This year, the US Business Roundtable redefined their ‘Purpose Statement of a Corporation’ for companies as serving not only the financial interest of shareholders, but stakeholders as a whole.
For decades, the overriding principle has been shareholder primacy. This update, signed by 181 CEOs, highlights a shift to modern standards of corporate governance where sustainability is core.
It represents a notable step in a jurisdiction where the change is led by business and society rather than political leadership.
In Europe, the principle of considering sustainability impact and risks when investing is being enshrined in law.
The Regulation on sustainability-related disclosures in the financial services sector, for the first time explicitly takes the principle of considering society and the environment as part of the fiduciary duty of investment intermediaries.
With these new rules, large financial institutions will be responsible for assessing possible adverse environmental and societal impacts before investing as part of their corporate governance and due diligence.
They also need to inform any end investors buying a financial product. Considering sustainability indicators is essential for companies’ long-term value creation.
According to the Sustainable Accounting Standards Board (SASB), as much as 80 percent of market capitalisation in many industries comes from intangible assets including brand value, customer relationships, human capital and - increasingly - environmental and social factors.
It is about time that company boards and the highest levels of management realise they need to take environmental, social and corporate governance (ESG) indicators as an integral part of all operations, risk management and strategic planning.
Sustainability is both a risk and an opportunity. The forthcoming EU taxonomy will set criteria for determining the sustainability of an economic activity and hence of a financial product.
Together with the Disclosure Regulation, these should be viewed as essential company governance tools for making informed decisions on the operating environment and risks.
Full information requires full taxonomy; when establishing criteria and thresholds for what is sustainable, harmonised indicators are normally taken as the foundation for new standards to ensure objective, science-based metrics covering the lifecycle of a financial product.
Rather than a binary distinction between green or non-green activities, a more useful approach is a taxonomy capable of fully capturing the environmental impact.
Green products cover a fraction of financial markets; rather than a green-only taxonomy, a more useful toolkit for investors would cover all economic activities.
Importantly for companies, a scaled taxonomy could recognise transitional, incremental steps towards sustainability. For investors, it would allow them to monitor the progress of investee companies.
"If the actions we need to take seem difficult today, tomorrow they will be harder still"
Just as sustainability affects all sectors, the EU taxonomy needs to be developed for all market participants.
While sustainability relates to different financial products and asset classes to varying degrees, the tools for what is measured, and how, cannot differ between asset management and banking sectors.
Another challenge is environmental and financial languages. A key task for the new Commission will be establishing harmonised sustainability indicators both readily usable by the investment community and readily reportable by corporates.
To use sustainability data, investors need accounting models that can help them calculate return on investment, sustainability-weighted risks, discount models, profitability, etc.
In other words, integrated accounting. Sustainability information is not separate from financial; integrated reporting and accounting will be part of company boards’ and investors’ daily decision-making.
The long-overdue revision of the Accounting Directive is the right place to address this. The EU is responsible for leading the development of sustainable accounting standards, industry-specific benchmarks and corporate reporting.
Furthermore, effective standards should be global. The future update of the Sustainable Finance Action Plan should advocate sustainability standards within the framework of the IFRS and the IASB, paving the way for global standards.
In fact, our approach to accounting itself must renovate, moving from linear forecasting to backcasting - defining where we want to be and then identifying the policies and actions that take us there.
The approach has to be fit for purpose. An exponentially-deteriorating climate and biodiversity emergencies require new ways of planning and forecasting.
Instead of linear approaches or planting a few more trees to capture carbon, our actions need to be equally exponential to match the challenge.
This applies to companies, investors and legislators alike; sustainable finance goes beyond the Capital Markets Union, cutting across all financial services and industries.
Rather than merely talking about how we improve sustainability impact or reduce our negative footprint today, we need to assess whether the trajectory is on a sustainable path.
If the actions we need to take seem difficult today, tomorrow they will be harder still.