Raising C-suite awareness of sustainability benefits is a critical initial step before even creating a roadmap. Some progress can be reported on this issue, as more CEOs are aware of the benefits of implementing corporate sustainability. According to MIT Sloan’s 2012 Sustainability and Innovation Global Executive Study, 48% of CEOs responded that they had changed their business model to incorporate sustainability; of those, 46% reported that sustainability added to their bottom line. However, out of 600 companies surveyed last year by CERES for The Road to 2020 Report, more than half still fall into the Tier 4 “Starting Out” in their Roadmap for Sustainability. In Tier 4, CERES catalogs those companies who are beginning to understand sustainability and which need considerable work to integrate sustainability into overall corporate accountability systems.

Corporate sustainability demands a broad view of issues and impacts, as well as a working understanding of what the company does and how it does it. Embedding sustainability means joining the two together through a series of concrete steps.

1. Understand sustainability and recognize what it means to the company

As a first step, it is important to define what sustainability means for every area in the company and to identify its benefits. From investment decisions, developing new products or services to changing procurement practices, sustainability has an increasingly central role in these decisions. Coca-Cola is one of the companies centering its investment decisions on sustainability. When considering the development and location of new production plants, water sustainability has been now included as a key factor. Sanjay Guha, president of Coca-Cola Great Britain says “potential markets and ease of distribution were once the only key factors. Now it is the long-term supply of water.” In order to understand where sustainability efforts should be concentrated in a company, it is necessary to identify those issues that have the biggest impact and are most relevant to the business and to stakeholders.

 2. Engage with stakeholders

Depending on its line of business, a company’s impact can vary among stakeholders. Generally, companies engage with the most influential groups, keeping close ties and a constant dialogue. However, engagement can happen on different levels and should respond to expectations from both sides. Different levels and methods of engagement bring benefits to both companies and stakeholders and can be translated into more sustainable practices. Bonnie Nixon, Director of Environmental Sustainability at Hewlett Packard explains, “allowing stakeholders to honestly critique us pushes us to improve our programs and helps us develop our thought leadership platforms.” In the same way, Procter and Gamble has benefitted through the engagement with local communities around the world by finding alternative uses for its waste materials. Through employee engagement, Kraft Foods has developed a model where employees contribute with ideas and viable plans to reduce waste while helping to reach the company’s waste reduction targets.

 3. Set goals and commitments

Once key environmental, social and governance issues have been identified and engagement methods for each stakeholder group have been defined, efforts must focus on reducing risks and seizing opportunities around these issues centered on sustainable practices. Whether driven by cost reductions, innovation or improved financial performance, sustainability commitments and goals need to be established.

For Wal-Mart, most of it commitments and goals on sustainability are focused around the use of renewable energy and the adoption of energy efficiency. Initiatives in these areas have resulted in the recognition of Wal-Mart as the largest on-site green electricity generator in the U.S. and have led to cost savings of over $500m USD a year. Another example is United Airlines. The airline aims to reduce its environmental impact through the participation of all its suppliers in its Sustainable Supply Chain initiative.

While companies like Wal-Mart and United Airlines aim for a complete transformation of their businesses, small companies are setting goals and commitments according to their scope of action. Initiatives mainly focus on cost reductions from energy use, waste management and commuting practices, as well as social actions in the community like local development projects and volunteering campaigns.

 4. Establish systems and processes

Once the goals are established, specific systems and detailed processes need to guide the implementation of each initiative. Throughout the design, processes and policies in place must be taken into consideration and collaboration among areas encouraged. At this point, gaining executive commitment is crucial. The appointment of an internal sustainability champion as the main driver of sustainability and the development of a successful employee engagement model are also good practice. According to the 2012 Report of Sustainability Leaders by VOX Global and Net Impact Berkeley, 78% of respondents say top management was a key contributor to embracing sustainability. However, 81% identified their colleagues across the company as primary drivers of success.

Unilever’s Sustainable Living Plan was launched in 2010. Under the leadership of its CEO Paul Polman, this ten-year sustainability plan has already accomplished considerable progress in its first two years. Under the umbrella of its comprehensive overall sustainability strategy, Unilever is utilizing its wide array of brands to target distinct social issues, invest in sustainable technologies and change consumer behavior. Unilever has also accomplished to fully embed sustainability across the company and to successfully engage external actors. Besides the appointment of a Chief Sustainability Officer in 2012, the company’s management structure includes a Sustainable Living Plan Steering Team, a group of external specialists in corporate responsibility and sustainability known as the Sustainable Development Group and the launch of the “Small Actions, Big Difference Budget” which finances employees ideas based on environmental benefit and financial return.

