Achieving sustainability objectives is a process of continuous improvement

Achieving sustainability objectives is a process of continuous improvement

Regulation is evolving and will require regular change and adaptation

Since the Paris Agreement in 2016 we’ve seen several sustainability initiatives develop around the world leading to clearly defined sustainability frameworks and regulation with the intention to accelerate the achievement of critical environmental sustainability goals. In Europe, one of the most proactive jurisdictions in terms of Sustainability, the EU Green Deal was launched. This has led to the introduction of the EU Taxonomy and Sustainable Finance Disclosure Regulation (SFDR) as well as the establishment of the EU Platform on Sustainability. Lots has happened in a short time, putting significant pressure on both corporations and financial services providers to comply with a wide range of regulatory requirements. And it’s not over yet.

First, what is clear from the fact that deadlines for the different EU regulations are spread over the next 2–4 years, is that the process for integrating sustainability into daily commercial activities is intended to be an ongoing process, not a one off event. It’s a moving target requiring continuous change to meet increased standards. Second, while Europe is acting quickly, several other global jurisdictions, such as China, Hong Kong, Singapore, and now even the U.S., are following suit. Sustainability… coming soon to all the markets near you!

In this context, sustainability goals should be addressed by companies and investment portfolios as a process of continuous improvement, not as a one time project. We all climbing the same steep learning curve towards sustainability. It’s a topic that is too complex to address all at once, even if we were all experts. This raises the question: How does a company achieve continuous sustainable improvement for the long term?

Simple Answer: Lather, Rinse, Repeat.

A strategy for continuous improvement — this is nothing new

We are not reinventing the wheel here. We’ve all been exposed to the recursive process of continuous improvement. In fact, the directions on a shampoo bottle: ‘Lather, Rinse Repeat’, have even become a standard idiom for this process, although perhaps not so ‘sustainable’ in the literal sense regarding shampoo. But it ultimately comes down to the standard management process.

• Measure, assess and prioritise the opportunity
• Set a strategy/plan to capitalize on the opportunity
• Execute the plan, measure and report the results
• Repeat — assess the results and revise the plan accordingly to make further improvements.

In this case, the opportunity is specific sustainability factors that a company or an investment portfolio can substantially influence.

Another critical success factor of this process is establishing the strategy at the top level first, then enabling the strategy to infiltrate the organization from the top down, from strategy to policy and management, to operations where the sustainable impacts can be tangibly measured, which brings us to the next point.

EU Taxonomy is Data and Data is the foundation

My colleagues and clients have heard me say it a million times: ‘If you can’t measure it, you can’t manage it’. And it’s true. Without standardized, comparable data, we can’t perform effective analysis or commit to critical decisions with confidence. The EU Taxonomy provides the framework that both establishes standardised, comparable data as well as a process for measuring and communicating results. The Taxonomy aligned data is the foundation for analysing and assessing the sustainability impact of a company’s economic activities, and for setting and achieving specific sustainability goals. When this is integrated with the overall business strategy, management and operations of an organization, it aligns the company’s sustainability impact with overall value creation.

Putting the Taxonomy into action to get the necessary standardised data, known as ‘Technical Screening’, is done in a three step process:

1. Categorise all of a company’s activities across Taxonomy eligible and non-eligible activities and assign a weight to each activity based on % of total revenue, CapEx or OpEx associated with the activity.
2. For each eligible activity, assess the company’s measurable sustainability factors against the thresholds for ‘substantial contribution’ defined by the Taxonomy.
3. Verify that the activity Does No Significant Harm to other Taxonomy defined sustainability factors that are not related to the company's activity and that Minimum Social Safeguards (MSS) set out by the OECD Guidelines on Multinational Enterprises and UN Guiding Principles on Business and Human Rights are met.

Step 2 of this process is the clear challenge. This is where quantifiable data that measures a company's sustainability impact needs to be captured and reported in a standardised format consistent with Taxonomy requirements. For example, if the activity of the company is the production of Hydrogen, the Taxonomy requires the company to measure the number of tons of carbon dioxide emitted for each ton of Hydrogen produced (tCO2e/tH). There are several data related challenges that could occur at this point:

• The data may not be available or systems may not be in place to create or capture the required data elements.
• Data elements may be available, but need to be transformed to align with the EUT standards, and they may be in non-centralised data silos
• Financial data may not be aligned with operational data to assess the tCO2e/tH in terms of and activity’s portion of revenue, CapEx or OpEx.

So before sustainability impacts can even be managed, it may be necessary invest time and effort in data management activities first. Data access, transformation and management is one of the biggest challenges to building the foundation required manage a company’s sustainability objectives.

Taxonomy aligned data drives continuous improvement by setting quantitative targets

With the data management foundation built, it will be clear where the company stands in achieving required sustainability targets. It will also know how it compares against its peers.  The market will know too. Whether a company is a leader or a laggard, the next logical step is to establish a plan to remain the market leader or catch the competition. The company now has the necessary data to make the decisions required to plan, execute and measure progress towards strategic sustainability objectives .

The Taxonomy aligned data will enable a company to identify specific components of eligible activities where quantifiable sustainability improvements can be made. And like any strategic development plan, a sustainability roadmap should be established to define the specific actions to be taken, the expected quantifiable results to be achieved and a timeline for execution. This sustainability roadmap can then be integrated and coordinated with other strategic initiatives across the company. Most importantly, the progress towards achieving the quantitative sustainability goals can be measured and communicated to the market and investors. By doing this, the Taxonomy data feeds the recursive ‘lather, rinse, repeat’ process for continuous improvement.

The Fountain Effect: Quantifiable sustainability at company level provides value to investors

Value creation from integrating sustainability into corporate strategy and policy has been documented in several recent studies. But what we are talking about here are the positive externalities for investors when a company provides quantifiable Taxonomy aligned data to the market. It now becomes much easier for investors to integrate sustainability factors into their core investment activities.

With the EU Taxonomy, investors and portfolio managers, including pensions and insurance funds will now have a standardised, comparable set of data for all investments that can be directly integrated into the standard investment process. From investment and due diligence to asset allocation and risk management, investors will have better information to support their decisions that they can tailor to their individual needs. For impact investors, it will be more feasible to determine the quantifiable sustainability impact on specific areas targeted by a portfolio. Another benefit is that Taxonomy aligned data from the company level enables financial market participants to meet the requirements of the SFDR.

Remember…

The EU sustainability regulations will be evolving over the coming years as we are all climbing an important learning curve regarding sustainability. Likewise, we should establish a mindset of continuous improvement, both to continually remain in line with regulation, but more importantly, to constantly increase the positive sustainability we can can achieve individually as well as collectively. So remember that the regulation to create Taxonomy aligned data is not the goal but rather a component to support the integration of sustainability factors into overall corporate strategy.

“The concern is that managers will be so focused on rushing ahead of this looming deadline, that they will not put in place sustainable processes and systems with the capability to respond to future evolution or expansion of mandatory ESG disclosures.”Andy Pitts-Tucker (managing director, Apex ESG Ratings & Advisory)

It is important to understand that integrating sustainability from the top down and incorporating sustainability into the business model of an organisation creates significant value for multiple stakeholders that would not be achieved by simply focusing on achieving compliance. And this will be the subject of one of my next articles.

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