Depending on which sector classification system you choose there are around 11 industry sectors covering pretty much every conceivable product or service available across the global economy.
Within each of these, there are sub-groups which account for a further 68 industries and 157 sub-industries. A crude calculation would put the ratio of industry to sub-industries at around 1:14, which to anyone vaguely familiar with capturing ESG data, could lead to what might be called a ‘specificity nightmare’. Or, at the very least a specificity headache!
According to the UN Principles for Responsible Investment,1‘there is little consensus on the importance of environmental and social measures, as these can vary by sector’ and that ‘different ESG lenses should be applied to different business sectors’. How then, do you begin to ensure that ESG metrics are captured and reported fairly, openly and without bias, but in a way that reflects the true ESG picture? And, how do you work on resolving the friction between demand-side materiality and supply-side relevance that results in truly comparable datasets?
Sustainability is intrinsically rather complex and does not follow a cookie-cutter approach to measurement and reporting. This is a well-documented challenge that many bright minds are attempting to solve. We know that in effect what is one person’s carbon footprint, is another’s boot print and that means, unlike financial indicators, that we can’t yet rely on a single methodology, rating or framework for measuring and reporting ESG.
Various databases such as the Reporting Exchange helps organisations to understand their reporting obligations from a sectoral side. What is important is that we seek to evolve the way in which information is gathered, organised and reported. This will enable the maximum number of ESG consumers to optimise their decision-making based on contextualised information.
So, why are ESG factors becoming more important across different sectors? And what are the key markers which help differentiate them and thereby tell us what we have to do to make better sense of cross-sector information?
Materiality is the prevailing criteria for determining ESG performance as SASB’s Materiality Matrix helps to frame. But there are significant gaps in the process that are undermining decision making. For instance, your evaluation of a company may be based on risk, performance, bottom-line or value creation and each of these inevitably requires treating differently on a sectoral basis. Beyond that, it is important to look at the type and scale of different variables over time. This is what we refer to as ‘supply-side relevance’ and there exists a conflict between consumers of ESG data and the relevance of the information to that decision or set of decisions being provided by organisations (respondents).
Take the construction sector for example. In the basic sustainability assessment provided by the UK’s Supply Chain School, there is a question relating to an organisation’s knowledge of ‘design for climate change adaptation’. This is clearly very specific to the sector and an important KPI of long-term risk mitigation for capital providers. You’d be unlikely to find the same question when assessing technology firms but, too often, we wrap all of this under the blanket of ‘sustainability data’. Or, we attempt to shoehorn data into a classic ‘square peg, round hole’ situation.
Furthermore, there is not enough acknowledgment or measurement of management proficiencies on a sectoral level. At best, we tend to evaluate a company for its maturity, but little is done to aggregate information on a sector’s ability. The Task Force on Climate-related Financial Disclosures (TCFD) recommendations has taken a sectoral approach starting with oil and gas for a very good reason. The climate-related risks to this sector are clear as well as the percentage impact on the global climate. However, it’s also about the scale and readiness of resource to become more sustainable and the appetite for doing so throughout the sector.
Board executives at oil and gas companies are incentivised (as are most others) to secure their success through a combination of short-term success and long-term thinking. But how you apply both of those is contingent upon the sector you operate in. This is especially important (and should probably be weighted) for critical industries that allocate commodities and provide essential infrastructure or systems support (e.g. energy) and for which we need to have information on the sector’s ability to adopt best practice, share responsibilities and act collectively on sustainability. Isolation and disaggregation would not be helpful at this critical time.
Sectors have developed to help us organise, classify and most importantly contextualise different industries. It is paradoxical then, that we are attempting to work on a one-size-fits-all solution for ESG metrics and expect complex, long-term decisions to be made responsibly and diligently.
It also feeds deep frustrations in respondent organisations in supply chains for example, who are unable to disclose the complete picture of their sustainability achievements because the frameworks are too prescriptive or the metrics too narrow. It would not be right, of course, to gather endless amounts of information that does little to add ESG value. But it is equally evident that we must pursue a flexible approach that enables smarter ESG driven decisions.