• Frankfurt, 17 November 2022

Beyond Just Climate - A Holistic Approach For Systemic Evaluation Of Sustainability Performance And Transformation

Value Balancing Alliances’ Contribution to NAFMII’s Financial Market Research Journal


About VBA:

The Value Balancing Alliance’s objectives are to create a global impact measurement and valuation (IMV) approach for monetizing and disclosing positive and negative impacts of corporate activity. The alliance represents large international companies, including Anglo American, BASF, Bayer, BMW, Bosch, Deutsche Bank, DPDHL, Dräger, Holcim, Kering, Kirchhoff Automotive, L‘Oréal, Michelin, Mitsubishi Chemical, Novartis, Otto, Porsche, Roche, Sana Kliniken, SAP, Schaeffler, Shinhan Financial Group, SK and ZF. The VBA is supported by Deloitte, EY, KPMG, PwC, the OECD as a policy advisor, and leading academic institutions, such as the Impact-Weighted Accounts Initiative of Harvard Business School. 


Opaqueness, incoherence, and incomparability of corporate ESG disclosure led to an ongoing decay of the overall value of current corporate reporting and nurtured a demand for a globally consistent sustainability reporting framework. To ensure practical applicability and meaningful information for stakeholder, reporting narratives need to be transformed into a common language of monetary evaluated externalities, considering corporate impacts on society, and sustainability effects on enterprise value, including strategy and target setting. Such a framework would enable both a cross-border and cross industry comparability, allowing investors and other stakeholders to derive more robust conclusions about the future development and resilience of a company. Risks and opportunities can be made more tangible by providing relevant and concise measures to evaluate an entity’s overall value contribution and conclude on the preparedness for physical and transitional risks such as climate change. This transparent and comparable reporting can lead to a purposeful re-allocation of capital, empowering the financial sector to become a driving force for the sustainable transformation of our economy. 


Christian Heller (Chief Executive Officer; Value Balancing Alliance) 
Florian Klinkhammer (Sustainable Finance & Financial Market Lead, Value Balancing Alliance) 


Over time, investors and shareholders have been driven by their desire to maximize yield and financial returns. In response, companies tuned their way of doing business toward primarily profit maximizing business models, eventually overstretching our planetary boundaries.1 This shareholder orientation also resulted in a dominance of financial performance in external reporting by companies. But with a growing awareness of the damage caused by our economy’s overly narrow scope of incentives, international efforts to guide business actors towards sustainability have evolved. Most prominently, the United Nations Sustainable Development Goals (UN SDGs) and the Paris Agreement on climate change urge companies to conduct their businesses in a sustainable manner – economically but likewise socially and environmentally. Fueled by these developments, policymakers continuously introduce new sustainability-related legislation, requiring companies to adapt their business models and strategies. Moving away from a pure profit maximizing focus towards balanced stakeholder-centric business models, reporting of sustainability performance and external disclosure have become central for external stakeholders to understand a company’s overall value contribution. To achieve this, not only is information on the enterprise value necessary but also information on the value to society, incorporating the concept of so-called “double materiality”.2 

For more than two decades, an abundance of Environmental, Social, and Governance (ESG) reporting frameworks proliferated to meet informational requirements of the public, investors, and internal stakeholders. To facilitate oversight and mitigate greenwashing in the very fragmented reporting environment, the establishment of the IFRS/ISSB3 in Frankfurt and Montreal aims at reversing the trend of fragmentation. The IFRS/ISSB merges several initiatives (the Value Reporting Foundation – SASB and IIRC – as well as the Climate Disclosure Standards Board) and considers recommendations from the Task Force on Climate-Related Financial Disclosures (TCFD), among others. At the same time, regulators around the globe are fueling the trend towards corporate sustainability reporting and acknowledging its potential by developing national sustainable finance taxonomies. With initiatives like the Sustainable Finance Disclosure Regulation (SFDR), Corporate Sustainability Reporting Directive (CSRD) and the EU taxonomy in the European Union, to name just a few, there is a strong focus on sustainability-related corporate reporting and enabling responsible investment with a dedicated sustainable finance strategy.4 


