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January 28, 2010
Report Links Effective Corporate Sustainability Reporting to Presence of Key Performance Indicators
    by Robert Kropp

Based on his survey of prominent investors and analysts, Dr. Axel Hesse of Sustainable Development Management develops key performance indicators for sustainability that should be included in corporate reporting.


Mandatory corporate reporting of environmental, social, and governance (ESG) factors has been a priority for sustainable investors for many years, and never more so than since the onset of the global financial crisis.

As Professor Mervyn King, Chair of the Board of Directors at the Global Reporting Initiative (GRI), and Chair of the UN Global Corporate Governance Committee, stated in March 2009, “As we seek to rebuild our economic system following the financial crisis, transparency on economic, social and governance issues from our companies must be paramount. Regulators, financial markets, companies and civil society will need comprehensive information on which to assess strategic risks and opportunities.”

In Germany, Dr. Axel Hesse, whose company, Sustainable Development Management (SD-M), provides sustainable management consulting to business and investors, has been fine-tuning for years the concept of what factors of corporate reporting are of the greatest importance to investors and analysts. His recently published copyrighted report, SD-KPI Standard 2010-2014, provides minimum reporting standards for sustainability information in the annual reports of 68 industries.

Hesse’s involvement with sustainability issues and socially responsible investment goes back many years. He told SocialFunds.com, “We licensed the Dow Jones Sustainability Index (DJSI) in 1999, right after it was established. HypoVereinsbank, with whom I worked with then, issued an index certificate.”

Increasing attention to sustainability issues led to the adoption by the European Union (EU) in 2003 of a regulation mandating corporate reporting on environmental, social, and governance issues, which Hesse quotes in his report: “To the extent necessary for an understanding of the company’s development, performance or position, the analysis shall include both financial and, where appropriate, non-financial key performance indicators relevant to the particular business, including information relating to environmental and employee matters.”

Hesse said, “I was very enthusiastic about such developments, but over the years I found that the DJSI might not lead to bringing capital to the most sustainable companies, and the EU regulation that large companies have to disclose key ESG topics was open to interpretation by those companies.”

As an example, Hesse referred to the status of BMW as a sustainability leader in the DJSI. “Each year, BMW is the industry sector leader. Does this mean that if I invest in BMW I’ll be directing my capital toward a more sustainable world? If you realize that BMW has one of the worst absolute values for the key performance indicator (KPI) of fleet consumption, you get the idea that there might be something wrong with the Dow Jones concept.”

In fact, as Hesse’s report states, “The Federation of European Accountants (FEE) declared at the end of 2008 that sustainable development (SD) information in annual reports had to be improved.” Furthermore, in a 2008 study undertaken on behalf of ASSET4 and the German Federal Environment Ministry, Hess found that “Leading institutional investors also evaluated this quality of reporting as insufficient.”

In the years following the EU mandate on corporate sustainability reporting, Hesse developed his concept of Sustainable Development Key Performance Indicators (SD-KPIs) in order to determine what information on sustainability was relevant, and therefore mandatory, for companies to report. In a 2006 report, Hesse asked companies to provide the three SD-KPIs that are most important for their respective industries. He found that their responses were often tailored to political expectations.

Hesse said, “When I asked German companies what key performance indicators for sustainability were relevant, their answers were not really helpful. I found that if a company has difficulty with a particular KPI, then they would not address it in their answers to my survey.”

“One example is the automobile industry, which is quite large here in Germany,” Hesse continued. “The first KPI for that industry is fleet consumption of fuel. In the EU and now in the US as well, fleet consumption is subject to regulation. The companies think it is a political question, and they do not want to report any more of their performance than necessary.”

According to the companies that Hesse surveyed, their most important publication is the annual report, which they said is targeted to investors and analysts.

So, for a 2007 report, “I asked investors and analysts about KPIs,” Hesse said.

The information Hesse received from investors and analysts in 2007 was greatly expanded for his most recent report, resulting in three SD-KPIs for 68 industries. The 13 investors and analysts surveyed by Hesse influence sustainable assets of over $2.8 trillion, and include EIRIS, RiskMetrics Group, and Sustainalytics.

Asked how they evaluated a good reporting of SD-KPIs in corporate annual reports, Hesse’s respondents prioritized quantitative indications, whether SD-KPIs are reported at all, trend analysis, and benchmarking.

Referring to the responses, Hesse said, “It really is industry-specific work, but what I did in the report’s summary was compile the responses to look at the KPIs on a sector-overlapping basis.”

The three SD-KPIs most often identified on a sector-overlapping basis were greenhouse gas (GHG) efficiency of production, green product design, and audit coverage of International Labor Organization (ILO) labor standards, both in-house and in corporate supply chains.

Industry-specific examples of SD-KPIs identified as important by the respondents include GHG emissions, hazardous waste, and health and safety in the energy equipment and services sector. In the banking sector, the SD-KPIs most often identified were integration of risks and opportunities in lending, risk management pertaining to remuneration and other issues, and customer satisfaction.

Hesse told SocialFunds.com that he believes the current EU regulations are sufficient, as long as companies are directed to report information that is most relevant for investors and analysts. Furthermore, with yesterday’s decision by the Securities and Exchange Commission (SEC) to issue guidance on disclosure of climate change risks and opportunities at publicly traded companies, “Maybe this will provide a good starting point for the SEC in considering what companies should report,” he said.

While the GRI includes KPIs in its corporate reporting guidance, Hesse noted that “There are many KPIs in the GRI, but many are not sector-specific. You have to be sure that you’re really addressing the most important questions. Sometimes less is more.”

“I work with investors to help guide capital toward better solutions, to come to a more sustainable world,” Hesse concluded. “We want our investments to lead to a more sustainable world and create outperformance effects.”

 

 
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