Social issues are harder to measure
The lack of clear measures for social issues makes the reallocation of capital to sustainable projects more difficult, explains Hans Beyer, chief sustainable officer, Skandinaviska Enskilda Banken.
Sustainable finance has made substantial progress since COP21 in 2015, establishing standards for environmental efforts and introducing fiduciary responsibilities for countries and organisations. Third-party verification, measurability and the science-based ‘truths’ from the Intergovernmental Panel on Climate Change are three of the most important features enabling massive capital re-allocation for climate change mitigation. The ability of society to leverage on private capital engagement is dependent on trustworthy, verifiable, auditable contributions where traceability of the effect of allocated capital is key.
When we move into social considerations (the S in ESG), the definitions and success metrics become more complex. Despite being based on international norms and principles that in theory are universal, it is an area that is more dependent on subjective assessment. The assessments differ substantially between countries and involve ethics, living standard definitions, labour rights, human rights and governments’ ability to deliver a desirable society to live in.
The functioning of national states is dependent on their ability to uphold effective institutions, including internal and external power of governance. It also depends on the right to defend a society that is – for lack of an objective truth and approximations – not violating the rights defined in the International Bill of Human Rights.
Due to Russia’s aggressive military action against Ukraine, a debate has erupted concerning weapons manufacturing and whether companies that manufacture weapons can be included in funds with sustainability-related labels. For as long as humans have been around, there have been military hostilities, started in order to conquer, grab and take control by disrupting rule.
Countries that are governed in a democratic manner and fulfil the International Bill of Human Rights are necessary to the transition to a more sustainable society. If we agree that those countries have a right to defend themselves – as described in the United Nations’ Charter – and that their ability to do so is dependent on their military capacity, then weapons manufacturing is not automatically contradictory to sustainable investments.
There are controversial weapons – often banned through UN conventions – that subjectively can be classified as having abilities that shouldn’t be allowed. The question of who (country or organisation) should have access to what weapons is important and should be rigorously governed. However, it is a contradiction to say that stable countries’ right to defend themselves necessary for sustainable development, while at the same time saying that the prerequisite to deliver that defence is not sustainable.
In ESG, the definitions and themes of social considerations are completely different to environmental. Efficiency measures such as carbon dioxide emissions are widely used and undebated, but establishing the same clear measures is harder in social contexts.
To engage private capital, the ability to deliver measurable and auditable effects is very important. Impact bonds work well but are limited in their overall reach. Governments’ welfare commitments mean the definition of ‘social’ varies in different countries. Although certain norms are generally accepted, the absence of generic measures and thresholds on what is desired social development creates much complexity.
As the concept of ‘sustainability-linked’ is growing within finance, so are key performance indicators that include social characteristics. These may include a decrease in health-related issues in the workplace for corporations or a decline in the crime rate for residential complexes. Reaching a global agreement on absolute levels on such measures is a very steep climb, so lenders and investors have to ensure materiality and ambition for the social KPIs chosen, primarily based on relativity (current state versus future desired position).
The S in ESG lends itself better to an international agreement on what principles to require adherence to in financial contracts rather than trying to establish metric systems that are internationally accepted. If we pursued more precise measures for international acceptance, the international capital would probably have to accept the metrics deemed relevant by individual national authorities or accept adjustments for local context.