Sustainable Investing and Environmental – Social – Governance (ESG) Metrics: Revealing The Truth Behind The Numbers

What better way to end a dismal 2020 than by looking ahead to a (much) better 2021?

Instead of leaning back and closing the year with the customary “Year In Review” blog post, I thought that I’d lean forward and invite my colleagues to a free webinar that I am presenting on January 20, 2021 from 4pm to 6pm Eastern time, 3pm to 5pm Central time. There is no fee for attendance; the webinar will be co-presented by the Houston CPA Society and the Sustainability Investment Leadership Council. See below for details.

If you wish to attend, please contact me at I’ll be delighted to forward the log-in codes to you. Happy New Year!

Here are the details:

Hundreds of millions of dollars are now invested in funds that are labeled “socially responsible investments.” But who determines what is “socially responsible”? How are standards and metrics defined for this large – and growing exponentially larger – sector of the capital markets?

Session Description

By June 2020, a quarter of a trillion dollars were invested in ESG funds. And the growth trend is increasing exponentially; the amount of capital that flowed into sustainable funds last year was roughly four times as great as the amount in the prior year, and six times as great as the amount in 2013.

Many wealth managers follow automated “robo-advisor” guidance by investing in ESG funds that track sustainability indices and other publicly available metrics. Thus, personal financial planners and investment managers who compete against such advisory services may find it helpful to learn about the “truth behind the numbers.”

In this session, we will review growth trends in the ESG fund industry. We will then engage in a detailed analysis of the investment methodology of the world’s leading set of sustainability indices. Finally, we will review the definitions and constructs of the world’s leading promulgators of ESG metrics and standards.

Target Audience

Wealth managers, investment advisors, and personal financial planners
Assurance professionals with professional interests in the ESG field
Accounting professionals and students with career interests in sustainability

Major Discussion Topics

Development of global ESG capital markets
The Dow Jones Sustainability Indices (DJSI)
Roles Played by RobecoSAM and Rep Risk in the DJSI
Case Study: Exxon Mobil
The Global Reporting Initiative (GRI) Standards
The United Nations Sustainable Development Goals (SDGs)
IPIECA International Petroleum Industry Metrics

Discussion Materials

CNBC, Money Moving Into Environmental Funds Shatters Previous Record

Dow Jones Sustainability Indices (DJSI) Methodology




Global Reporting Initiative (GRI)

United Nations Sustainable Development Goals (SDGs)

IPIECA International Petroleum Industry Metrics

Integrated Reporting: Built To Last

Four months ago, I wrote about the International Integrated Reporting Council’s (IIRC’s) efforts to update its 2013 sustainability reporting model. The world has confronted numerous new challenges since that time, and the financial community has risen to these challenges by pouring resources into ESG focused index funds.

As of the last quarter, for instance, a quarter of a trillion dollars were invested in such funds. Furthermore, the amount of capital that flowed into sustainable funds in 2019 was roughly four times as great as the amount in 2018, and six times as great as the amount in 2013.

It thus appears reasonable that the IIRC wishes to update its 2013 model to account for new developments, doesn’t it? Four months ago, for instance, I noted that the IIRC’s “String to Spring” approach bore some helpful similarities to COSO’s relatively new 2017 Helix model of Enterprise Risk Management. So how far from the IIRC’s original 2013 framework has its 2020 revision progressed?

Page 13 of the “Companion Document” of the 2020 revision contains the details. It compares the original 2013 Framework to a “mock-up” of the revised framework. How many of the proposed changes are radically new?

In a word? None. Indeed, the new mock-up merely contains five clarifications of the original Framework:

“Outcomes” are now referred to as “Short, Medium, and Long-Term Outcomes” to emphasize that organizations must assess impact throughout the time horizon.

“Business Activities” are now referred to as “Activities” to incorporate the non-business activities of organizations.

“Mission and Vision” are now expanded to “Purpose, Mission, Vision” to emphasize that a holistic sense of purpose should define all strategic activities.

“External Environment” now appears above the organization and not below it to emphasize that organizations must survive within their environments.

“Value Creation” is now expanded to “Value Creation, Preservation, or Erosion Over Time” to explicitly remind organizations that their actions may destroy value as easily as they build it.

