Sustainability reporting is a dry topic, so try to hang in there for at least the first three paragraphs, even if your business is primarily a service business and you cannot conceive that sustainability reporting has any relevance. (Note to file: You probably are mistaken.)
We always have been skeptical about most of the sustainability and other Environmental, Sustainability and Governance reporting initiatives. While well-meaning, virtually all ESG initiatives are run by groups that have an agenda other than the protection of the financial interests of investors, and some, such as the Sustainability Accounting Standards Board, produce rules that do not have the appropriate technical or procedural underpinnings. Without belaboring this issue too much, but just as an example, SASB's rules largely are the product of Google searches to determine what "sustainability" issues are of the most interest, with a ranking of importance by groups of volunteers, many of whom have little or no discernible expertise in the applicable industry or underlying science. It was particularly troubling that last month SASB announced that it no longer was seeking to follow ANSI rule-making standards, which we view as an admission that its standards, at least with respect to the procedures followed in their development, fall too far short of the mark in order for them to easily repair their shortcomings.
Against this backdrop, two recent reports caught our eye. First was McKinsey & Company's March 2017 Interview entitled "When sustainability becomes a factor in valuation." Then just last week Goldman Sachs released "The Portfolio Manager's Guide to the ESG Revolution." These build on some prior work, such as "Corporate Sustainability: First Evidence of Materiality," a study published by the Harvard Business School in 2015. There are a number of other, similar analyses as well.
The Goldman study is particularly interesting. It considers sustainability across all industries and concludes that there is a strong correlation between published sustainability metrics and higher total shareholder return. For some industries the sustainability measures considered are obvious, such as greenhouse gas emissions. For others, such as financial institutions and technology firms, the sustainability measures are less obvious, such as employee turnover and employee training and development practices. Of importance, however, is that Goldman found, regardless of industry, that where companies performed poorly under the metrics that Goldman considered – generally falling into the lowest quartile – their total return underperformed significantly as well.
What Goldman also determined is that soft disclosures, such as disclosures of sustainability policies without tangible metrics or goals, generally correlated to underperformance. This practice – more specifically the practice of publishing lengthy feel-good information without much substance – is known as "greenwashing." Good results correlated to favorable performance on a handful of metrics that Goldman determined were important.
What does this mean? Increasingly investors, and not just socially aligned investors, are going to insist on knowing more about companies' sustainability initiatives and metrics, and this is going to be true whether the company is an oil refiner, credit card processor, auto manufacturer or insurance company. While Goldman's analysis did not penalize companies that made no sustainability disclosures, as sustainability disclosures increase (which we do not expect to take that long), we expect the non-disclosing companies to be penalized in their valuations.
In turn, this suggests that companies should actively consider what metrics are appropriate given their business. One industry, the electric utility industry, is working with its national trade association to develop a common set of metrics, and we believe that trade associations may be a good resource. Other companies may find guidance from Goldman's work or the work of GRI, SASB or one of the many other self-appointed standard setters. To us, however, it is critically important that companies identify technically valid metrics that truly fit their industry and not simply adopt metrics that some organization is promoting for its own self-interested purposes.
We continue to be uncomfortable publishing sustainability metrics in SEC filings. It would be exceptionally rare for disclosure to be required in an SEC filing – in a description of the business, MD&A or otherwise – and we do not want to suggest that sustainability metrics are material (for SEC purposes) through their inclusion. This would have liability implications, which concerns us given the lack of technical maturity with most of the standards. We would prefer that sustainability metrics be disclosed in a separate report or website section with appropriate (and abundant) qualifications.
There are a growing number of businesses and other organizations that produce and publish sustainability ratings. Some use publicly available data, while others solicit data from the companies that they want to analyze. Some of these solicitations are easy to respond to, but others are not, and we recently heard that a major consumer products company had estimated that it was going to cost it almost $100,000 in time to respond to a request that it had received. Companies will need to prioritize the resources that they devote to this area and will need to recognize that they cannot respond fully to every request that they receive.
Bottom line: We see sustainability reporting as growing significantly over the next four or five years and believe that companies are best served by controlling their own destiny in this area.
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