As new global baseline and EU sustainability standards for companies launch, some warn they don’t reflect an organisation’s true sustainability within Earth’s boundaries.
Happy Earth Overshoot Day! Today (August 2), humanity’s demand for biological resources has exceeded Earth’s capacity to regenerate for the rest of the year, according to Global Footprint Network, which has been measuring the ecological deficit since 1971.
It coincides with this week’s adoption of Europe’s first set of European Sustainability Reporting Standards (ESRS) – in part a response to concerns on the lack of robust information on companies’ extraction of earth’s ecological systems, as well their human rights impacts.
Europe says its mandatory ESRS will provide investors the information they need to understand the sustainability impact of the companies in which they invest on issues such as climate change, biodiversity loss and human rights. It follows the publication a few weeks ago of the International Sustainability Standards Board’s (ISSB) first set of sustainability standards expected to be widely adopted by regulators worldwide.
Many have welcomed both moves but intense debate has oscillated around whether the standards will give a full reflection of a company’s sustainability.
Europe has come under fire for weakening its stance on key disclosure indicators being reported on a mandatory basis, instead allowing companies to conduct their own materiality assessments on what to report.
The ISSB has been criticised for adopting a financial materiality lens, instead of applying a double materiality approach, adopted by ESRS and the Global Reporting Initiative (GRI), which require companies to outline how sustainability issues impact their business, as well as the organisation’s impact on sustainable development beyond internal operations.
There’s also some confusion on why the 26-year-old GRI’s well-established and widely adopted sustainability reporting standards are not being considered as the “global baseline” instead of creating a relatively new initiative, the ISSB, albeit one which has amalgamated the resources and standards of several existing bodies.
Thresholds and allocations
Amongst all the chatter, less attention has been given to another, potentially serious gap in all three sustainability reporting standards – that of thresholds and allocations – which, according to initiatives like NGO r3.0, reflects a company’s true sustainability – whether it operates proportionally within Earth’s ecological boundaries.
Bill Baue, Senior Director at r3.0, who has been a very public critic of the ISSB, going as far as calling it “sociopathic” on social media for its financial materiality approach, tells ESG investor that there has been significant work to develop thresholds and allocations over the last 20 years, but it is yet to be embraced and codified by standard setters of sustainability accounting.
Broadly thresholds and allocations accounting are seen as an avenue to foster a better understanding of how best to use earth’s shared resources in ways that ensure their ongoing availability.
r3.0 says this means applying a context-based approach to sustainability reporting, with firms allocating their fair share impacts on common capital resources within the thresholds of their carrying capacities – a measure of the level of demand a capital resource can support for its goods. This approach is outlined in a 2015 report from the UN Environment Programme (UNEP) on sustainability reporting.
“If you look at the foundations of a thresholds and allocations-based approach, the threshold side of things reflects that ecological and social systems operate in an optimal, balanced space. When you get too far out of balance – the technical term for this would be a carrying capacity – if you go beyond that carrying capacity, the system starts to collapse – that’s the system-based science underpinning it,” explains Baue.
For true sustainability accounting, a company would need to measure its impacts on vital capital resources such as the climate regulation system, a watershed’s ability to provide water, or a living wage, through a threshold-based approach, continues Baue.
Therefore, the impacts that a system could handle would be delineated, and the stocks and flows of the systems resources would be based on that underlying thinking.
He says this approach goes back at least 300 years in the West, and further back in certain Indigenous Peoples approaches to sustainability.
On allocations, Baue says a good analogy is a pie that apportions resources in a fair, just and proportionate way. “If you look at our existing society and economy, it pretty much by design allocates resources in a grossly unfair, unjust and disproportionate way.
“That’s why we have the likes of Jeff Bezos in the world.”
So, for a company, its proportionate share of a full stock resource such as water in a watershed, would be allocated to it and between other users, once natural processes were accounted for such as plant, animal and human consumption.
And even with an estimated 334 million companies worldwide, Baue claims it is viable for them to be able to understand, extract and report on their proportionate allocation of commons capitals.
“That information generally exists,” says Baue. “And allocation is only necessary in a small portion of threshold-based approaches – when you are using common resources like the climate regulation system or water.”
He adds: “There are many other areas where a company’s allocation is not shared with other companies or have ecological limits. There are many social resources that are arguably unlimited.”
Baue says companies are already testing this type of accounting, such as GLS Bank, which took part in a pilot programme with r3.0 and the UN Research Institute for Social Development, where it developed a set of indicators that were threshold-based.
The ISSB does not integrate thresholds and allocations into its sustainability standards and didn’t respond to request for comment on why.
A GRI spokesperson said: “The GRI standards themselves do not set allocations, thresholds, goals, targets, or any other benchmarks for good or bad performance. As such, GRI as an institution does not develop allocations and thresholds, nor does it require organisations to perform within a certain threshold in order to report in accordance with the GRI standards.”
However, when developing GRI standards, the standard setter said that it takes account of global scientific consensus on thresholds and allocations.
“For example, GRI 303: Water and Effluents refers to credible tools for assessing water stress and the thresholds set by these tools,” the spokesperson told ESG Investor. “Meanwhile, GRI’s current work to revise its climate change-related disclosures will include reporting on the goal to limit global warming to 1.5°C.”
On Europe’s newly adopted ESRS, r3.0 has said it welcomes the mentioning of ‘thresholds and company-specific allocations’ in most of the environmental standards, but it regrets the lack of thresholds and allocations in social and governance standards.