None of these revisions is truly new. In fact, these concepts were already embedded in the original 2013 guidance. The 2020 mock-up simply presents these implicit points in a more explicit manner.

Thus, a model that was developed seven years ago to address the world of 2013 has been updated to address the radically transformed world of 2020. And yet this update does not include any radically new concepts at all.

It appears that the original Integrated Reporting Framework was built to last. Like the QWERTY keyboard — a model that remains just as indispensable on a 2020 Apple Macbook as on an 1893 Remington typewriter — the Integrated Reporting Framework perseveres as the leading standard of sustainability reporting.

Integrated Reporting and Risk: A Helix and a Spring

Note: This post has also appeared on the blogs of the Public Interest Section of the American Accounting Association and the Sustainability Investment Leadership Council. I encourage you to use these links to peruse these outstanding online publications.

Three years ago, COSO updated its Integrated Framework for Enterprise Risk Management (ERM). It was a noteworthy event in the business community, given that the Committee of Sponsoring Organizations of the Treadway Commission (COSO) is the leading authority that promulgates guidance about internal control and enterprise risk management systems.

Prior to this update, organizations utilized a cubic ERM framework that COSO first promulgated in 2004, following a scandal plagued era that featured the collapses of Enron, Arthur Andersen, and WorldCom. The original cubic ERM model emphasized the practices of event identification, risk assessment, control practices, and response capabilities.

After years of widespread use, the 2004 COSO Cube became synonymous with the practice of ERM. In its 2017 update, though, COSO presented a new “Focused Framework” with five components: (a) Governance and Culture, (b) Strategy and Objective Setting, (c) Performance, (d) Review and Revision, and (e) Information, Communication, and Reporting. To emphasize the “interrelated” nature of these five components, COSO designed a visual framework that weaves the five together in the form of a multi-colored Helix.

The designers of the Integrated Reporting <IR> Framework may have taken this Helix into account when they defined their own framework development goals earlier this year. Since 2013, issuers of integrated reports have used the International Integrated Reporting Council’s (IIRC’s) colorful Six Capitals model to structure their presentations. Some even referred to the framework as the Octopus Model, given its vaguely mollusk-like shape.

Like COSO, the IIRC felt the need to update this original framework. Its design project remains in progress, but the organization recently issued a model entitled “From String to Spring” that features an extension of the Six Capitals model.

Each of the six capitals of the <IR> Framework, like each of the five components of the ERM framework, is represented by a colorful String. Whereas the five “interrelated” Strings of the ERM framework are woven into a colorful Helix, the six “integrated” Strings of the <IR> Framework are woven into a colorful Spring.

Given the obvious similarities between the Helix and the Spring, it is hard to believe that the two design teams were oblivious to each other’s efforts to update their original Frameworks. Indeed, by presenting such similar models, COSO and the IIRC remind us of the significant “interrelationships” and “integrations” that link the functions of enterprise risk management and integrated reporting.

Can We Rely On Coca-Cola’s Water Use Disclosures?

Have you read the recent investigative news story regarding Coca-Cola’s water use? Apparently, the firm has been reporting data in an incomplete (and potentially misleading) manner.

The news story focused on the company’s claim that “For every drop (of water) we use, we give one back.” Why the concern? Because, even though clean water has become a scarce and precious resource around the world, Coca-Cola utilizes massive amounts of the liquid to produce its eponymous product.

The company claims that its water conservation efforts fully replace the volume of liquid that it draws out of the natural environment. But the investigative reporter revealed that the company “… does not count water in its supply chain — including the water-guzzling sugar crop — in its ‘every drop’ math.”

The reporter also noted that a company researcher once revealed that he was pressured to “ … adopt a ‘net green’ accounting method that would have lowered the water footprint of its agricultural supply chain.”

Huh? A “net green” accounting method? Any Certified Public Accountant or Chartered Accountant can confirm that no such method is defined by Generally Accepted Accounting Principles or International Accounting Standards. Coca-Cola concocted it to serve its needs.

Interestingly, the investigative reporter failed to note that Coca-Cola arranges for the Big Four global accounting firm Ernst & Young LLP (EY) to attest to the accuracy of its Water Replenish and Water Use Ratio metrics. The statistic is one of seven sustainability measurements that are assessed by the external accountants.

