Historically, environmental impacts created by humanity have been considered external to the market economy. They are either “externalities” since dumping toxic waste into rivers is “external” to the company property (and the P&L) or they are “public goods” such as global fisheries that seemingly defy effective global management. While governments and the international community struggle to figure out a way to manage environmental impacts, our fragile planet’s life support systems continually shrink against the expanding negative impact of human “development” on forests, rivers, oceans, prairies, tundra, and most of the non-human species who cling to existence in their diminishing habitats. Is our only hope the same competitive nature that has caused the majority of these problems? Can corporations be redirected towards solving the planet’s social and environmental crises? Can the source of the problem be the solution as well?
How can we align business objectives and sustainability? Several trends indicate significant steps are being made in the right direction. These include Impact Investing, increased use of and disclosure of ratings and metrics, and the increasing use of market-based tools for environmental management.
First, there is the emergence of increased interest and capital flow into what have been termed “Impact Investments”. These are defined as “investments intended to create positive impact beyond financial return”. A recent report suggests there could be over a trillion dollars of investment opportunities. If we include a broad definition of Impact Investments with the full range of sustainability sectors such as clean tech and renewable energy as well as the more traditional Bottom of the Pyramid (BOP) investments such as microfinance, rural electrification, and fair trade, the number will be much higher. Impact investments differ from Socially Responsible Investments (SRI) in that SRI tends to involve only publically traded companies that are screened against various filters and where shareholder activism is the main tool to push corporations to reduce their impacts. Although SRI and corporate social responsibility show enormous promise for slowing down humanity’s destructive arc, Impact Investing can capture the spirit of social entrepreneurship, startup creativity, and rapid developing market penetration to create the level of impacts needed to reverse some of the largest negative trends.
Impact Investors are making investments in private funds, startup companies, and small to mid-size enterprises and seek double- or triple-bottom-line returns. The investors want a financial return and they want their money to matter. The investments provide a risk adjusted financial return together with measurable social or environmental benefits. Financial instruments of this type span the gamut to include different forms of debt, equity, cooperative shares, and limited partnerships (funds). According to Mission Markets, a company created to facilitate sustainability and impact investments (disclosure, the author is a consultant to Mission Markets), an impact investment is validated as such when using some kind of third party assessment, rating, or certification; termed “ratings” here for simplicity. Additionally, in most cases, there is an effort to quantitatively measure the social and environmental impacts of the company’s activities, termed “metrics”. Rating systems provide scores by which investors can compare companies and monitor annual progress. There are many rating systems for public companies including Trucost’s partnership with Newsweek to create “Green Rankings”. Fewer rating systems have widespread acceptance for private companies but B Labs has been working with multiple partners to develop and launch the Global Impact Investing Rating System (GIIRS). This rating system has the potential to evolve into an international standard for social enterprises and investment funds.
As important as rating systems are for comparative and historical perspectives, actual impact metrics are even more valuable in the long term. In fact, the best rating systems will use quantitative metrics as part of their analysis (as is the case for Green Rankings). The search for standardized impact metrics is ongoing and has taken a leap forward with the establishment the Impact Reporting Information System (IRIS). The IRIS taxonomy defines terms used in measuring impacts. Other systems have been designed and are being refined that help guide companies and organizations through the process of identifying their impact objectives, activities, outcomes, and measureable impacts in a systematic way. These systems often seek to help quantify what is termed “Social Return on Investment,” (SROI) that uses economic analysis combined with the systematic metrics described above to estimate the social wealth created by a company or initiative. Similar tools could be developed to measure the Environmental Return on Investment (“EROI”?) but currently most environmental assessments are focused on risk mitigation rather than positive returns. Both social and environmental ratings and metrics systems continue to evolve and improve and are critical to increasing the flow of capital into impact investing.