 5. Track progress, communicate actions and meet expectations

Lastly, it is important to set a system that measures the performance towards each goal. Defining key performance indicators to meet the identified goals will allow to detect areas for improvement and will gather relevant data to track progress. Metrics and indicators are also central for the reporting and communicating activities of the company. Internally, the availability of data contributes to the prioritization of issues and initiatives and to promote employee involvement around sustainability. Externally, collecting data is fundamental for an accountability strategy, to respond to stakeholders’ expectations and interests and to comply with reporting standards.

Companies reporting under the Global Reporting Initiative guidelines have already embraced the development of indicators. In addition to these guidelines, the Sustainability Accounting Standards Board is currently preparing frameworks that will standardize sustainability key indicators per sector. Alongside these efforts, companies are designing their own systems to measure performance, like Wal-Mart’s Sustainability Scorecards, which, among other criteria, ranks suppliers according to their environmental footprint and contributes to Wal-Mart’s performance measurement.

In the end, corporate sustainability needs to adapt to the maturity of the business and the company’s willingness to treat sustainability as a strategic opportunity. These steps are only the beginning of a process that can eventually transform a company’s entire business strategy into a sustainable business strategy.

What is materiality and why is it important?

The concept of materiality has its origins in the auditing and accounting processes of financial reporting. In financial terms, a concept is considered material to the company if its omission or misstatement influences the economic decision of users. In recent years, the concept of materiality has been adopted in sustainability and is increasingly influencing the design of sustainable strategies and reports.

Compared to financial statements, sustainability considers a broader scope of action and covers a multitude of issues- environmental, social, economic and more. This context requires a more comprehensive definition for materiality. The Global Reporting Initiative (GRI) defines as material those issues with “a direct or indirect impact on an organization’s ability to create, preserve or erode economic, environmental and social value for itself, its stakeholders and society at large”.

In simple terms, materiality aims to identify the societal and environmental issues that present risks or opportunities to a company while taking into consideration the issues of most concern to external stakeholders. The process of labeling material topics in a company requires a comprehensive framework that methodologically identifies and prioritizes issues, risks and opportunities, commonly known as materiality analysis.

Materiality analysis

Source: PGS Advisors

When to perform a materiality analysis?

A materiality analysis is a tool that takes into consideration the company’s financial concerns while foreseeing future risks and opportunities around ESG issues. A materiality analysis is especially useful for companies building a sustainability strategy, preparing a sustainability report or looking to explore new business opportunities.

As in traditional enterprise risk management, strategic planning for sustainability requires a deep understanding of the impacts of a company’s operations and a comprehensive stakeholder map. Materiality analysis helps a company tailor its sustainability strategy and stakeholder engagement activities around the issues that are most pressing to their business and sector. It not only identifies issues with significant social or environmental impact for the company but also takes into account the understanding of stakeholders. When preparing reports, the availability of this information guarantees addressing the issues that represent a major concern to stakeholders and consolidates a company’s accountability strategy.

In addition, materiality analysis can provide information to develop products and services with the greatest potential for sustainable business growth and can influence a company’s decision-making process by weighing risks.

How to identify materiality

Generally, materiality varies considerably from company to company. Material topics can be similar within an industry or a sector, but they also respond to particular characteristics of a company such as size, location, time of establishment, level of stakeholder engagement, financial performance, etc. As a result, the practical application of materiality is constantly evolving. Recently, organizations like the Sustainability Accounting Standards Board (SASB) and the GRI have developed tools to consolidate the process of identifying materiality.

The SASB is in the process of building materiality maps for each industry. It has determined materiality according to issues under five categories: Environmental Capital, Social Capital, Human Capital, Business Model & Innovation, and Leadership & Governance. Until now, materiality maps for the healthcare and financial sector have been published. Maps per industry will be available in the short to medium term.

At the same time, the GRI developed a materiality framework to guide sustainability reporting: the Reporting Guidance for Defining Content in the GRI Sustainability Reporting Guidelines. Companies reporting under these guidelines are taking advantage of the materiality analysis beyond reporting and are using the process to target their sustainability efforts.

Common elements in materiality analysis include:

1. Identification of a universe of relevant economic, social, environmental, and governance issues for consideration;
2. Evaluation and ranking of the level of stakeholder concern regarding each issue;
3. Evaluation and ranking of the potential impact on the company of each issue;
4. Presentation of issues prioritization, typically in a matrix format that is subsequently used to inform strategy and reporting.

In addition, the process usually takes into consideration surveys involving consumers and sustainability experts, feedback from stakeholder meetings, engagement events, media scans, internal business impact surveys, corporate risk maps, etc.

Materiality analysis is about setting priorities right. By complementing financial and non-financial performance, materiality helps align a business strategy with a company’s ESG risks and stakeholders’ interests while achieving larger impacts in sustainability. It is quickly becoming the dominant concept in sustainability reporting and it is just a matter of time before companies realize the potential and benefits of a materiality analysis for their overall performance and sustainability in particular.