Many of the existing reporting initiatives focus primarily on climate related aspects (such as the TCFD) and on enterprise value and target investors as a main recipient of information. The target group, without a doubt, has the needed leverage for change. Enterprise value, however, is just one side of the double materiality coin.5 The other, increasingly relevant, side is the impact an enterprise and its associated value chain have on the environment (society and nature).6 This second perspective is increasingly relevant for stakeholders who think about risks and opportunities in a more holistic sense. Both perspectives are fundamentally important to support decision makers (internal or external) with relevant information that empowers them to better understand and manage impacts. Now more than ever, recipients of sustainability information require a holistic backward and forward-looking view to set new, ambitious targets for companies. However, sustainability indicators across the entire range of ESG can only be defined and operationalized when a common impact language is found, which is so far not available via traditional reporting frameworks. Monetary valuation – converting measures of social and environmental impacts into a single monetary unit – offers the opportunity to create this common language for the concept of double materiality and enhances the comparability of different impacts. Furthermore, monetary valuation has the potential to facilitate impact-oriented exchange between stakeholders, from a firm’s managers to its investors and other regulators. 


To fill the gaps in current ESG reporting and facilitate the transformation of existing business models toward greater sustainability, disclosure in the future will need to incorporate general information on risk management and governance along with three specific components that provide backward-looking and forward-looking information (see Figure 1). Such a framework will enable both cross-border and cross-industry comparability, allowing investors and other stakeholders to derive more robust conclusions about the future development and resilience of a company. 



 Although sometimes derided, there is no chance of establishing a meaningful reporting and disclosure without a robust and consistent governance structure. It is a fundamental prerequisite for the successful integration and effective management of sustainability matters at a company and should be adequately accompanied by a committed leadership, a clear direction, and a strategic influence.7 Beyond the mere implementation of this structure, the disclosure of information about the company’s governance around sustainability-related risks and opportunities is of great importance. Content-wise, such disclosures should reflect the requirements accepted by consensus among the leading sustainability standard setters and published in the climate-prototype of the Technical Readiness Working Group (TRWG) of the ISSB.8 


While monetary valuation of impacts is essential when it comes to sustainability reporting and disclosure to stakeholders, there are prior steps to be considered and disclosed in conjunction with a company’s overall impact. Investors should first be provided with general information on corporate activity with respect to the inclusion of sustainability topics in risk management and the overall governance structure. Companies should be encouraged to focus on the nature, type, and extent of identified risks and opportunities arising from the sustainability matters to which the company is exposed. A differentiation between different types of risks and opportunities for each sustainability matter would be advantageous since a consistent categorization and disaggregation will enable investors and other stakeholders to perform a more targeted assessment of a company’s ESG status. Usually, risks and opportunities related to sustainability matters vary depending on the region, market and industry in which companies operate.9 To account for these important disparities, a proper reporting and holistic disclosure would also include an explanation of potential differences in risks and opportunities in certain regions, markets or industries.10 Furthermore, investors and other stakeholder are keen for companies to disclose information about the identification, assessment and management of sustainability-related risks and opportunities. Such a process should also include a narrative on how companies integrate these into their overall risk management. 

Value-to-Business (Enterprise Value)
The first component of future sustainability disclosure should represent backward-looking information with a focus on enterprise value. To promote consistent and comparable sustainability reporting, this section should provide investors and other stakeholders with relevant quantitative information about the ESG performance of the company for the current and previous reporting period. Like the three-layered logic proposed by EFRAG,11 this component should differentiate between Universal, Sector-Specific and Company-Specific disclosure. 

