‘The worth of a thing is the price it will bring.’ I heard that phrase somewhere in my finance education and career and, although its origins aren’t entirely known, it’s stuck with me. Whether valuing a business’s operating division for sale or assessing the relevance of a sustainability issue and what to report about it, this saying always brings me back to being objective about what really matters.
But it’s not common to think about prices (or valuation) when it comes to assessing the relevance of sustainability issues. In many ways, that’s a problem. Articulating the potential effect an issue has on something’s value (and its price) can be an effective way to get senior-level interest in addressing it – whether to enable resilience or encourage growth – and then for reporting about it.
That’s why the International Sustainability Standards Board’s (ISSB) approach to identifying sustainability-related risks and opportunities (SRROs), coupled with the European Financial Reporting Advisory Group’s (EFRAG) method for identifying financially material sustainability matters, bring such a monumental change in the way sustainability is thought about in business.
Beyond virtue
When people see sustainability as being primarily (or only) about doing good things, being virtuous and being nice, the sustainability-related issues that can affect a company’s profitability, risk exposures and ultimately its value tend not to get the attention they need.
This is not to say that doing good things isn’t important. On the contrary, the positive impacts that stem from doing so and the negative impacts that can be avoided can have material financial benefits, immediately and over time. In fact, the distinction between financial materiality and impact materiality is not as stark as many seem to believe. Impacts and dependencies can have financial implications, sometimes quickly and sometimes slowly.
Use the 'It Proposition' to consider if a sustainability matter is a risk or opportunity
New York University professor Aswath Damodaran, in his 2024 Musing on Markets blog on catastrophic risk, refers to the ‘It Proposition’ when valuing an asset or business, and it is just as relevant for assessing sustainability issues. ‘For “it” to have value, “it” has to affect either the expected cashflows or the risk of an asset or business,’ he says. And risk is typically reflected in the cost of and ability to access capital.
Companies can use this simple principle to consider whether a sustainability matter qualifies as a risk or opportunity (or an impact that might turn into either) that can reasonably be expected to affect their cashflows, access to finance or cost of capital over time.
Assessing impact
How can companies assess whether a sustainability issue is relevant to their business and what implications it may have, financially or operationally? Here are a few ideas for getting started.
Evaluate the relevance of the issue to your financial planning activities. Ask yourself: Is there a revenue, cost or investment implication associated with it, whether positive or negative, during your planning horizons? Are you confident your planning horizons are long enough to allow you to see what may be coming? While the sustainability disclosure standards don’t have quantitative thresholds, a general rule of thumb could be whether this is something that keeps, or should keep, the board and executives up at night.
Ask questions such as: Could this make or break your business?
Identify effective ways to mitigate (or, in the case of opportunities, capitalise on) the issue, and frankly consider whether the cost of managing it is less than the benefits of doing so. This will tell you how serious the issue is and how seriously it should be taken, and will give helpful input to the financial planning evaluation above.
Ask questions such as: Could this make or break your business? Could this become an issue if current events or trends continue? Is this relevant for others around you, even if it doesn’t seem relevant to you? Ultimately, if an issue needs to be managed, it will be factored into the financial planning process. If it doesn’t, it probably isn’t significant for your business, at least for now, but it’s wise to keep an eye on it.
Finally, focus on what’s meaningful and relevant. Start by asking: What could affect your share price, expected returns or cost of debt? What could make your business not investable in the medium to long term? An issue only needs to meet one of the ISSB’s ‘prospects’ criteria – cashflows, access to finance or cost of capital – to be an SRRO that you need to make disclosures about. And, whether materiality is assessed top down or bottom up the objective is the same.
But don’t search high and low to find sustainability issues that just might be relevant. I start with top-down (what matters for this business, in this industry, in this geography) and use bottom-up (detailed review of the issues that could be relevant) as a check for completeness to make sure nothing important was missed.
Approaching sustainability – and sustainability disclosures – in this way can help avoid two common responses to how people deal with threats to their business: denial and then panic.
Having information about what matters and over what time horizon it might arise can help companies come up with a plan early on for mitigating risks and capitalising on opportunities. This will give them time to build in adaptability, for both protection and growth. And that has value.
