having (i) procedures in place for systematic and principled stakeholder engagement is key for (ii) securing the local license to operate, on the basis of which a company (iii) can improve the conditions under which it operates, including an optimal tax regime under which its green innovations are recognized and rewarded.
Argument 6: A company that (i) has effective environmental (and other) risk management systems in place, communicating its use effectively through reporting and other means, is in a position to (ii) secure a better risk profile which again opens the way for (iii) obtaining capital at a lower cost. This applies to both debt capital and equity capital.
A good integrated report should provide examples of the above. This type of integrated disclosure in <IR> is still surprisingly hard to come by. One for example sees companies that report on investment in green R&D or the launch of new, green product ranges, yet making the link with overall sales growth is not evident. Others report various examples of efficiency improvements and reduction in polluting substances or waste, yet stop short of translating this into impact on overall profit margins and capital expenditure.
Could it be that (a) they lack the necessary data to quantify the cause and effect connections? Or (b) do they have the data, but hesitate to disclose it (to the general public and regulators) as the results are not seen to be sufficiently impressive? Or (c) if they have impressive data, do they not disclose it due to an unwillingness to share the information (with the general public and competitors)? If this type of integrated information does not find its way into concise, integrated reports, is it shared behind close doors, e.g. bilaterally with investors?
Not all agree with the prioritization of the third type of integration listed above, namely integration between financial and non-financial information. The IIRC has after all not positioned financial capital at the centre of its Six Capital Input-Output Model. The Reporting 3.0 conference hosted by BSD Consulting in Berlin this past October illustrated that some fear an obsession with monetisation, translating sustainability metrics into financial metrics. The emphasis on financial valuation has also drawn criticism - some ideological - in debates on Natural Capital. In the field of economics, some academics have expressed their worry that "the current enthusiasm for ecosystem service methods (used in tandem with contingent valuation methods) has locked the rhetoric of environmental valuation in a vary monistic, utilitarian, and economic vernacular that leaves little or no room for other social scientific methods, or for appeal to philosophical reasons".*
Criticisms of the emphasis on financial values can be based on three arguments. Firstly (i), many sustainability or ESG issues are too complex to be realistically captured and communicated in financial terms. It would for example be futile to reduce a discussion on human rights to financial values, considering for example only the likely costs of liability for human rights violations. Secondly (ii), it can be argued that certain issues involve matters of principle and business ethics, where financial valuation is misplaced. Even accounting standards recognise that materiality decision-making involves consideration of also qualitative information. An example is corruption, which is wrong as a matter of principle irrespective of the amount of money involved. Thirdly (iii), it can also be argued that an obsession with monetisation leads to analysis that is backward looking and gets stuck in fine accounting details, loosing sight of broader strategic and forward looking questions. Against this background, a fourth type of integration can be identified:
- Strategic integration: the integration of relevant sustainability and financial information into core business planning and strategy, including the business model and value chain approach pursued by an enterprise.
This fourth type of integration highlights the fact that accounting, be it the financial or sustainability variant, will not save the enterprise or our planet for that matter. Diverse disciplines need to be engaged in the strategic transformation of business, showing an ability for multidisciplinary and interdisciplinary teamwork. But for strategic integration to effectively happen, the integration or connection of non-financial and financial information has to be made. It is a critical building block in the making of strategic integration.
Here is a call for both sustainability and financial accountants. Over the last three decades few CSR or sustainability experts have bothered to develop an understanding of corporate finance. Similarly, few financial experts and accountants have bothered to develop an understanding for the sustainability or ESG agenda. This needs to change. Sustainability accountants and financial accountants need to discover each others` domains. Considering Natural Capital, the Association of Chartered Certified Accountants (ACCA) has encouraged Chief Finance Officers to consider whether and how Natural Capital can be incorporated into financial accounts (ACCA, KPMG and F&FI. Is Natural Capital a Material Issue? 2012). This comes at a time when attempts at mainstreaming is presented in all kinds of catchy formats, from "environmental financial statements" or "environmental P&Ls" to "ethical" or "common good balance sheets".
Pressed for clarity on the business case, managers in a commercial enterprise will always need to compile in as far as possible quantitative information and translate these into financial values. The reason for this is simply that cash flows represent the blood of the commercial enterprise. It does not imply ignoring the diet of the body involved. But it highlights a liquid that is a central conveyor of vital signs, the resources and health of the enterprise. This does not imply an obsession with short termism and quarterly "vital signs". Any decent financial analyst will admit that a key performance indicator of a healthy enterprise is not short term profit, but rather sustainable cash flows in the longer term. Therefore, integration between financial and sustainability metrics is not the sole criteria but certainly one of the decisive factors in the making of quality performance. We need to see more of this type of connected information in integrated reports, if <IR> is to live up to its mission statement.
* Norton, B.G. and Noonan, D. 2007. "Ecology and Valuation: Big Changes Needed" in Ecological Economics, Vol 63, pp 664 - 675.