Value-to-Society (Impact on Society)
Incorporating the double materiality perspective, sustainability disclosure should provide external stakeholders with a more detailed picture of a company’s value contribution to society.12 This second component should illustrate positive as well as negative impacts of corporate activities on socio-economic and environmental dimensions. For each dimension, a set of indicators with standardized calculation rules should be reported, displaying impacts driven by companies’ production inputs and outputs (e.g., water consumption or GHG emissions for the environmental dimension, or occupational health and safety for the social dimension).13 Further, companies should report all socio-economic and environmental impacts occurring in their value chain, including impacts of their own operations as well as impacts occurring in upstream and downstream activities. Environmental and social impacts are based on different metrics, e.g., environmental impacts can be based on tons of CO2 equivalents, social impacts in occupational health and safety on number and severity of injuries. This makes it difficult for external stakeholders, such as investors, to compare impact dimensions and form investment decisions. Thus, valuing and disclosing all reported impacts in monetary terms ensures comparability across different dimensions. 


Component III represents the final component and focuses on forward-looking information that informs investors and other stakeholders about the strategy and how management approaches certain sustainability matters. First, companies should disclose their strategy and emphasize how the progress towards the respective objectives is measured. In order to provide more specific information, it would be relevant to investors and other stakeholders to list and explain the activities that contribute to the defined strategic targets. This explanation should include the capital and operating expenditures (CapEx and OpEx) incurred in the current reporting period in relation to each activity.14 Furthermore, each activity should be accompanied by a specific activity target and a corresponding evaluation of the progress. 

Existing frameworks for sustainability reporting already oblige companies to disclose information on their sustainability strategies, but they lack further requirements with respect to an assessment of impacts.15 Meanwhile, it is evident that investors are interested not only in understanding whether the management has a strategy with clear and precise objectives and activities, but also what consequences this strategy is bringing about. Reporting about these consequences should focus on Value-to-Society and Value-to-Business and should be activity-specific disclosures, if possible, without too many redundancies. For an activity’s impact, a company should disclose all qualitative and quantitative information necessary to understand the activity’s impact on society and business. The Value Balancing Alliance (VBA) has developed and continues to refine methodologies that support impact measurement and valuation from both a backward-looking and forward-looking perspective.16 
Hence, the proposed structure establishes a clear link between the sustainability strategy, the activities needed to achieve the strategic targets and the estimated impact on the society (Value-to-Society) and on the enterprise value (Value-to-Business). Investors will be able to evaluate the progress of certain activities and their contribution to the overall strategic objective. 


While the intrinsic motivation of corporate frontrunners and regulation are driving forces behind the transformation of businesses and the economy, financial market players also have a pivotal role as enablers and facilitators of sustainable transformation. In line with the overall objectives of the European Commission’s Renewed Sustainable Finance Strategy and the G7 Impact Task Force, financial market participants – particularly investors and banks – are crucial when it comes to (re)allocating capital into sustainable activities and undertakings. For them, comparability is an essential precondition to evaluate and assess the long-termism and resilience of business models and strategies. While most company disclosure is sophisticatedly prepared and diligently reported, the risk remains high that most reported non-financial information will not be comparable even within the same industry.17 This considerably reduces the value add of sustainability reporting and might put its overall usefulness and relevance at risk. 

Ensuring the meaningfulness, comparability and usability of sustainability-related performance data requires a standardized framework that renders abstract performance metrics more tangible. For better-informed risk management and investment decisions and to derive adequate measures, the focus must be on the overall resilience and transformation of a company (investee), extending the scope from a single KPI-driven assessment to a holistic evaluation of the company’s value contribution. Not only must this evaluation take economic components into account, it also needs to account for the ecological and social dimensions. While traditional reporting stops at quantifying environmental and social outputs (e.g., tonnes of greenhouse gas emissions), valuing impacts caused by these outputs would allow for a clearer understanding as to the scale of consequences. It would also enable a direct comparison of different impact dimensions. 

