Money, Sustainability Reporting, and Real Impact: The Pursuit of Convergence

As I examine the findings of a 2022 survey on ESG Regulatory Reporting in Asset Management, and juxtapose these insights with the most recent developments in the European Sustainability Reporting Standards (ESRS) approved by the EU on July 31, my cognitive gears have connected certain dots. These moments of reflection unfolded before me a tapestry interlaced with the stark realities of power imbalances in our world, the intricate maze of sustainability and impact reporting, and my own analytical ponderings on the opportune instances to exhibit adaptability or to resolutely demand alignment with the urgent imperatives of our climate and biodiversity dilemma.

I invite you to embark on this journey with me, commencing with the initial shockwave.

The shockwave

Within the realm of global finance, there emerge 22 industry heavyweights, collectively stewarding a colossal $37 trillion in Assets under Management (AUM). This staggering figure translates into a remarkable 33% sway on the market. These titans also gleam among their peers as they work towards being well-perceived in the realm of Environmental, Social, and Governance (ESG). Strikingly, a resounding 77% of these corporate giants harbour aspirations to secure their status as archetypes of ESG leadership, staging themselves as embracing the tenets of sustainability and responsibility. This apparent commitment finds its ultimate expression in that a substantial 86% of them express adherence to the Sustainable Finance Disclosure Regulation (SFDR) standards.

However, the labyrinthine complexities inherent to ESG integration unveil a multifaceted challenge. While 60% of these influential entities have successfully articulated the scope of activities and behaviours deemed sustainable, a mere 45% have explicitly drawn the line on what constitutes UNSUSTAINABILITY. This gaping fissure underscores a larger industry-wide enigma: how to precisely demarcate the boundaries of a genuinely sustainable investment. The perpetual struggle to etch lucid definitions introduces layers of complexity into the quest for authentic sustainability.

Adding to this intricate dance is the pursuit of high EU taxonomy alignment, a trek guided by thorough regulatory benchmarks. The EU taxonomy, with its focus on environmental objectives, recognisably defines "highly sustainable funds". It imposes stern criteria for categorizing activities as substantial contributors, all while demanding healthy safeguards against inflicting significant harm. In a not-so-surprising revelation, the industry openly acknowledges the steep climb towards substantial alignment with these regulations, with expectations of an average taxonomy alignment ranging between an insufficient 0% to 5%.

The ramifications of this ungenerous taxonomy alignment are profound, as it signals a potential uphill battle for asset managers in crafting products that can claim substantial environmental merit in the discerning eyes of regulatory authorities and, more importantly, the average investor. This looming uncertainty casts a blanket over the potential of these products to genuinely foster a positive environmental impact, raising pertinent questions among vigilant investors.

Shifting focus to the ESRS

Now, let's turn our gaze to the contours of the new European Sustainability Reporting Standards (ESRS), where we detect an active effort to intermingle financial materiality with impact:

The ESRS unfolds a comprehensive definition of materiality that expands previous ones from its predecessors in scope and nuance. In essence, it accentuates the pivotal principles that shape its approach:

• Materiality is presented as inextricably linked with an organization's ECONOMIC, environmental, and social footprints.
• Material topics confirm their prominence, as they exert substantial influence on stakeholder decisions and serve as mirrors reflecting an organization's IMPACT.
• The concept of materiality is elevated in importance, spanning the realms of both financial reporting and sustainability reporting.
• The horizon of materiality extends to both internal and external factors, entwined with international standards and agreements, with a spotlight on relevant stakeholders, forming the multifaceted fabric of its assessment.
• The ESRS revitalises the concept of "significant impacts," spotlighting these as concerns that command the discerning gaze of expert communities as an especially relevant stakeholder group.