Sadly, industry critics will likely refer to this situation as an illustration that “corporate sustainability reporting (is) a great waste of time.” But even though it’s possible to regard the Coca-Cola brouhaha as an exemplar of misleading reporting practices, it’s important to keep in mind that — as a result of the company’s disclosures — its water use practices can now be scrutinized by external parties who care deeply about the environment.

Would Irving Fisher continue to defend the Net Present Value model in our era of sustainability?

Do you remember Irving Fisher? He may have been America’s first celebrity economist. A professor who taught at Yale, he doled out pearls of investment wisdom to the business press during the early years of the twentieth century.

But one interview, in particular, wreaked irreparable damage to his reputation. In 1929, at the height of his fame, Fisher attempted to reassure the jittery investment markets by declaring that equity values had reached “a permanently high plateau.” He implied that investors would be wise to hold onto their stocks and ride out any period of market volatility.

Those who followed his advice were in for a very long ride. The Dow Jones Industrial Average fell 89%, and didn’t recover until the 1950s. An entire generation of investors was wiped out, the nation plunged into a Great Depression, and Irving’s followers suffered a very harsh blow.

Nevertheless, Fisher did leave an impressive legacy. His classic 1907 book The Rate of Interest and 1930 text The Theory of Interest helped popularize the Net Present Value (NPV) model of Discounted Cash Flows. It remains the dominant valuation method of modern finance.

How does it work? In essence, it incorporates the Time Value of Money into an evaluation of an investment opportunity. Cash flows that occur in the near future are worth more today than cash flows that occur in the distant future. In essence, the burden of “waiting for one’s money” cheapens the latter type of cash flows.

Although Fisher didn’t invent this model, he did as much as any other individual to establish it as the cornerstone of modern valuation theory. And by doing so, he may have helped launch our society on an unsustainable path.

Why? Because, quite simply, it discounts the future. It ensures that we’ll always choose to receive a dollar today over a dollar tomorrow.

But what if we find a business opportunity that can yield billions of dollars of profits today? An opportunity, perhaps, that would trigger the impoverishment of our descendants one century in the future? Along with the utter degradation of our planet?

At any reasonable rate of interest, the impact of that future catastrophe would be discounted to zero by the NPV model. Indeed, any event that far in the future would be insignificant from an NPV perspective.

That’s the sustainability conundrum that faces our contemporary investment community. Although we may care about our distant future, our long-established investment methods fail to place any significant value on it. And yet, as the effects of climate change increasingly impact our environment, events that were initially expected to occur in the distant future are beginning to be felt in the present.

If Irving Fisher were alive today, would he still choose to defend the NPV model in our era of sustainability? Although he gave such wrong-headed advice to “stay the course” in 1929, we can only hope that he would offer more sensible advice to “change our course” today.

Climate Change: Tipping Points

For the past few years, environmentalists have voiced concern that we’ve passed a tipping point of climate change. Even if we achieve drastic reductions in emissions, they fear, the current levels of carbon dioxide in the atmosphere may inexorably increase its temperature by more than two degrees. And meteorologists warn us that such warming may create catastrophic damage to our global weather patterns.

But before you lose all hope for our planet, you may wish to consider a different tipping point. Namely, public awareness of the problem — and demand for solutions — may have passed the point where polluters can safely continue their behavior.

Consider, for instance, the Financial Stability Board. It’s the global consortium of central regulators and banking institutions that was formed during the global economic crisis of 2009 to establish universal financial standards. It launched the Task Force on Climate-Related Financial Disclosures eighteen months ago to address environmental concerns.

Last week, the Task Force issued its final report. It recommended that publicly traded corporations issue more detailed disclosures about their governance practices, business strategies, risk management processes, and metrics and targets involving climate change.

Let’s think about that for a moment. The banking institutions that finance our global economy are establishing a universal expectation that corporations must integrate climate change considerations into all core business activities.

Although the Task Force announcement didn’t receive a fraction of the attention that was generated by the United States’ decision to withdraw from the Paris Accord, this new expectation may explain why many leaders are now optimistic that America will still meet the Agreement’s emission reduction targets.

So if you’re feeling depressed about the possibility that the environmental impact of climate change is irreversible, please keep in mind that our society’s awareness of the problem — and our determination to address it — may be irreversible as well.

