Article 16 August, 2022

Is there a ‘one size fits all’ solution to impact reporting?

Lucy Cheng considers how investors evaluate the impact of their portfolios on the environment and society, with a closer look at the United Nations' sustainable development goals.

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The requirement for impact reporting

In recent times the term ‘greenwashing’misleading claims about environmental (and wider) ESG practices[1] – has had investors fearful of being associated with it in any manner. Allegations and fines from regulators for greenwashing in the financial industry has dominated our news headlines over the past few years, with companies including DWS2, Deutsche Bank[2], BNY Mellon[3] and BlackRock[4] in the headlines. To distance themselves from any chance of being associated with ‘greenwashing’ and with increasing sustainability disclosure regulation, investors are now reporting the impact of their investment and stewardship strategy on the environment and society to clients, regulators and wider stakeholders. There are several ways investors are reporting impact; some methods focus on positive impact (such as number of cars taken off the road equivalent to a carbon-tilted fund or examples of successful engagement), other reporting techniques hone in on mitigating negative impact (such as the SFDR Principle Adverse Impacts). One popular framework used by investors is the United Nations Sustainable Development Goals (UN SDGs) – let’s look at this one in closer detail.

What are the UN SDGs?

“The 2030 Agenda for Sustainable Development, adopted by all United Nations Member States in 2015, provides a shared blueprint for peace and prosperity for people and the planet, now and in the future. At its heart are the 17 SDGs which are an urgent call for action by all countries – developed and developing – in a global partnership.” – United Nations[5]

Source: United Nations Website

Use of UN SDGs by the investment industry

Despite the SDGs being primarily aimed at governments, the SDGs have become an important framework for many corporates as material factors to business planning and operations. In the investment sphere, many investors are now reporting their impact against the SDGs and allocating capital to contribute to the achievement of the SDGs with some investors even launching thematic products that align themselves to a portion of the SDGs. To quote Principles for Responsible Investing (PRI) Blueprint for responsible investment “Driving sustainable development in line with the UN SDGs will create a more prosperous world, to live in today and to pass on tomorrow.”[6]

Through investors reporting impact against the SDGs, it signals transparent reporting and, for those consuming the information, can provide a standardised framework in which to demonstrate impact allowing comparability. SDGs can also be used as a universal benchmark for sustainability progress to be measured, bringing consistency for investors to analyse companies. Additionally, to achieve the SDGs, global coordination between governments, businesses, and society – including investors - is required therefore companies’ alignment to the SDGs can demonstrate they are aligned to sustainability, forward looking and potentially indicate that they are sustainability leaders. Investor alignment to the SDGs can also demonstrate alignment to the UN’s sustainability campaign.

“Where investors are determining alignment to the SDGs themselves, there are limited standardised methodologies to determine this, and external validation is scarce. This means reports are subjective and lack standardisation.”

PVT Equities team view

The PVT team recognises that the SDGs can be a useful tool to help identify sustainable initiatives, however we believe there are certain drawbacks to using them as the sole method for demonstrating sustainability impact.

UN SDGs were designed for governments rather than investors

The nature of SDGs is to incentivise governments into making policy changes to create a more sustainable planet and society, they were not designed as an investor impact measurement tool. Consequently, it is often large cap companies in developed countries that have resources to commit to SDG alignment disclosure, excluding a large portion of the investment universe. Additionally, it can be challenging for some companies to determine which SDGs they are aligned to where their direct impact is limited; for example, a renewable energy company installing and operating wind farms would naturally positively contribute to SDG 13 – Climate Action however, one of the wind turbine component manufacturers may find it hard to align themselves to this SDG as they are part of an extensive supply chain. Companies’ own assessments of SDG alignment is rarely verified externally, meaning analysis is often subjective and biased.[7]  The Sustainable Finance Disclosure Regulation (SFDR) Principle Adverse Indicators (PAI), which was designed for companies and investors to disclose social and environmental impact, may be a more appropriate framework with a standardised methodology.

Differing methodology

Where investors are determining alignment to the SDGs themselves, there are limited standardised methodologies to determine this, and external validation is scarce. This means reports are subjective and lack standardisation. Where third party data providers are used to determine SDG alignment, reporting and measuring SDG methodologies vary widely. Some providers measure SDG impact based on alignment to a firm’s products as well as an operational aspect, while other data measures align more broadly as a percentage of revenue exposure. Additionally, some providers only look at either positive or negative alignment to the SDGs (which can result in sustainability opportunities/risks not being captured) whilst others combine both positive and negative impact to rate portfolios.