The GRI, which is widely considered to be the closest thing to a standardized reporting framework in the sustainability world, has conducted a study of existing integrated reports: reports that have been issued by organizations and self-identified as integrated.  These findings are shared in its recently published “The sustainability content of integrated reports – a survey of pioneers” report.  The report categorizes existing integrated reports into three categories:

1. Sustainability structure – The report focuses on sustainability while neglecting financial metrics, and is thus integrated in name only.
2. Cover structure – Sustainability and financial performance are discussed separately and published in the same document.
3. Embedded structure – The report contains “clear evidence of inter-linkage between reporting on financial and sustainability performance.”

In its report, the GRI is careful to describe these three reporting styles in neutral terms, but it is clear that an embedded structure is a more genuine integration of sustainability and financial reporting, and that this kind of structure is the direction in which they assume <IR> will evolve.  Feedback from companies currently practicing integrated reporting (of the embedded structure variety) confirms that they view the practice as “the natural logical expression of their intrinsic business model” and that to report in any other fashion would actually be “counter-intuitive.”

The companies that report such sentiments are most likely in the minority, and in fact, most companies probably have some work to do before integration becomes so comfortable, but the International Integrated Reporting Council is seeking to facilitate the transition to <IR> by developing a reporting framework that companies can use.  As a starting point, the IIRC released a Consultation Draft  of the International <IR> Framework earlier this spring, and they are currently soliciting feedback with an open comment period that started on April 16 and runs until July 15.

The main themes of the Framework are value creation over different time frames (short, medium, and long term); and accounting for the different kinds of capital, both internal and external, that an organization utilizes and creates.  Organizations are invited to decide upon and justify their individual short, medium, and long term time frames.  In its Framework, the IIRC categorizes capital as financial, natural, manufactured, intellectual, social and relationship, and human, and posits that each kind, whether owned or not, plays a role in creating or diminishing company value.  The IIRC also suggests that determining materiality – the factors that significantly affect value creation over time –  will be fundamental to an organization’s business model, its growth strategy, and its ability to participate successfully in the <IR> process.

During this open comment period, the IIRC encourages stakeholders to read and evaluate the draft Framework, and in addition to providing general commentary, to answer a specific set of Consultation Questions regarding the Framework’s content.  These questions generally pertain to definitions and the scope of the report, as well as how such a report might be verified.  The responses to these questions will be taken into account when updating the Framework, and the IIRC intends to publish the first – of probably many, in this iterative process – official version of the Framework in December 2013.  We look forward to the continued evolution of sustainability reporting, and of <IR> in particular.

Participants in the forum identified as the critical issue that both sides rarely speak the same language. A typical analyst will not necessarily ask questions about sustainability but is certainly interested in issues concerning succession planning, regulatory compliance, energy efficiency or customer relations. All of these issues of course about corporate sustainability, when defined by a company’s triple bottom line of social, environmental and economic performance, but it might not be apparent to the investor. While a company with a strong sustainability strategy and record shows superior risk management and long-term growth prospects, the terminology used to describe sustainability practices may alienate investors. Eric J. Hespenheide, global leader of Deloitte’s Sustainability Audit and Enterprise Risk Services is quoted in the article as raising the question: Is the disconnect “all a grand misunderstanding? It sounds like analysts are actually interested in this but not getting through because of the language.”

And, at least in the US and Europe, the language is clearly the problem, since there is no shortage of disclosure on nonfinancial performance data anymore. On the contrary, as one senior investor pointed out, there is lots of bad and irrelevant data released, essentially creating noise, preventing investors from seeing the real CSR picture of a company.

To allow companies to remedy this communication gap, Mehallow summarized five steps suggested by participants at the forum.

1. Investors need industry-specific data. While companies can and need to produce the data, it is difficult to know what exactly individual investors are looking for. The work of the Sustainability Accounting Standards Board (SASB), which is developing standards for ten sectors and 88 industries and is set to release standards in 2015, will facilitate bridging this barrier.
2. Avoid loaded language. The term CSR is a good example in itself, as its terminology suggests that there is no economic benefit for the company and investors involved. Communicating that a company’s sustainability engagement is really about integrating social, environmental and economic performance to create lasting value is more accurate and certainly more appealing from an investor perspective.
3. Talk to the right players. Issues of sustainability should be a routine and integral part of an investors’ assessment of companies and part of the conversation with management, not just a company’s sustainability officer.
4. Provide useable data. Where sustainability performance can be measured and standardized, companies need to go ahead and provide such data as easily digestible as possible to investors, so it can be fed into models. Examples include carbon emissions, human capital, natural resources and other sustainability performance metrics.
5. Explain the meaning behind the data. Companies need to explain why their sustainability performance is good for its bottom line. 