In other words, one tipping point is confronting a countervailing one. And because so many individuals around the world are racing to manage both elements, it’s possible to hope that our planet has a fighting chance of survival.

A Tale Of Three Nations

This is a tale of three nations, with each writing its own unique story.

Or are they? After all, appearances can be deceiving. There are times when ostensibly unique stories are woven together into a common narrative.

So let’s review our trio of tales and ask ourselves whether the three nations are indeed writing their own distinctive histories. Or, conversely, whether they are each playing a different role within a single universal saga.

First, let’s discuss Great Britain. During Victorian times, the Industrial Revolution roared to life, powered by the coal mines of Newcastle. Did you know that the phrase “London Fog” often referred to smog events? With a heavy manufacturing economy based on burning fossil fuels, the British air was filthy.

But last week, the fifth largest economy on the planet enjoyed its first full day of coal-free energy in its industrial history. This epochal event was made possible by the nation’s embrace of renewable energy sources.

Now let’s discuss China. Two weeks ago, Greenpeace East Asia released a report that predicted that Chinese renewable energy production would replace 300 million tons of coal by the year 2030. They attributed this projected transformation to the planned quintupling of the size of China’s wind and solar power industries between 2015 and 2030.

Finally, let’s discuss the United States. How is America responding to emerging trends in the global energy industry?

Well, four weeks ago, President Trump signed an executive order to repeal his predecessor’s prior actions to minimize carbon emissions. With a group of West Virginia coal miners standing beside him, Trump justified his desire to support “the truly amazing people … our incredible coal miners … (who) love to mine …

To a certain extent, these are three distinct actions by a trio of unique nations. Each one resides on a different continent, and each one is confronting its own set of social and economic priorities.

But each nation shares our common planet, and each is managing its interests within an increasingly globalized society and economy. If it’s possible to weave together a common story from these individual tales, it might also be possible to anticipate which nations will prosper, and which will become impoverished, as this tale unfolds.

Playing God With Animals

Have you heard the great news about the California Channel Island Fox? Due to the conservation efforts of the National Park Service, the Nature Conservancy, and other groups, the species with the “naive, adorable little personality” was removed from the endangered list last week.

That success represents the fastest ever recovery of an endangered species, as measured by the time that elapses from the day of its inclusion on the protected list to the day of its removal. So to what cause can we attribute this impressive success?

Regrettably, the species’ path to sustainability has been a bit brutal. The foxes were being hunted by golden eagles, carnivorous birds that were initially attracted to their habitat by tasty wild pigs. So wildlife officials slaughtered thousands of pigs, depriving the eagles of a significant food source and compelling the birds to search for prey elsewhere. The foxes then thrived once more.

But the environmental trail of death didn’t end there. The federal government also killed more than one hundred wild turkeys that bred freely on island turf, after their porcine land competitors were eliminated. And the elimination process occurred in a spectacular manner, with hunters hired “to track down the (animals) using helicopters with snipers, traps, dogs, and electronic collars.”

It all makes you wonder why we chose to support the foxes instead of the pigs and the turkeys, doesn’t it? And instead of the majestic eagles too, given that the elimination of their porcine diet staple undoubtedly led to the diminishment of their population. Perhaps the conservationists decided that the foxes deserve the land more because they inhabited it first, though their “adorable little personalities” surely didn’t hurt their cause.

Indeed, the entire affair raises a troubling ethical question about whether we have the right to play God with any animal species. After all, if we’re not about to eliminate the descendants of the European settlers of the American continents in order to return their lands to the Native American peoples who preceded them, why should we slaughter the innocent pigs and turkeys of California in order to return their territories to the island foxes?

Climate Change: Winning While Losing

Is it possible to win while losing?

Yes, of course it is. Think about Sylvester Stallone’s character Rocky Balboa, for instance. He actually lost the championship match in his very first film. But the loss established and enabled the character — not to mention the actor who played him, the Academic Award winning movie, and the sport of boxing itself — to repeatedly win throughout the forty year run of the Rocky franchise.

And how about this year’s Presidential primary season? Bernie Sanders may soon be ready to cede the Democratic Party nomination to Hillary Clinton, but the progressive movement that he spearheads will probably thrive for years to come. Likewise, even if Donald Trump loses the November election, many experts believe that he will permanently transform the Republican Party.

