SRI and the next sustainability sea change
I admit it. I was probably too harsh ("simplistic and senseless") on the socially responsible investment (SRI) community when I wrote my first column on this subject earlier this year. I so much want them to be the savior that moves corporate America to accelerate their sustainability programs.
That’s unreasonable. While the SRI community is an effective ethical watchdog on important CSR issues, they are not the force that will bring sustainability to the mainstream financial markets.
Since then, I’ve learned about the Future of the Capital Markets Project, led by High Meadows Institute’s (HMI) president, Chris Pinney. The project is about transforming today’s ESG 1.0 to ESG 2.0. This work may sound incremental, but his view is actually very disruptive. It hopes to turn the sustainability profession on its head, embracing new bedfellows while dumping some sacred cows.
The Future of Capital Markets Project is still early in its journey. Pinney has assembled the ESG (environment, social, governance) leads from major financial investment management firms, asset owners and corporate finance to start working on the challenge of getting to ESG 2.0.
- ESG 1.0 is externally driven by stakeholders; risk-based; peripheral; niche; siloed and incremental.
- ESG 2.0 is about value creation. It’s industry driven; integrated; reward-based; global and transformative.
Sustainability professionals drink way too much of the SRI Kool-Aid when it comes to incorporating the investment community as part of their business case. Ask your CFO tomorrow how many sustainability questions she or he has received from mainstream financial asset managers in the last year. I’ll bet the answer is zero, or close to it.
Yes, there’s $21 trillion in SRI funds. That sounds like a lot. In the context of a total capital market of $325 trillion, SRI is small.
"By and large, the SRI field is certainly a fast-growing part of the investment marketplace," said Pinney. "But at the moment it’s very much a niche market, and it’s still for people who have certain values or certain kinds of things they don’t want to invest in. It’s not seen as a strategic lens by which you manage the core of your investment portfolio, your strategy, your valuation models."
Abundance of data?
The other Kool-Aid SRI argument I often hear is that an abundance of sustainability data is available to the investment community. For example, every asset manager has a Bloomberg terminal with a tab for dozens of ESG factors. The problem is the data behind these factors is gathered through companies’ CSR reports and other public information. According to Pinney, most of this has little direct connection to financial value.
Pinney envisions a different investment world. He does not see dozens of sustainability criteria and checkboxes: "ESG will not get traction until sell-side analysts, when doing an analysis of an industry or a company, actually consider a handful of key ESG factors that have a material impact the performance of the company, and they say, ‘I’m going to include them into my valuation model.’"
The research and collaboration that Pinney is leading with HMI board member and Harvard Business School Professor George Serafeim is a momentous fork in the road for corporate sustainability professionals. It challenges the notion that a company can focus on lots of goals.
"If you tell me a company’s got 15 sustainability initiatives it is managing, and it is working to satisfy everybody, it is unlikely to generate any measurable financial value that will attract the interest of mainstream investors," said Pinney. The key, Pinney said, is to identify a few sustainability issues material to the business and manage them well. Then track their impact on organizational and financial performance and communicate this to investors.
Who reads CSR reports?
Pinney said most CSR reports provide little value to investors: "Think of the amount of time and money that goes into the CSR reports that companies put out. Who reads these? Very few investors do, I can assure you."
I cringed as he said this to me, having orchestrated many of McDonald’s CSR reports, and proud of it. But I concede his point. Who really reads these reports? Do they move any needle at all?
At the same time, according to Pinney, we are seeing a large increase in the number of shareholder activism and proxies around ESG issues. "If you are not clear about which ESG issues are material to your firm and its performance, you can find yourself wasting a lot of time on ESG issues that may placate a few stakeholders but distract you from the issues that matter and add value."
Sustainability leaders have led the charge over the past decade to get sustainability more mainstream in business, with much success, judging by the plans we see from companies with goals, measures and accountability.
Now, sustainability leaders have another chance to create the next sustainability sea change. And this leads to several questions for today’s sustainability leader.
Can you imagine the traction we would get if the financial markets put value on sustainability? Given this, should you work even more closely with your finance and investor teams to explore the shifts that Pinney is suggesting?
Can you team up with your financial team and agree on the three sustainability goals that bring value to the business? Should you focus your attention more internally on accomplishing these goals versus spending time with external stakeholders?
If you did not produce a CSR or sustainability report next year, what would happen? Maybe nothing. Many companies don’t do such reporting, and they don’t get dinged in the marketplace.
Corporate sustainability leaders have done an outstanding job integrating sustainability into areas such as supply chain and operations, gaining efficiencies, reducing risk and saving money. Now it’s time to shift toward getting the attention of the mainstream investment community.
Before you know it, your CFO will be calling you weekly. Be careful what you wish for.