Sunday Brunch: is disclosure the 'exam technique' of sustainability?

When it comes to sustainability from a corporate perspective, there has been a heavy focus on disclosure as recent years have seen an acceleration in the implementation of frameworks and standards requiring management and operational teams to provide new disclosures. ISSB S1 and S2, CSRD, SFDR, TCFD and Nasdaq’s Board Diversity Rules are just a few examples of requirements that have either been finalised or became mandatory just in 2023!

Disclosure is important so that stakeholders, be they investors, employees or customers can clearly understand how a business is being sustainable and compare it with their other interests.

However, there has to be a business strategy too. That may seem obvious, but with the concepts behind ESG and sustainability being new to many, and the very 'compliance' nature of disclosure requirements, there has been a tendency to lean towards “What’s the minimum that I need to do?” 

For sustainability professionals, and particularly Chief Sustainability Officers (CSOs) that has meant an evolving role. As Alison Taylor and Robert G. Eccles put it:

"Historically CSOs have acted like stealth PR executives - their primary task was to tell an appealing story about corporate sustainability initiatives to the company's many stakeholders, and their implicit goal was to deflect reputational risk."

^{Alison Taylor, Robert G. Eccles, "The evolving Role of Chief Sustainability Officers", HBR}

However, the role is becoming more strategic and how what a business choose to do - or not to do - can help the broader business environment (which also includes THE environment!) and its own sources of competitive advantage.

Steven dived into the topic in a recent blog which you can read here 👇🏾

The evolving role of a Chief Sustainability Officer

As a prospective CSO perhaps one of the first questions you should ask of your new employer is ‘who will I report to’. The closer we are to the financial and strategy decision makers, the more influence we can have.

The Sustainable InvestorSteven Bowen

Strategy and disclosure are an 'inseparable pair'. We need both, particularly if we are to raise finance and frankly get things done. There is a positive feedback loop between them.

I found a parallel with how we study at school, at university and even in professional exams. How we learn. How we study. How we are assessed.

In many ways there is a 'tail wagging the dog' situation. We have historically been taught to pass exams first and foremost and not necessarily to understand the knowledge. League tables have only exacerbated that.

There is a key issue: the confusion between measures and targets. The target should be to equip children with the knowledge they need for life, how to apply it and how to learn. Exam success is a measure.

As Charles Goodhart famously postulated in the 1970s, which has come to be known as 'Goodhart's law':

"Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes."

^{Charles Goodhart, "Problems of Monetary Management: The UK Experience" 1975}

Or more simply, "when a measure becomes a target, it ceases to be a good measure."

Memorising and regurgitating can seem more efficient in an exam, but is it? I'll start with an example from my ... [big yawn] securities regulation and derivatives exams from 2001.

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Two cards or twenty?

Back in 2001 I moved from PwC to work on the trading floor at Morgan Stanley. One of the requirements was that I needed to be FSA regulated (now FCA) which included taking the regulatory and derivatives exams. To be frank the regulatory part was a big 'memorise the telephone book' exercise but I enjoyed the derivatives bit. It was mathematical and it suited my brain. I learned and understood the basics of the two fundamental options - calls and puts.

A call option gives the holder, for a relatively small upfront cost (the 'premium'), the right to buy a stock at a particular price (the 'strike' price) up until a specified date ('expiry'). They are not obliged to buy ('exercise' their option) hence the name 'option'. A put option gives the holder the right to sell at a particular price up until a specified date.

Options can be used to limit the loss on a position or magnify your gains given the small size of the premium relative to the price of the underlying stock.

Each option has a particular payout diagram which shows how much the buyer or seller makes as the stock price changes. Here are the basic ones for buying a call and a put (going 'long').

Of course options can be used in conjunction with each other to create interesting and complex payouts depending on what you want from them. For example a call spread, where you buy a call at one strike and sell another call at a higher strike for the same expiry is typically cheaper, less risky but limits your reward.

I can remember sitting outside the exam hall just before the derivative exam and I had two cards with notes on. One had four payout diagrams on it (although I could have gotten away with just the two above): Long call, long put, short (sell) call, short put. The other listed the different types of strategies. The cards were designed to jog and kick my mind into gear for the exam. I had already done the work and I understood the fundamentals.

I glanced over to the guy sitting next to me on the short wall just outside the exam hall. He had an A4 ring binder with pages and pages of drawn out payout diagrams for EVERY possible options strategy. He had chosen to memorise and regurgitate. That was his technique for passing the exam, and it is a valid one. For passing the exam. But is that the aim? Shouldn't it be to understand and apply to any derivative situation in the future?

And how does this relate to sustainability?

Disclosure and target setting: solution or distraction?

As I mentioned at the beginning we are seeing an acceleration in disclosure requirements coming in focused on sustainability and ESG. Companies are in some cases scrambling to meet those requirements but therein lies the rub. The focus is more on disclosure than it is on strategy, much as there can be too much focus on passing the exam rather than understanding the material.

And with too much of a disclosure focus we can end up with a focus on measures that become targets (remember Goodhart's law?).

One area where this is particularly prevalent is diversity, equity and inclusion (DEI).

For sustainability professionals, understanding the most effective way to develop and embed a DEI culture within a firm can enhance strategy and performance for the long term. However, with non-financial disclosure requirements increasingly focusing on DEI, is target setting which typically centres around demographic diversity at the board level helping or hindering the development of a culture of DEI. We discussed this in the context of diversity and inclusion here 👇🏾

Diversity target setting: solution or distraction?

Understanding the most effective way to embed a DEI culture within a firm can enhance performance. However, is narrow target setting, particularly centred on diversity, a help or hindrance?

The Sustainable InvestorSandy Jayaraj

In today's Sunday Brunch I have used studying for (and passing exams) to illustrate a point about sustainability strategy and disclosure. Exams (and coursework) are valuable in providing an efficient way of demonstrating a degree of skill but the balance has to be made in their approach. Exam technique is important in allowing a student to effectively demonstrate their knowledge but that knowledge and understanding needs to be there in the first place.

Sustainability needs to be part of an organisation's strategy. But what does this actually mean in practice? Two main areas:

• Sustainability as risk reduction: anticipating change including stranded assets, reducing future legal risks and shifts in markets that could turn competitive advantage into competitive disadvantage.
• Sustainability as a growth and value driver: building new sources of competitive advantage including supply chains and value propositions, competing with, and beating incumbents, innovation, and DEI as a value creator.

But strong reporting on and tracking of ESG initiatives also improves risk reduction and value creation feeding back into the strategic plan. It educates the business.

Bottom line, the two go side-by-side. They are an inseparable pair.

Please read: important legal stuff.