This “winning while losing” phenomenon occurs in the business world as well. Consider, for example, what happened last week to Chevron and Exxon Mobil, the two global energy giants that are headquartered in the United States. Shareholder activists at both firms lost very similar fights at their corporate annual meetings. But while losing their immediate battles, they may have managed to achieve a victory for the long term.

So what were they fighting about? According to MarketWatch, the activists wanted to require the firms to perform annual “stress tests to determine the risk that … climate change pose(s) to their business.” Just as global banks in the United States perform stress tests to address risks in the world’s economy, these individuals hoped to require global energy companies to conduct similar tests to address climate change factors.

Their proposals were voted down by shareholders, but Chevron’s proposal drew 41% support, and Exxon Mobil’s drew 38% support. Apparently, these represent the highest climate proposal voting totals in the history of the firms. In fact, according to Sustainable Brands, Chevron’s 38% support total occurred after their “investors overwhelmingly rejected the (same) proposal at last year’s meeting with a 96.8 percent “no” vote.”

An increase in support from 3.2% to approximately 41% in one year? Now that is a win, even though any vote total less than 50% is recorded in the corporate records as a loss.

Either way, there’s an important lesson to learn from these events. Whether or not you believe that climate change represents an existential threat to the global environment, the number of investors who express concerns about the topic seems to increase each year.

And let’s face it. A stress test is merely, by definition, a hypothetical exercise. So why wouldn’t any global energy company (or any other organization, for that matter) consider engaging in such an activity? If there is no harm in doing so, and if 40% of its investor base might approve of it, why not give it a try?

Sustainability And Net Present Value

How can an organization possibly know whether an investment in an economically, environmentally, or socially sustainable project is worthwhile? For instance, how can it place a value on a flex time policy that reduces rush hour traffic? Or on an energy policy that shifts from a carbon based fuel to a renewable source? Or on a charitable contribution that supports a local hospital?

That may have been the question that generated the most “buzz” among the attendees at last week’s First Annual Conference on Sustainability in the Big Apple. Co-sponsored by the New York Hedge Fund Roundtable and the New York State Society of CPAs, the Conference attracted financial professionals from around the world to ponder such weighty concerns.

It’s a very important consideration because, if organizations aren’t able to value such expenditures, they may easily decline to make them. And without such expenditures, we might find ourselves confronting numerous situations of economic decline, environmental crisis, and social unrest.

Many organizations are addressing this question by defining complex models and metrics for measurement purposes. The Global Reporting Initiative, for instance, has now issued its fourth generation (i.e. its G-4) of sustainability standards. And the Sustainability Accounting Standards Board is doing similar work for more than eighty industries throughout ten organizational sectors.

Sometimes, though, it can be helpful to rely on traditional approaches to solve contemporary problems. After all, even if such approaches cannot provide comprehensive solutions, they can offer the universal tools and techniques that we can utilize to address our challenges.

So, with this in mind, here is a question: can the simple Net Present Value method help us place values on sustainability expenditures? The NPV calculation was first formalized in Irving Fischer’s landmark 1907 text The Rate Of Interest. Although it is more than a century old, it still serves as the contemporary investment industry’s favorite valuation method.

Basically, NPV values an investment as the sum of the (discounted) future cash flows that can be attributed to it. Cash flows that occur later (i.e. in the relatively remote future) are discounted by a greater extent than cash flows that occur earlier (i.e. in the near future) in order to account for uncertainty and the ability of investors to accrue interest income over time.

So how would we apply this concept to investments in sustainability projects? Well, organizations that invest in flex time programs, renewable energy sources, and local hospitals would be helping people, societies, and organizations conserve and generate resources. The future value of such resources, discounted appropriately to the current year, would represent the Net Present Value of such expenditures.

Is there anything wrong with such an approach? Of course, reasonable people may raise all sorts of concerns about it. For instance, individuals with a deep sense of morality and religiosity may protest that this technique (perhaps disturbingly) expresses charitable impulses in purely financial terms.

But if we need to start somewhere, why not start with NPV, the most commonly utilized valuation metric of the past century of financial analysis? On the one hand, it may strike us as a somewhat simple option. But on the other hand, as Friar William of Ockham once taught us, it may be wise — as a general rule, or “razor” — to prefer simpler scientific constructs to more complex ones.