The two most important words in finance and business generally at the present time are ‘sustainability’ and ‘impact’. Businesses are expected to operate in a sustainable manner (as part of their contribution to reducing climate change and meeting a range of ESG measures). Finance, on the other hand, whilst interested in sustainability, increasingly requires businesses to demonstrate their impact.
The problem here (or should we say the challenge?) is that sustainability and impact are not the same thing. Sustainability means being able to use a resource (often to produce a specific product) on an indefinite basis without ever depleting the resource (although this does get more complicated when supply chains are considered). Impact, on the other hand, means making a difference, it involves change.
So, it is possible that acting sustainably also means having an impact. It is also possible to act sustainably without having any discernible positive impact (although acting sustainably presumably means not having a negative impact on a range of ESG measures). It is also entirely possible to have an impact, both positive and negative, without acting in any way sustainably.
The trick, of course, for businesses seeking finance and for businesses and financiers concerned with achieving positive ESG outcomes is to hit the sweet spot where sustainability and impact overlap. The problem here (or, once again, the challenge) is measuring and demonstrating either sustainability or impact or both.
There is currently a huge amount of energy and thought (and quite a bit of heated debate) going into attempts to resolve the question (indeed, the many questions) about how best to measure and demonstrate both sustainability and impact. Many companies, although not all, are using KPIs mostly derived from the UN’s Sustainable Development Goals to show sustainability and impact in a highly individualised manner. Indeed, this is the approach adopted by the businesses we at Sustainable Capital are working with. Other companies, although again not all, make use of one of the many ESG rating agencies (or one of the more specialist ESG rating agencies approved as ‘second party opinion’ providers) to demonstrate sustainability and impact.
The problem with the above approach is, of course, that it is highly individualistic and idiosyncratic as each company chooses its own KPIs and it is well known that ratings agencies give divergent ratings. The difficulty we have with this is that people do not like inconsistency. Humans are hard wired to look for patterns and we find chaos cognitively uncomfortable. It is this feeling that is driving the search for consistency and fuelling the fire of (ever more detailed and complex) regulation.
The problem with this problem is that we are setting ourselves on a path of searching for the Holy Grail. How can we achieve order and consistency in ESG ratings (particularly those focused on sustainability and impact) when there is so much about sustainability and impact that lies outwith human knowledge? How can we achieve order and consistency when the businesses that are the target of regulation are almost infinitely diverse? Regulation, therefore, might just be a chimera.
Regulation is also a weak motivator of behaviour change. There are always ways for clever people to game regulation (they are already doing it) and putting our faith in regulation to achieve the changes that are absolutely necessary to secure a positive future for humankind and the planet is demonstrably misplaced. Putting significant efforts into regulation may also be a massive distraction from the task at hand.
It may well be that best way of achieving and demonstrating sustainability and impact is to allow a thousand flowers to bloom.