It’s all about measurement...right?

Mike Penrose, Chair of the Investment Committee for Vala Capital’s Sustainable Growth EIS makes a strong case for rethinking the way in which businesses are screened in terms of their ESG and impact credentials

There is an old business adage that ‘you treasure what you measure’, and with sustainability and ESG measurements, there are certainly no shortages of metrics and measurements out there to choose from.

Having your own proprietary set of ESG indicators has become de rigeur for many major investment firms.

This is partly because being perceived as being on the right side of the sustainability debate is now an absolute necessity, but also, and definitely more importantly, because the money trickling down through the system from the big investment firms and pension funds are now conditional upon it.

From the pressure coming from initiatives such as Task force on Climate-related Financial Disclosures (TCFD), to the now (in)famous letter written by Larry Fink at the beginning of the year, the ability to quantify the impact your investments have on the climate, the environment, and on society are now an expectation, and no longer an exception.

MEASURING SUSTAINABILITY

Unfortunately, when it comes to measuring sustainability, nearly all the indices and methods of measurement out there tend to fall into one of two camps, neither of which we think really hits the mark.

Now forgive me for sounding a little obtuse, but surely ‘not actively being bad’ should not be an aspirational goal for most companies

The first is the standard ESG negative screening systems used by many more conventional firms and intelligence indices. These effectively measure data that can be scraped or easily requested, and make sure that organisations have the policies and procedures in place to ensure they are not actively or intentionally causing harm.

Now forgive me for sounding a little obtuse, but surely ‘not actively being bad’ should not be an aspirational goal for most companies. In fact, given what we know today, it should probably be the minimum price of entry for doing business in the modern world.

GOOD – OR JUST NOT BEING BAD?

Many companies today promote themselves as being good, using high ESG ratings on major index providers as evidence, when in truth they are just ‘not being bad’, and the only evidence they have to back up this claim are policies that attest to this, to the best of their knowledge, as long as you don’t look too far down the supply chain.

This is what led to the Boohoo scandal last year, where just prior to The Sunday Times expose on poor labour standards and below minimum wage compensation, the fast-fashion retailer was given an AA ESG rating by MSCI and had over 20 ESG and Ethical funds as investors.

Now I have no doubt that Boohoo probably had all the right policies in place. The problem was there was a gap between policy and practice, which is not picked up by negative screening. And because there are no consistent, and more importantly auditable standards available as to what makes a business ‘good’, companies can pretty much declare that policies exist, and unless they get caught out in the way BooHoo did on labour practices, and Volkswagen did on emissions, then having a binder full of ethical policies can pretty much guarantee you a high ESG score with many major measurement providers.

At the moment this approach values what is easy to measure, it doesn’t measure what we all value.

A ‘GOLD STANDARD’ BADGE?

The other ESG camp that exists is one that is both incredibly worthy and rather elitist or, dare I say, cultish. Born from worthy conversations amongst the already rich and successful in Davos and at events that surround the circus that is the UN General Assembly, there are ways of getting a ‘gold standard’ badge that proves you are indeed a good company.

The problem is that to get these stamps of approval, you must spend tens of thousands of pounds, and take years collecting extremely detailed and academically focussed data. There is no doubt that this approach is highly effective at evidencing that a company is ‘good’, the problem is that it is accessible only to an elite few who were arguably already on a path to being sustainable from their outset. It is more of a form of validation for the very best (who can afford it) than an incentivised journey that is accessible to all who have the right intentions.

These badges of honour are beyond the price range and capacity of the majority of small to medium-sized enterprises, who might have the intention of being not just ‘not bad’, but to do the maximum they can within the confines of their industry and business model.

A NEW PARADIGM

If, however, everyone was incentivised to do what they can, with what they have, and ensured that a quantifiable and measurable sense of purpose, as well as profit, was built into their business model from the very outset, then the scale of change that is achievable would inevitably aggregate to create the type of economy we need to see if we are to truly address the social, environmental and climate challenges we know we all face.

Democratising sustainability must be the next investment catalyst if as investors we are truly serious about creating meaningful change and reaching the 2030 Global Goals.

It shouldn’t be about an elite few feeling worthy, and the rest trying to prove they are just ‘not bad’. It should be a democratised, affordable, and accessible process that is available to all, from the largest multinationals to the smallest start-ups. And it can be if a few simple conditions are met.

The first is that we agree on a common set of indicators that measure intent and purpose in the early stages of a business, followed by outcomes as they scale. We all know how important a company’s culture can be and trying to change that once scale has been achieved is incredibly tricky. It is far better to ensure that the intent to make the right decisions and implement the right practices is established from the outset, than get a team of very expensive ‘experts’ to come in once business practices have been established to tell you how they can be improved or, worse, undone.

The second is that the practices that are measured are based on ease of application and not academic rigour. The classic example for us is the question in one goldstandard certification scheme that asks if you “know the carbon footprint of the food served in your canteen or to your clients or employees”. As opposed to checking and measuring if the company is taking the simple steps of ‘Local and Seasonal Sourcing’ and reducing the quantity but increasing the quality of the high carbon foods such as red meat that it serves.

Particularly for small companies, we think helping them develop sustainable practices is far more important than imposing unduly burdensome measurements and processes.

Lastly, investors, particularly early-stage investors should make easy and applicable sustainability indicators not only a part of how they decide on which investments to make, but part of how they measure performance over the investment period, from seed to Series A, through to exit. If every VC and PE firm made participation in a programme that allowed even the smallest firms to set out with the right intent, and measure their progress as they scale, the net end-result would be enormous, and we would reach that anticipated sustainability tipping point far quicker than is currently predicted.

Democratising sustainability must be the next investment catalyst if as investors we are truly serious about creating meaningful change and reaching the 2030 Global Goals. As the current dichotomy of near meaningless negative screening versus worthy but unobtainable certification is just not working.

ABOUT MIKE PENROSE

Mike is the co-founder of leading sustainability consulting firm, The Sustainability Group, and is Chair of the Investment Committee for Vala Capital’s Sustainable Growth EIS. He was an adviser on the development of the UN’s 17 Sustainable Development Goals and formerly the Executive Director at UNICEF UK.