Lack of clarity on the type of UN SDG impact

As described by Stewart Investors[8], the contribution companies make to the SDGs can include:

  1. Direct contribution to targets
  2. Enabling/supporting activities
  3. Sustainable and socially useful products and services, but not directly relevant to a target

Therefore, SDG impact can be misinterpreted when the type of company contribution is not clarified.

We are confident in our S-PVT Philosophy and Process

The PVT team integrates sustainability into its investment process through our Sustainable PVT (S-PVT) framework centred around the pillars People, Innovation and Environment. Our company analysis is focused on material sustainability issues which vary by industry, business model and stage in a company’s life cycle (more information about our S-PVT philosophy can be found on our website here). We believe, at a company level, that our S-PVT philosophy and process allows us to identify sustainability risks and opportunities and embed this within the investment process. By investing in improvers[9] and enablers[10] as well as existing sustainability leaders – as assessed through the aforementioned S-PVT framework – we believe we can support positive change within society and the environment. Such companies might not screen well through SDG alignment as they can be sustainability laggards today but through our analysis, we identify opportunity and potential for improvement and material real-world impact.

UN SDGs are currently a framework of choice

SDGs are currently the favoured impact reporting metrics by a wide variety of stakeholders, including corporates and investors. We understand the attraction, in principle, of a well-defined, standardised framework sponsored by supranational bodies and which has broad adoption by governments, companies and investors, and there are indeed some useful aspects to the SDGs. However, we also identify a number of limitations to the SDG approach and believe that it can give incomplete assessments of the nuanced sustainability credentials of an investment. It is also open to the risk of third parties, or even companies themselves identifying SDG impact when the reality can be a more tangential contribution.

So, is there a ‘one size fits all’ solution to impact reporting?

No, we do not think so – SDGs can certainly be a technique used by investors to demonstrate impact however, we believe they should be used as part of a wider framework. Taking the discussed drawbacks into consideration, we believe that for investors to demonstrate their true impact, it is important to demonstrate output and impact, both positive and negative, through a range of reporting frameworks.

As a firm (and as part of our overall impact reporting), we are able to provide SDG alignment reports for all of our portfolios. However, alongside the UN SDG reporting, we believe that disclosing our stewardship activities and showcasing case studies of ‘improvers and enablers’ best demonstrates the impact our portfolios, and underlying companies, have on the environment and society. We are currently working on our first impact report for 2022 – please get in touch with a member of the team should you wish to hear more on this topic or request access to this report once ready.

 

[1] CFA ESG Investing Official Training Manual, Edition 3, 2021

[2] FT - German police raid DWS and Deutsche Bank over greenwashing allegations

[3] FT - SEC fines BNY Mellon over ESG in first case of its kind

[4] Citywire - Hedge fund giant accuses BlackRock of being 'full of greenwash'

[5]  THE 17 GOALS | Sustainable Development (un.org)

[6] Enable real-world impact | PRI Web Page | PRI (unpri.org)

[7] Aegon Asset Management makes a similar argument Beware SDG “rainbow washing”: Aegon AM’s Beacham - MRM (mrm-london.com)

[8] Rainbow washing the SDGs away (stewartinvestors.com)

[9] Improvers – companies whose sustainability credentials are improving

[10] Enablers – companies whose business activities contribute to improving sustainability credentials of wider stakeholders/society/whole sectors e.g., business activity will allow decarbonisation of a whole sector

This information has been prepared and issued by River and Mercantile Asset Management LLP (trading as “River and Mercantile” and “River and Mercantile Asset Management”). River and Mercantile Asset Management LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference Number 453087).

The value of investments and any income generated may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. Past performance is not a reliable guide to future results. Changes in exchange rates may have an adverse effect on the value, price or income of investments.

Please note that individual securities named in this report may be held by the Portfolio Manager or persons closely associated with them and/or other members of the Investment Team personally for their own accounts. The interests of clients are protected by operation of a conflicts of interest policy and associated systems and controls which prevent personal dealing in situations which would lead to any detriment to a client.

R&M European Change for Better Fund

A sustainable SFDR-9 fund focused on the transition of polluting activities which aims to achieve real-world positive impact for the environment.

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