In the context of reporting, the ESRS primarily focuses on materiality's essence and significance. It reverberates with the concept of a dual materiality framework, influencing both financial and sustainability reporting. The reinforcement of "significant impacts" is central, recognizing them as subjects of concern championed by expert communities. This addition aims to resolve the conundrum often encountered by organizations, where stakeholder input often results in a cacophony of requests rather than clear material topics, although it also offers the risk of exclusion to the analysis. By amplifying the role of experts and expert communities, the ESRS seeks to strike an equilibrium, emphasising the reputation of these critical concerns.

Furthermore, the ESRS emphasizes the organization's impact on the economy, environment, and society in conjunction with the existing financial materiality framework. This concept (while not exactly novel) operates in congruence with international standards and agreements, affirming their essential role in materiality assessment. It also acknowledges the influence wielded by organizations on entities upstream and downstream of the value chain, extending the dimension to encompass societal expectations.

In the swamp of understanding materiality and distinguishing between financial risks & opportunities and impact - an illustrative example:

In a FINANCIAL materiality analysis, the spotlight falls squarely on deciphering the significance of environmental and social risks and opportunities in the realm of their financial ramifications. Consider an energy company contemplating a shift to renewable energy sources. Within this analysis, the company weighs factors such as the costs involved in transitioning from fossil fuels to renewables, the potential reduction in operational expenses, and the impact on revenue in response to shifting energy demands. This analysis undertakes to answer questions such as:

• How much will the transition cost or save the company?
• Will it lead to enhanced profitability?
• What will be its implications for shareholder value and investor attraction?

In contrast, an IMPACT materiality analysis takes a more panoramic approach, venturing beyond financial metrics to consider broader societal, environmental, and stakeholder impacts. In the case of the same energy company embarking on an impact materiality analysis, the focus shifts to evaluating the broader implications of transitioning to renewables:

• Environmental Impact: This spans assessments of reduced carbon emissions, the preservation of ecosystems, and contributions to climate change mitigation.
• Social Impact: It encompasses considerations of local community effects, such as job creation in the renewable energy sector, improved air quality near power plants, and overall public health benefits.
• Stakeholder Impact: This dimension assesses how the transition affects an array of stakeholders, going beyond financial stakeholders to encompass employees, customers, investors, and the community, including local economic changes. This often involves engaging with these stakeholders to gather their perspectives on the transition.
• Long-Term Sustainability: The impact materiality analysis extends to the long-term sustainability of the business. It considers factors such as reputation, the ability to attract and retain talent, and resilience in the face of regulatory changes and market shifts.

In essence, while the financial materiality analysis primarily scrutinizes the direct financial implications of environmental and social risks and opportunities, the impact materiality analysis adopts a broader vantage point. It reveals a tapestry that encapsulates multifaceted organizational responsibilities, acknowledging its profound influence on a diverse array of stakeholders.

Now, as we consider the connections forged by these developments, one question emerges with distinction: Can the profound clarifications introduced by ESRS in materiality empower Asset Managers to discern the nuances of unsustainable behaviour, thus expediting transformative shifts within financial markets?

While I refrain from casting definitive bets, I am eager to harness the potential of ESRS to enlighten my clients across the financial sector and beyond. 

To carry out this mission effectively, I have enriched my initial analysis of ESRS with further insights:

The endorsement of the European Sustainability Reporting Standards (ESRS) in Europe on July 31, 2023, emerges as a laudable stride towards the standardization of sustainability reporting practices and the enhancement of transparency across diverse industries. The inclusion of alignment with the Corporate Sustainability Reporting Directive (CSRD) standards and the phased implementation strategy is indicative of a commitment to embracing global most reasonable practices in sustainability reporting. Moreover, this measured approach underlines the importance of enabling organizations to transition gradually, reducing the potential for disruptions, and cultivating the adoption of these pivotal sustainability standards.

A notable advantage of ESRS is the latitude it affords organizations in employing various methodologies while upholding the core concept, a practical and adaptable approach. This flexibility empowers companies to select technical methods that best suit their unique operations and circumstances. It's an acknowledgement that organizations come in diverse sizes, complexities, and industries and that a uniform, one-size-fits-all approach to the intricacies may prove impractical and less effective. Thus, the flexibility in method selection can significantly boost the adoption of ESRS across a wide spectrum of organizations and industries.

