Dow Jones Sustainability Index 2017 uncovers new challenges

The launch of the Dow Jones Sustainability Index (DJSI 2017) results this morning highlights an interesting trend – a growing focus on Impact Measurement & Valuation.

A new criterion was piloted last year and included in nearly all industry evaluations this year. It assesses:

• whether companies are measuring the social and environmental externalities of their business activities and

• whether they are reporting on them.

Taken together with a related topic on Corporate Citizenship & Philanthropy, this now represents about 5% of the total score in the DJSI – a sign that impact measurement is becoming a material issue for responsible investors.

Investors will welcome this development as they are increasingly interested in “impact investing” but often struggle to identify and quantify the positive and negative impacts of companies’ business activities on society and on the environment. However, whilst the DJSI’s focus on this topic contributes towards bridging the gap between investors’ growing expectations and companies’ efforts to adopt more comprehensive approaches to account for the “shared value” they create, it also reveals some of the challenges that lie ahead.

We identify 3 areas that we believe will require further improvements in the coming years.  

Clarifying what is in scope

One of the key challenges lies in identifying what should be included in this valuation exercise. First of all, from the company perspective, what activities should be considered relevant? Core revenue-generating business activities, strategic philanthropy, or both? On this the DJSI provides some guidance but in practice it is still extremely difficult to categorise corporate activities as either “Business Programs for Social Needs”, “Community Investments” or “Inclusive Business”.

Whatever the label, there is a slow and gradual convergence taking place between pure “for profit” activities and pure “philanthropic” activities. Following the launch of the SDGs, companies are increasingly keen to position themselves as social enterprises by demonstrating the shared value created beyond the financial bottom line. So ultimately, this categorisation might become irrelevant as companies choose to focus on what matters most: their core business activities. In this scenario, an input-output model similar to the Integrated Reporting framework proposed by the IIRC that includes all types of capital (e.g. financial capital, natural capital, human capital etc) might be more useful[1], as it will shift the focus away from listing and categorising specific activities, to looking at all the resources and assets that a firm utilises and how it transforms these into new sources of societal value (also commonly described as outcomes, impacts, benefits etc).

Aggregating in a meaningful way

Companies are complex entities with multiple business lines, so finding common metrics to account for impact is a daunting challenge. Whilst many investors use fundamental analysis to assess corporate performance as comprehensively as possible, they are still shareholders of the entire business and are therefore primarily interested in the total impact. Moreover, as they move towards “impact investing”, they are looking for impact metrics that can be consolidated at a portfolio level, typically across many different industries. Finding meaningful common denominators remains a huge challenge.

Here the SDGs provide a useful reference framework and the work of several initiatives[2] on developing impact indicators and accounting mechanisms are encouraging. Companies can support this by testing and piloting different approaches, helping the more robust one to emerge. According to the DJSI results[3], European companies are leading in this regard, with 29% of European companies participating in the assessment able to measure the value of their social and environmental impacts or working on a pilot project to do so.

Reporting in a standardised way

The DJSI assessment also focuses on improving corporate disclosure of impact measurements and valuation, as transparency is key to building stakeholders’ confidence and enabling investors to shift capital allocation progressively towards companies that create broader societal value. The DJSI results suggest there is still a long way to go, as only 10% of companies participating in the 2017 assessment currently communicate the value of their environmental and social impacts either qualitatively, quantitatively or monetarily. This is not surprising considering the challenges identified above and shows that it will take some time for a standardised reporting framework to emerge. Investors can also help in this respect, by communicating which impact indicators they find useful for investment decisions. Some investor-led initiatives[4] are proposing impact reporting frameworks which would benefit from being tested by investors and companies alike.

This is an exciting area of work, given its potential to support a more efficient capital allocation geared towards creating value whilst maximising societal benefits and minimising environmental impacts. It will require an ongoing dialogue between responsible investors and companies that are pioneering these new integrated accounting approaches.

 

Notes

[1] http://integratedreporting.org/what-the-tool-for-better-reporting/get-to-grips-with-the-six-capitals/

[2] http://social-capital.org/introducing-protocol/what-protocol 

[3] http://www.robecosam.com/images/CSA_2017_Annual_Scoring_Methodology_Review.pdf

[4] https://www.cisl.cam.ac.uk/business-action/sustainable-finance/investment-leaders-group/pdfs/ILGimpactfactsheets.pdf

 

The article can also be found in Contrast Capital's website.

More on Cecile Biccari here.