Measuring the social and environmental impact is still a core challenge in Impact Investing. 18 By monetizing the environmental and social footprint of companies, the VBA methodology provides an approach that enables stakeholders to translate their impacts on nature and society into comparable financial data, making it more transparent, tangible, and easier to understand and use. 
Monetary units are widely used in the global market space. They are the language that business decision makers and financial market actors understand and which they are accustomed to. Corporate and investment decisions – on both equity and debt – are based primarily on monetary values and returns, as are the heuristics to evaluate business risks and opportunities. Monetary valuation provides a tangible, quantitative unit and eases complexity for financial market actors to better assess and evaluate the sustainability performance and risks, but also the opportunities, of a company compared to qualitative narratives. Monetary valuation of non-market priced impacts provides a single unit to consolidate various categories of business impacts and dependencies among business activities and the capitals on which they depend. Presenting a monetary unit for impacts also allows direct integration into existing models and can serve as a basis for shareholder engagement or other active engagement strategies. 


Although – or perhaps because – corporate reporting has significantly evolved, we currently have an alphabet soup of reporting frameworks. This creates barriers to informed investor decisions and effective company steering and necessitates harmonization (e.g., via the ISSB). To date, much of the sustainability information reported by companies remains difficult to compare and interpret. A lack of common language in the field and finding the right level of meaningful information seem to be the greatest challenges. This is why holistic approaches that consider companies’ embeddedness in their context, along the concept of double materiality, can offer a solution and enable the balancing act between impact-oriented governance, risk management and strategy. Impact measurement and monetary valuation ultimately provide stakeholders, in particular financial market players, with the information they require to make informed decisions. Such holistic sustainability disclosure will thus eventually contribute to harmonizing financial return on investment and tangible impact return on investment. 

FIGURE 1&nbsp;<br>The three components of holistic sustainability disclosure&nbsp;


Sustainable Finance Disclosure Regulation (SFDR)
The Sustainable Finance Disclosure Regulation (SFDR) imposes mandatory ESG disclosure obligations for asset managers and other financial markets participants. Its objective is to bring a level playing field for financial market participants on transparency in relation to sustainability risks, the consideration of adverse sustainability impacts in their investment processes and the provision of sustainability related information with respect to financial products. The SFDR requires asset managers to provide prescript and standardised disclosures on how ESG factors are integrated at both an entity and product level. The SFDR entered into force on 10 March 2021.

EU Non-financial reporting Directive (NFRD) 
The EU’s non-financial reporting directive (NFRD, Directive 2014/95/EU) lays down the rules on disclosure of non-financial and diversity information by large companies. The reporting requirements only apply to large public-interest companies with more than 500 employees. This covers approximately 6 000 large companies and groups across the EU, including listed companies, banks, insurance companies, other companies designated by national authorities as public-interest entities. The directive requires companies to include non-financial statements in their annual reports since 2018. Companies falling under the scope of the NFRD will also be obliged to report the proportion of their turnover, capital and operating expenditures that is derived from taxonomy-compliant activities (reporting obligation according to article 8 of the Taxonomy Regulation) starting in 2022 for financial year 2021. 

The NFRD identifies four sustainability issues (environment, social and employee issues, human rights, and bribery and corruption) and with respect to those issues it requires companies to disclose information about their business model, policies (including implemented due diligence processes), outcomes, risks and risk management, and key performance indicators (KPIs) relevant to the business. It does not introduce or require the use of a non-financial reporting standard or framework, nor does it impose detailed disclosure requirements such as lists of indicators per sector. 

In its Communication on the European Green Deal in December 2019, the Commission committed to review the NFRD as a public consultation in early 2020 identified current problems with the NFRD such the lack of comparability, reliability and relevance of the reported information and key aspects for its revision such as the need for common reporting standards, the scope of the directive or the digitalization of non-financial information. 

Corporate Sustainability Reporting Directive (CSRD)
On 21 April 2021, the Commission adopted a proposal for a Corporate Sustainability Reporting Directive (CSRD) that amends the existing reporting requirements of the EU’s Non-Financial Reporting Directive (NFRD). The proposal will extend the scope of sustainability reporting requirements to all large companies, whether they are listed or not and without the previous 500-employee threshold. 