Furthermore, the ESRS incorporates some voluntary disclosures. The recognition of voluntary disclosures stems from a keen understanding that organizations may grapple with distinctive challenges or constraints when gathering specific types of data. For instance, smaller entities might find it resource-intensive to amass comprehensive data across all facets of sustainability. Allowing for voluntary disclosures serves as a catalyst, encouraging these organizations to initiate their sustainability reporting journey. However, it's of paramount importance to emphasise the need for voluntary disclosures to be coupled with sound justification that authenticates their bearing. The principle is clear: companies should opt for voluntary disclosure only when reporting on a particular aspect is genuinely unfeasible or lacks meaningful substance. This safeguards the credibility of voluntary disclosures and ensures that organizations don't sidestep critical sustainability topics without a valid reason.

ESRS also finds itself under the microscope of critical evaluation. One notable concern centres around the absence of climate materiality as a universally mandatory facet of reporting. This omission becomes particularly disquieting in the context of the ongoing climate crisis. Our world is currently experiencing the distressing realities of global warming, with temperatures soaring between 1.2 to 1.4 degrees Celsius globally. Some regions, such as Switzerland, have already reached temperatures exceeding pre-industrial levels by 2.2 to 2.5 degrees Celsius. Moreover, we stand at a crossroads, having breached six out of the nine planetary boundaries, signalling an imminent environmental devastation. To permit companies to circumvent climate materiality as a mandatory reporting aspect seems, in the eyes of many, out of sync with the emergency of addressing climate change and its grievous consequences. It's the belief of many that comprehensive climate reporting should be an obligatory requirement for all organizations, as it intrinsically correlates with the well-being of our planet and society.

A prudent stipulation for astute readers to bear in mind: while the financial and asset management domain adheres to its specialized sector standards, the ESRS's broader application across all companies has the potential to serve as a catalyst for fostering convergence.

Bringing it back to a sounding conclusion:

As we cross the intricate landscapes of data and the realities of sustainability impact deliveries within asset management, while examining the recently ratified European Sustainability Reporting Standards (ESRS), a multi-layered narrative uncovers. It interlaces an allegory convolutedly contradictory with the biggest sustainability aspirations and complexities, offering reflective insights into the financial world's pursuit of authenticity. ESRS, extending its reach across all sectors, marks a creditable milestone, introducing standardization and adaptability to the sustainability reporting landscape. This development grants organizations the much-needed clarity to discern what truly holds significance and materiality and the flexibility required to navigate the nuanced realm of sustainable practices. The potential for transformative change in financial markets, as well as other sectors, is evident. However, the absence of mandatory climate materiality reporting contradicts and emphasizes the urgent necessity of facing our climate crisis with unwavering urgency. In this intricate narrative, amid the complexities and realities that intertwine, ESRS emerges as a direction to a longer road that may propel the business mainstream toward a future characterized by transparency, adaptability, and, above all, the overarching aspiration of a more sustainable world.

This blog post is authored by Karime Brecailo Abib from AdvantiKA GmbH - Responsible Results . Explore our services, schedule online appointments, and discover more about our IDG Swiss Business Fit Hub. You can find our credentials through the testimonials from our valued customers here.

The information sources for this post include:

1. ESG Regulatory Reporting Asset Management Survey 2022 by EY.
2. European Sustainability Reporting Standards Presentation to EFRAG SRB of 14 July 2023.
3. Draft ESRS - Sustainability Reporting Standards from November 2022.
4. GRI News - Final Adoption of ESRS a Game Changer for Mandatory Reporting
5. EFRAG public statement
6. Multiple commentary articles from various sources discussing the ESRS and its adoption by the European Commission EC on July 31, 2023.