Has ESG become a bad word?
It is becoming clear that ESG is not sufficient to assess the true impact of companies. However, it is possible to go beyond the ESG model, thanks to the larger volume of data collected within the framework of impact analysis.
Contrary to popular belief, ESG was never designed to measure sustainability.
Rather, ESG is a measure of financial risk and of the materiality of E (Environment), S (Society) and G (Governance) factors for a company's financial performance. Although IFRS1 and the ISSB2 defend the single materiality approach (ESG), Europe is taking the lead by adopting the double materiality approach, that is also taking into account the impacts of a company's activities on E, S and G. Not only does this make sense ethically speaking, but these impacts will also become financially material over the long term.
Moreover, E, S and G are inextricably linked, and considering only one letter (as proposed by The Economist) shows an inability to grasp the complexity of the impacts generated. The same is true for the United Nations Sustainable Development Goals (UN SDGs).
The differences between impact and ESG
Sustainable investment has become an overused term that encompasses several investment strategies: exclusionary, ESG-based, themed or impact-oriented.
But how do you define impact investing? Impact is the result of a measurable change in the life of a stakeholder (a group of people such as customers, suppliers, communities, etc. or even the planet) over time. It can be positive or negative, intentional or unintentional.
An outcome is the level of well-being experienced by a stakeholder as a result of an action or event. Impact management is the process of identifying the negative and positive impacts of a company on its stakeholders.
The fact that ESG agencies claim to measure "impact" misleads many investors who end up making themed investments, founded on an ESG-based approach.
From double materiality to single materiality
This concept is at the heart of the debate, given the divide between Europe and America. Materiality is the process of identifying whether an issue is material to a given entity. If an issue has an impact on the valuation of a company, it can be categorised as financially material. If it has an impact on stakeholders, it can be considered material for them. The double materiality approach takes both dimensions into account, whereas the single materiality approach only considers the former.
Why is this important? Single materiality (ESG) advocates argue that the role of financial institutions is to ensure the prosperity of their clients, while those for double materiality argue that we need to broaden our scope to truly save our planet. The debate becomes interesting when the former argue that stakeholders' problems are financially material in the long run, and therefore should only be considered under the lens of the single materiality. In theory this works, but in practice it does not, as a majority of ESG analyses use SASB3 standards that do not incorporate this long-term view. As a result, investors using the single materiality approach "risk missing risks" not only material for stakeholders but also for themselves in the long run.
Going beyond ESG
ESG, by design, is insufficient to achieve the SDGs. We need to contextualise the data with a holistic approach, based on the double materiality approach and covering the full range of impacts. Impact assessment provides an additional layer of risk management and a "best in class" vision of alignment with the SDGs. A rigorous, anti-washing methodology to obtain credible data is essential to support sustainability claims.
Basing one's sustainable investment strategy on ESG data and single materiality in 2022 is the equivalent of an investment strategy based solely on a company's assets and liabilities in the 1920s, and not on a complete view of its financial balance sheet here.
impak was born from the idea that ESG as we know it today is not an adequate response to the major problems facing the world in which we live. As such, impak works to plug the gaps in ESG and to reflect the reality of the impacts of a company’s activities on society and on the environment.
impak’s methodology distinguishes positive impacts from the mitigation of negative impacts and is founded on international standards such as the 17 UN SDGs and the Impact Management Project (IMP).
Through its solution, impak’s mission is to help investors to make more sustainable decisions by providing them with a suite of impact data.
Founded in 2017, impak serves clients such as Societe Generale, HSBC, Franklin Templeton and Vega IM (a Natixis subsidiary), and is backed by Institutional investors including Societe Generale Ventures and Altalurra (a US-based impact VC fund). impak’s team consists of c. 125 employees (and growing), 85 of them expert impact analysts4.
Boris Couteaux, Vice President, Business and Product Development Impak Analytics
1International Financial Reporting Standards
2International Sustainability Standards Board
3Sustainability Accounting Standards Board
4Impak internal source, as of December 2022