The first report  is called “Integrated Analysis”. It utilizes almost 20 case studies from brokers and research providers, including Citi, Société Générale, UBS and West LB to show different aspect of how understanding the impact of ESG factors on sales, costs and long-term return on capital can enhance investment decisions.

The structure of the review followed what the reports calls a “stylised stock review.”  It used five stages from the analysis of the economies in which a company operates, through the industries in which it operates, the way it conducts its operations, the financial impacts of those operations and finally the valuation tools used.  The document then goes on to highlight innovative research in each of these five stages.

Overall, the report finds,

advanced use of integrated analysis in all aspects of fundamental equity valuation, particularly in industry analysis, forecasting earnings and adjusting discount rates. These integrated approaches to estimating fair value point towards significantly improved valuation models that account for scarcity of resources, future regulatory directions and timeframe tensions.

However, challenges remain. The main challenges the report identifies are:

• Short-term valuation tools cannot always capture ESG issues that will impact companies over longer timeframes;
• Acquiring consistent, comparable, audited information remains an obstacle to integrated analysis, making it more resource intensive than traditional analysis relying on audited financial information;
• Since there are different regulatory regimes around the world in terms of disclosure requirements ,raw ESG data without context can be misleading.

The second report, “Aligning Expectations” is intended to serve as guidance for asset owners on incorporating ESG factors into manager selection, appointment and monitoring. The report shows that asset owners featured in the report are becoming more advanced in ensuring that their asset managers meet ESG guidelines. It also shows that investment managers are rising to the challenge of integrating ESG factors into their investment decision-making.

The report also offers guidance on a number of issues in order to enable asset owners to include ESG expectations in their processes. Examples in the report include requests for proposals, questionnaires, and monitoring and discussions with managers.

For the first time, Rule No. 341requires all listed companies to provide on an annual basis (no later than March 31) to the SVS information on a catalog of corporate governance questions regarding the immediately preceding fiscal year. In essence, companies are requested to perform a kind of self-evaluation against a set of best practices. According to the rule, companies are requested to indicate whether they have or have not adopted the corporate governance practices laid out in the regulation. In addition, they have to explain how, if adopted or – if not adopted – why not and what steps are being taken towards adopting.  Since 2013 is the first year the norm has been put in place, companies have until June 30 to submit their answers.

The catalog of 19 questions is divided into four areas. In addition, companies can add practices they have adopted that are not covered by the questions of the rule.

The four areas addressed by the questionnaire are:

1. The functioning of the board with 7 practices;
2. Shareholder and public relations with 6 practices;
3. Executive compensation and succession planning with 2 practices; and
4. Internal control and risk management with 4 practices.

While the initial reaction of Chilean companies to the new Norm is predictably negative, it will be interesting to see the degree and quality of information companies will disclose when the self-evaluations against the new rule becomes public upon filing at the end of June.

One key driver of the increased reporting on sustainability strategies, initiatives, programs and performance seems to be that reporting companies are more likely to be included in key sustainability rankings, indices and reputational lists. Naturally, companies disclosing their ESG practices also tend to be evaluated higher by raters focusing on sustainability issues.

In terms of financial performance, the study indicates that companies focusing on their ESG issues tend to perform slightly better over the long term, but cautions that a larger number of companies over a longer period of time will have to be examined to definitively prove this causality.

In either case, the analysts of the report conclude:

The arguments for not reporting are shrinking day after day for companies that have yet begun to report on their sustainability progress (…) non-reporters are now in the minority. We believe this minority will continue to shrink as it has in the past few years. The benefits of sustainability reporting will become increasingly obvious as more time passes and the long term benefits are easier to measure. The lesson for management and boards: If you are not reporting, your competitors and peers almost surely are. The task of “catching up” will only grow larger.

• At 88%, enhanced reputation was the main driver behind CSR reporting
• Competitive positioning and social consciousness were tied at 71%
• Significantly, profitability (38%) and pending or existing legislation (32%) were determined to be motivating factors

The study also made a number of recommendations:

1. There should be a comprehensive reporting process with a direct link to the CEO
2. The CEO and top management support is also critical in driving the company’s CSR programs
3. CSR responsibilities should be embedded into every employee’s job descriptions
4. Holding the CEO and top management accountable for the implementation and results of the company’s CSR program
5. An understanding of the influence and importance of various groups in the company’s CSR processes
6. Coupling the company’s standard measurement tools with a regular evaluation of traditional and social media coverage about the company.
7. Communicating about the company’s CSR efforts through social media platforms, including Facebook and Twitter, in addition to posting information regularly on the company website

The overarching recommendation is to encourage companies to use plain language in their communication with shareholders to allow them to effectively assess the board’s performance. The document can be accessed here.