The Sustainable Development Goals (SDGs) and Paris Climate Agreement outline a clear framework with goals to achieve the future we want. Business knows it has a leading role to play in the transformation that is ahead. It can bring innovation, financing power and management talents. But what’s sometimes left out of the conversation is the role the financial system needs to play in speeding the transition.
The current aim of the financial system is too narrow. It moves and manages the returns on financial capital and that’s pretty much it. It was not designed to consider impacts and dependences on other forms of capital, such as the value of nature or people, for example. As a result, it misses a lot of value-creating information.
Focusing solely on financial performance has meant that companies and their investors have blind spots with respect to their risk profiles and performance. The incentives are simply not covering all relevant areas of risk and opportunities.
In the context of today’s turbulent geopolitical environment, businesses need to redefine their conception of “value” to go beyond traditional financial terms. It is only by taking the integrated approach that we will create a socially, environmentally and economically successful future.
It all starts with better business decision-making. If companies can get better at understanding and disclosing environmental, social, governance-related (ESG) risks, they will better inform their decision-making processes to improve over the long term. Companies need to future-proof their enterprise risk management processes to capture and prioritise ESG risks and improve their corporate governance.
Key developments in this respect are recommendations from the Task Force on Climate-related Financial Disclosures (TCFD). These focus on improving processes, disclosures and scenario-analysis which will have a material impact on corporate governance.
Governments and other stakeholders are also pushing for better corporate transparency. Because of this, business is increasingly expected to know how to reduce negative social and environmental impacts. However, many businesses do not disclose any ESG information and those who do are mainly focused on backward-looking data, whereas what we need is to measure and manage the risks in the future.
According to the Business & Sustainable Development Commission’s Better Business, Better World report, 79 per cent of investors say they’re unhappy with their ability to compare sustainability reporting between companies in the same industry.
Boards need to ensure that the businesses they oversee are transparent, and management needs to disclose investment grade, forward-looking and decision-useful ESG information to meet the demands of their investors and better understand their risks and opportunities, while adhering to their fiduciary duties.
Doing so will allow investors to integrate the sustainability risks in their valuation models and as such lower the cost of capital for more sustainable companies.
To report consistent, comparable and meaningful information, we need prescriptive, generally accepted methodologies to assess non-financial information, such as natural and social capital.
The new World Benchmarking Alliance that will create benchmarks within sectors against the SDGs is going to help drive compatibility and disclosures in the conversations between corporates and investors.
Beyond that the implementation of the recommendations from the TCFD, maturing reporting standards and mainstream adoption of ESG disclosure will ultimately change the way we make decisions, integrating all impacts and benefits, including the way we govern our companies and, ultimately, society.
We have to realise that only when we reboot the financial system, will the movement towards a more equitable, inclusive and sustainable world get the traction and scale we need to deliver the SDGs.
By Peter Bakker, president and chief executive of the World Business Council for Sustainable Development