The draft directive requires reporting on a full range of sustainability information relevant to the company's business. Sustainability information would cover environmental factors but also social and governance factors. Reporting must be in line with mandatory EU sustainability reporting standards. The European Financial Reporting Advisory Group (EFRAG) will be responsible for developing these draft standards. They will cover both the risks to companies but also the impacts of companies on society and the environment ('double materiality' principle). The Commission plans to adopt a delegated act on the European Sustainability Reporting Standards (ESRS) in summer 2023. 

The CSRD proposal also requires that the sustainability information is subject to a limited level of audit assurance and that companies need to prepare their financial statements and management reports in a digital, machine-readable format and to tag the sustainability information. 
The new reporting requirements would become applicable for financial years starting on 1 January 2024 or later. 

IFRS Foundation and the creation of the International Sustainability Standards Board ISSB
On 30 September 2020, the Trustees of the IFRS Foundation published a Consultation Paper to assess demand for sustainability reporting at a global level and to explore the Foundation’s role in the development of global sustainability standards. The responses received by the Foundation indicate growing and urgent demand to improve the global consistency and comparability in sustainability reporting, as well as strong recognition that urgent steps need to be taken and broad demand for the IFRS Foundation to play a role in this. Based on this feedback, the Trustees have agreed to undertake further detailed analysis and to form a Trustee Steering Committee to oversee the next phases of work and added an additional key requirement for success. 

In April 2021, the Trustees published an Exposure Draft proposing targeted amendments to the IFRS Foundation Constitution to accommodate the creation of an International Sustainability Standards Board (ISSB) with the objective to develop and maintain a global set of sustainability reporting standards, utilizing existing sustainability frameworks and standards.

The Trustees announced the establishment of the ISSB at the meeting of the United Nations Climate Change Conference COP26 in Glasgow on 3 November 2021. The Climate Disclosure Standards Board (CDSB) and the Value Reporting Foundation (VRF, which houses the Integrated Reporting Framework and the SASB Standards) consolidated into the ISSB in Summer 2022.The IFRS Foundation and Global Reporting Initiative (GRI) announced on 24 March a collaboration agreement under which their respective standard setting boards, will seek to coordinate their work programmes and standard-setting activities. 

The ISSB will have a global and multi-location presence. Frankfurt will be the seat of the Board and the office of the Chair and will be responsible for key functions supporting the new Board and deeper co-operation with regional stakeholders (together with an office in Montreal). Offices in San Francisco (seat of the VRF) and London (seat of the IFRS Foundation) will provide technical support and platforms for deeper cooperation with regional stakeholders. 

Emmanuel Faber (former CEO of Danone) has been selected as Chair of the International Sustainability Standards Board (ISSB), effective 1 January 2022. Sue Lloyd will act as Vice-Chair. She has currently served as Vice-Chair of the IASB. 

The ISSB has published on 31 March 2022 two so-called exposure drafts for potential IFRS S – one sets out general sustainability-related disclosure requirements and the other specifies climate-related disclosure requirements. 

Overview of international standard-setters for sustainability reporting 
The five most significant framework- and standard-setting institutions at international level are: 

• CDP (Carbon Disclosure Project), 
• CDSB (Climate Disclosure Standards Board), 
• GRI (Global Reporting Initiative), 
• IIRC (International Integrated Reporting Council), and 
• SASB (Sustainability Accounting Standards Board) 

They have published a statement of intent to work together towards a comprehensive corporate reporting system in September 2020. While GRI, SASB, CDP and CDSB set the frameworks and standards for sustainability disclosure, including climate-related reporting, along with the TCFD recommendations, the IIRC provides the integrated reporting framework that connects sustainability disclosure to reporting on financial and other capitals. The collaboration aims at providing preparers with a joint market guidance on how the frameworks and standards can be applied in a complementary and additive way and a view on how these elements could complement financial generally accepted accounting principles. 

Additionally, the IIRC and the SASB merged into the Value Reporting Foundation in June 2021. The merger creates a unified organization intended to provide investors and corporates with a comprehensive corporate reporting framework across the full range of enterprise value drivers and standards. 

