The Elephants in the Boardroom – The Sustainability Imperative

First Published in SID Conference Book “The Sustainability Imperative”
By Professor John Lee

Some leading companies are pioneering best practice towards truly sustainable business models. For the majority, followers and a handful of sceptic, whilst there is some acceptance that sustainability is “good”, there remains doubts as to how, in the current capitalism, sustainability can positively impact company financial performance.

The reality is that the vast majority of boardrooms today work to an agenda dominated by short-term issues, pressures and priorities. Current financial decision-making does not fully capture the value of sustainability-related investments. These investments are often based on long-term and intangible rewards, environments, social and governance (ESG) factors, whereas many investments made are based on the short-term impact on the bottom line.

Hence, it is imperative to address the short-term and long-term ways to assess and justify sustainability related investments? Until sustainability becomes accepted as a legitimate and value-creating activity, it will remain as the “elephant in the boardroom”.

The sustainability elephant
A May 2016 INSEAD paper, “Turning Sustainability into Value Drivers”, highlighted how an asset manager, Robeco Asset Management use of a “Value Driver Adjustment” (VDA) approach is giving companies practicing sustainability higher market valuations.

The VDA approach consists of three steps:

1. Identify and focus on the most material issues for the respective industries.
2. Analyse the impact of these material factors on the individual company.
3. Quantify competitive (dis-)advantages to adjust value driver assumptions.

In the context of sustainability, materiality as defined by Global Reporting Initiative is “relevant topics that reflects the organization’s significant economic, environmental, and social impacts or that substantively influences the assessments and decisions of stakeholders.”

The VDA approach ties traditional investment approaches, linking ESG factors to value drivers through their expected effects on business models and competitive positions. In deriving competitive advantage from its ability to manage any ESG factor, company should reflect such advantage in its value drivers. In the end, company should have higher sales growth, higher margins, more efficient use of capital, or lower risk. Which in turn drive the ROIC (return on invested capital) and the firm’s valuation.

Robeco is not alone in applying sustainable investing. A Wall Street Journal article, “‘Sustainable Investing’ Goes Mainstream”, reported that signatories to the Principles of Responsible Investment, a UN-supported initiative, pledge to incorporate elements of sustainability into their financial decisions, with funds under their management totaling about US$59 trillion, or about half of all institutional assets world-wide.

Ever since the Industrial Revolution, our economy has a basic structure: we dig things out of the ground, turn them into products and then dispose of them into the air, water or bury them back into the grotmd as landfill. This linear model has recently experienced economic pressure from rising resource prices. This continued resource depletion and subsequent commodity price increases, has motivated some leading companies to adopt a regenerative business model in which products and components are reused multiple times, the circular economy.

An effective transition from a linear economy to a circular economy entails a substantial departure from the status quo, requiring collaboration from various stakeholders, and would release a vast amount of disruptive innovation across a variety of industries.

The Asian Development Bank estimates Asia Pacific (APAC) food wastage, including both food losses (up to the moment of sale) and consumer waste, to be at 37 per cent. Often ending up on trash heaps and in landfills, where they break down releasing methane, 21 times more potent than carbon dioxide as a greenhouse gas.

To feed an ever-increasing hungry population, reducing this massive wastage proves to be both an uncharted challenge and a golden opportunity. “Disrupting the Food Logistics” is an initiative of “Forum for the Future”, an international non-profit organisation which is working with business, government and civil society to solve complex sustainability challenge. The initiative aims to use today’s cutting edge web based tools to map the innovations that can deliver sustainable, zero-waste food supply chains, ensuring that all produce, whether animal or vegetable, contributes to feeding the growing population.

Natural capital elephant
Another elephant in the boardroom is natural capital depletion. Natural capital refers to the elements of nature that produce value, directly and indirectly, for people and organisations, such as forests, rivers, land, minerals and oceans. It includes the living aspects of nature, such as fish stocks, as well as the non-living aspects, such as minerals and renewable or non­ renewable resources.

In the not-too-distant future, we may well have to value, account and make public the natural capital in our businesses. A concerted effort is underway to create methodologies and frameworks to value and account for natural capital in business. The Natural Capital Coalition, a multi-stakeholder initiative, is seeking to create a harmonised framework that will help standardise how natural capital is accounted for and valued: the Natural Capital Protocol (NCP). It is supported by, among others, the United Nations Environment Programme, the World Bank’s International Finance Corporation, and the accountancy professions.

The NCP is designed to generate trusted, credible, and actionable information that business managers need to make truly informed decisions. It brings together and builds on a number of approaches that already exist to help business measure and value natural capital, and, by harmonizing them, will allow all businesses everywhere to benefit from understanding their relationships with nature.

According to a 2013 report commissioned by the Natural Capital Coalition, half of all existing corporate profits would be at risk if the costs associated with natural capital were to be internalized through market mechanisms, regulation or taxation. A water shortage, for example, would have a catastrophic impact on 40 per cent of Fortune 100 companies.

Natural capital brings together the environmental strands of climate, water, energy, biodiversity and waste into a uniform strategic approach. When adopted, the NCP has the power to revolutionize the way that businesses evaluate their operations and make decisions, helping them to reduce pollution, protect biodiversity, and limit the impacts of climate change, while simultaneously producing positive business results, safeguarding operations and supporting efforts to create a more sustainable world.

We are committed
With 139 Parties of the 197 Parties to the Convention having ratified, the Paris Agreement entered into force on 4 November 2016. The Paris Agreement’s central aim is to strengthen the global response to the threat of climate change by keeping a global temperature rise this century well below 2 degrees Celsius above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5 degrees Celsius.

Singapore is a signatory of the Paris Agreement and is committed to reducing emission intensity by 36 per cent from 2005 levels, and peaking around 2030. Towards achieving this commitment, Finance Minister announced in February 2017 that the government is looking at a tax rate of between S$10 and S$20 per tonne of greenhouse gas emissions on large direct emitters such as power stations from 2019.

To the skeptics, the message is this: climate change and other sustainability issues are not a passing fad; it is a disruptor that will transform our economy and society.