Comparability and monetisation
One key driver for the development of the ISSB as a global baseline for sustainability, is the lack of comparability and consistency in sustainability reporting amongst a myriad of approaches, some of which have now been integrated into the ISSB.
Consistency, comparability and reliability across companies’ sustainability disclosures is seen as vital to help investors make more informed financial decisions by supporters of the ISSB.
Last week, the International Organization of Securities Commissions (IOSCO) called on its country members to adopt the ISSB into their respective regulatory frameworks, with Jean-Paul Servais, Chairman of the IOSCO Board saying it would enable pricing in of sustainability-related risks and opportunities.
Baue acknowledges thresholds and allocations accounting would mean methodologies differ between companies, but says comparability would be improved “because of the triangulation with the real world”.
As reporting of companies’ sustainability impacts starts to become standardised and mandated globally, there are some initiatives working on the development of monetising impacts to allow for greater comparability with financial accounts.
Baue says the current approaches are not fit-for-purpose as they don’t integrate thresholds and allocations.
“You would have to integrate what’s called monetisation cost curves,” he says. “You can monetise an impact until you reach the threshold of that impact, and then you would need to take that impact off the market, if you will, as the price it would need to be is infinitely high.
“The Impact-Weighted Accounts Project and the Value Balancing Alliance, they all know this. They keep saying they’re going to implement it, but none of them do.”
Harvard Business School’s Impact-Weighted Accounts Project is seeking to drive the creation of financial accounts that reflect a company’s financial, social, and environmental performance. In a similar vein, the Value Balance Alliance is a membership organisation seeking to translate environmental and social impacts into comparable financial data.
Rob Zochowski formerly led the Impact-Weighted Accounts Project at Harvard Business School (HBS) and is now President and CEO of the International Foundation for Valuing Impacts (IFVI) which has absorbed the work of the HBS project and is partnering with the Value Balance Alliance. He says the IFVI will work on implementing thresholds and allocations into its methodologies.
“We already incorporate a threshold for local living wages in our employment methodology where we evaluate worker pay against the cost of living and penalise firms for paying below this critical threshold,” he says. “As we update and align our existing environmental methodology with that of the Value Balancing Alliance, we are also looking at critical thresholds such as science-based targets for evaluating relative impact.”
Zochowski says the IFVI believes that sustainability impact accounting needs to evolve to put a monetary value on impact.
“It comes down to transparency and accessibility,” says Zochowski. “And that ease-of-conscious decision-making.”
He says the reporting that will start to come through from sustainability standards will need a level of expertise to fully understand for different sustainability issues such as biodiversity loss or human rights, so an additional monetary lens will help decision-makers make better informed choices.
“If you are the CEO of a consumer goods company, you are an expert in that segment, but you probably don’t have a great understanding of environmental sciences to fully understand reporting on impact on ecosystems such as biodiversity loss, so when you put it into monetary terms, it’s much easier to make a decision,” he says.
“If a company launches a new project, it does a profit and loss. There is an economic assumption on the cost and the benefits, and you can calculate making US$10 million per year for the project and then compare it to the negative sustainability impacts for different stakeholders in monetary terms and tell whether there is an overall net positive gain for society or a deadweight loss there.”
This month, the IFVI and VBA will be launching a consultation on foundational, open-source, general principles that will help corporates and investors to translate and monetise their impacts as they seek to develop a methodology.
Zochowski says its vision for the future is that a regulatory standard setter will take up its work. Its “North Star” for a completed methodology and critical mass adoption by companies is three-to five years.
It maintains dialogue with the IFRS Foundation which houses the ISSB, and the European Financial Reporting Advisory Group (EFRAG) which makes recommendations to Europe on reporting standards such as the ESRS.
The GRI sits on IFVI’s board as an observer. The Impact Economy Foundation, which is also working on monetising impacts, sits on IFVI’s technical practitioner committee and has regular contact with the organisation.
Rules of the market
Werner Schouten, Director at the Impact Economy Foundation, says that for a fundamentally sustainable economy the rules of the market need to change so a company’s cost or impact on CO2, water, biodiversity or human rights isn’t externalised. The foundation works with companies on this and plans to lobby the EU so that pricing of a company’s impacts is common practice.
The broader vision, says Schouten, is for an ‘impact economy’ which redefines what is valuable.
“Today, we implicitly value nature at zero, or human rights at zero, by not including them in our decision-making metrics. And we need in the long run that broad adoption of valuing nature or climate, so we can start to steer economies towards societal value creation, not just solely financial value creation.”
On, thresholds and allocations, Schouten says monetising impacts must account for this by default, as one must look at the ecological thresholds in a region, to price a company’s externalities on that region. He says the Impact Economy Foundation encourages organisations to use region-specific databases to work out the ecological threshold and monetise it.
“In that regard, through pricing, you take into account local ecological thresholds to also take into account the carrying capacity of the system,” he tells ESG Investor.
Funders of the Impact Economy Foundation include the European Commission, with IFVI receiving grants from philanthropic organisations including the Ford Foundation and Summa Equity.
Baue says r3.0 has historically struggled to get funding. “It’s slow going and frankly difficult to get funding for this,” he says, noting that philanthropic organisations are tied into the existing economic system and r3.0’s work is a divergence from that.
It has, however, recently received some funding to develop a global thresholds and allocations network of organisations recognised in the space. “We’re moving forward on the network side of things as an energising force on this work,” says Baue.