Task Force on Climate-related Financial Disclosures (TCFD) 
G20 Finance Ministers and Central Bank Governors asked the Financial Stability Board (FSB) to review how the financial sector can take account of climate-related issues. The FSB established the Task Force on Climate-related Financial Disclosures (TCFD or Task Force) to develop recommendations for more effective climate-related disclosures that could “promote more informed investment, credit, and insurance underwriting decisions” and in turn, “would enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks.” 

The Task Force’s 31 international members, led by Michael R. Bloomberg, include providers of capital, insurers, large non-financial companies, accounting and consulting firms, and credit rating agencies. The Task Force also has more than 3,400 supporters from 95 countries and jurisdictions around the world. 

The Task Force’s 2017 report outlines the TCFD framework for reporting climate-related financial information. The recommendations are structured around four thematic areas that represent core elements of how organizations operate. 

• Governance, 
• Strategy, 
• Risk Management, 
• Metrics and Targets.



1 https://sustainabledevelopment.un.org/content/documents/5987our-common-future.pdf; Rockström, et al. 2009. A safe operating space for humanity. Nature, 472-475, https://www.nature.com/articles/461472a  
2 https://www.lse.ac.uk/granthaminstitute/news/double-materiality-what-is-it-and-why-does-it-matter/  
3 https://www.ifrs.org/news-and-events/news/2021/11/ifrs-foundation-announces-issb-consolidation-with-cdsb-vrf-publication-of-prototypes/ 
4 https://ec.europa.eu/info/publications/210706-sustainable-finance-strategy_en  
5 https://www.lse.ac.uk/granthaminstitute/news/double-materiality-what-is-it-and-why-does-it-matter/  
6 https://www.lse.ac.uk/granthaminstitute/news/double-materiality-what-is-it-and-why-does-it-matter/  
7 Eapen 2017, Business for Social Responsibility (BSR), https://www.bsr.org/en/our-insights/blog-view/how-to-build-effective-sustainability-governance-structures.  
8 Climate-related Disclosures Prototype, https://www.ifrs.org/content/dam/ifrs/groups/trwg/trwg-climate-related-disclosures-prototype.pdf.  
9 On the importance of consistent categorization of climate-related risks for TCFD framework, see TCFD 2017, Final Report – Recommendations of the Task Force on Climate-related Financial Disclosures, p. 7.  
10 SASB Standards often require a discussion of potential differences in strategies, plans, and/or reduction targets for different business units, geographies or emissions sources. See, for example, Iron & Steel Producers - Sustainability Accounting Standard, Greenhouse Gas Emissions, EM-IS-110a.2. Discussion of long-term and short-term strategy or plan to manage Scope 1 emissions, emissions reduction targets, and an analysis of performance against those targets, note no. 4.  
11 European Reporting Lab @ EFRAG - Proposals for a relevant and dynamic EU Sustainability Reporting Standard-Setting (February 2021), p. 9.  
12 https://www.globalreporting.org/media/jrbntbyv/griwhitepaper-publications.pdf  
13 Value Balancing Alliance. 2020. Methodology Impact Statement General Paper, https://www.value-balancing.com/en/downloads.html  
14 Under rare circumstances or for specific industries there might be cases where there is no alignment between CapEx and OpEx listed in the Strategy & Target Setting disclosure and the classification of sustainable investments according to the EU-Taxonomy Regulation. In such cases, a company should be required to explain why the referring activity is not considered sustainable according to the EU-Taxonomy Regulation. If this is the case, a corresponding explanation should be disclosed. 
15 See Sustainable Accounting Standards of the investor-orientated Value Reporting Foundation that will merge into the ISSB by June 2022.  
16 Heller et al. 2021, Global Solutions Journal, Issue 7, 104-112.   
17 Berg, et al. 2019. Aggregate Confusion: The Divergence of ESG Ratings, MIT Sloan School of Management, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533  
18 Addy et al. 2019. Calculating the Value of Impact Investing, Harvard Business Review, https://hbr.org/2019/01/calculating-the-value-of-impact-investing