Another promising trend is that companies are increasingly disclosing their environmental and social ratings and metrics so that investors and consumers can act on this information. This sharing occurs through both corporate social responsibility (CSR) reporting and emerging product-based footprinting disclosures. CSR reporting is rapidly becoming a corporate obligation and groups like the Global Reporting Initiative are establishing needed reporting norms. Product footprinting holds even more promise as a lever for significant changes. One example initiated by the Sustainable Apparel Coalition – a group that includes Wal-Mart andPatagonia among others – seeks to report and reduce the social and environmental impacts of a wide range of apparel and footwear products. Improved quantification of the impacts inherent in supply chains and production methods for various products will help companies with publically presenting each product’s full life cycle footprint to end consumers. With this public disclosure, the members of this coalition will be incentivized to constantly improving their design, production, and sourcing efforts to keep these footprints to a minimum. If footprint information is presented effectively, consumers will increasingly demand footprints for other products as well. Currently there is minimal transparency with the impacts of our purchases. As transparency increases, consumers can better integrate the entirety of a product’s impact into their buying decisions. California’s requirement of disclosure of toxic ingredients might lead to requirements for disclosure of energy and water use, waste, toxicity, carbon, etc. This will allow companies to compete on sustainability in addition to price. Many of these Coalition partners and numerous other corporations worldwide, see sustainability as a key branding issue. Improved disclosure will decrease “green washing” and improve real sustainability. Companies who truly are sustainability leaders will be better recognized – a great benefit to brand and employee satisfaction.
Measuring and reporting social and environmental impacts is a necessary but insufficient means towards achieving sustainability. Consumer demand, government regulation, and personal ethics are part of the drive that helps move businesses of all sizes towards sustainability. Once the drive is there, how far can companies go towards actually achieving “sustainable business”? Currently there are very few commercial activities that are truly sustainable. For example, any use of fossil fuels or other non renewable resource that cannot be 100% recovered or recycled is non-sustainable by definition. This is where the concept of environmental “offsets” and other market-based mechanisms enters the toolkit. Commonly used for carbon emissions, wetlands and endangered species habitat, environmental offsets allow companies to purchase credits that counterbalance their negative environmental impacts. In concept, offsets should be allowed after a company has made all “economical” efforts to reduce their footprint so the offsets counter post-mitigation residual negative impacts of commercial activities. That is after the company reduces its impacts, it can offset the remaining impacts through purchasing offsets for its water use, carbon emissions, impacts on wetlands and habitats, etc. Offset markets exists for carbon, SO2, NOx and are emerging for water quality and other environmental assets. The value of market-based mechanisms is their ability to encourage economic efficiency. The market will determine if tree planting, methane capture, energy efficiency, etc. is the cheapest way to reduce atmospheric CO2 and with the right market signals, this evolution will continue and reward innovation.
In the case of wetland and habitat banking, land developers in the US are required to offset their impacts to wetlands or endangered species habitats through creating, restoring, or enhancing (or preservation in certain cases) wetland or endangered species habitat. Environmental bankers conduct the work and federal credit certification in anticipation of demand from developers then bank the credits until a developer requires them for permitting. This is currently a $2bn dollar industry (see Ecosystem Marketplace). The ecological benefits of banking and offsets can be significant as the bankers establish large, contiguous wetlands and other habitats that significantly improve long term viability of these ecosystems into the future. These examples of offsets create an economically and ecologically valuable means of getting to “net zero” (also called “no net loss”) – allowing a corporation to offset all of their residual negative impacts so their products and services have no net negative impact on the planet while they develop more sustainable products and processes. Given the trend towards increased disclosure, the ability of a company to offset its remaining impacts can lead to a product that has a net zero impact (and even a positive impact). The European Union has recently made advances towards the use of biodiversity and ecosystem offsets.
The combination of increased metrics tracking, disclosure of corporate and product-based social and environmental footprints, and the expansion of environmental offset markets creates the opportunity for an economically efficient means to rapidly decrease our impact on the planet. In order to generate the most effective impact reductions, standards are key; for metrics, reporting, and verifiable offset programs. As described above, there is significant progress on many of these fronts. The latter is perhaps the area where the greatest amount of work is needed as many environmental impacts are complicated, difficult to measure, and interact with other features of the economy and environment. Yet the complexity does not diminish the need and the opportunity for these market based solutions. Advances are being made to establish verifiable standards for water quality, water supply, a range of carbon offset solutions including Reduced Emissions from Deforestation and Forest Degradation (REDD), biodiversity, wetlands, habitats, etc. The gamut of environmental services range from local through global – creating challenges towards the establishment of a global market based trading system. Increasing examples of successful small scale “Payment for Ecosystem Services” (PES) systems are emerging and could lead to larger regional and national markets. A common example is where farmers upstream in watersheds are paid by water users (including hydro-electric dams) downstream to maintain watershed quality through tree planting and other easily verifiable activities. Over time, it should be possible for the diversity of local market-based mechanisms to be integrated into a global marketplace for environmental services and attributes such that companies of all sizes can offset their residual environmental footprints and economically achieve net zero while they transition their businesses internally towards more sustainable products and processes.