Banking for Impact - impact accounting and the financial sector
The importance of impact accounting
Companies are increasingly being asked by stakeholders and regulators about the impact they are having on the world. In addition, more and more investors, non-governmental organizations (NGOs), and specialist groups are speaking out against companies deemed to be negatively impacting people and the planet. Financial firms, specifically, have become a focus for activist groups given the role they play in funding certain industries. While their efforts help bring attention to important topics, it is hard to assess such assertations without the proper tools to evaluate the real impact companies are having on the environment and society, or enter constructive discussions about the social cost of divesting too rapidly from industries known to be harmful. Fortunately, impact measurement methodologies are emerging to help create such a levelling language. One well-known study by the Harvard Business School Impact-Weighted Accounts Initiative (IWAI) assessed 1,800 publicly listed companies using impact monetization techniques and found 250 create more environmental damage annually than they earn in profit (source: Freiberg, D; Park, DG; Serafeim, G; and Zochowski, R (2021) Corporate Environmental Impact: Measurement, Data and Information). Yet the methods of evaluating non-financial impacts are still evolving, and increased standardization as to how to account for corporations’ ecological and societal footprint is still needed.
There are a variety of impact alignment efforts underway within the financial sector, and more broadly. The Principles for Responsible Banking (PRB) and Impact Management Project’s (IMP) Structured Network are both industry initiatives with impact measurement and management at their core. The former outlines robust corporate sustainability standards that align business strategy to the sustainable development goals (SDGs), while the latter is focused on industry convergence. Meanwhile, the Value Balancing Alliance (VBA) and Impact Weighted Account Framework (IWAF) are developing approaches to measure, monetize and report the impacts of corporations across all sectors. While a step in the right direction, none of these activities are focused on defining the impact accounting standards for financial institutions (FIs). And a focused effort is needed to solve for the added complexity of measuring and valuing impacts in the sector. For a diversified financial institution such as UBS, impact measurement requires the evaluation of direct and indirect activities – i.e. those that arise from clients via lending, financing, and investing decisions – and the majority of our impacts are indirect. In fact, it is estimated that 65-85% of industry GHG emissions are a result of client actions (source: Impact Institute’s Global Impact Database 2020). It is key for financial institutions to have a clear understanding of our client impacts and the role we play in contributing to these outcomes. Only once we can account for the full picture of these positive and negative impacts can we truly accelerate the transition of capital towards the annual USD 2.5-3 trillion SDG funding gap (source: UNEP FI Positive Impact Initiative (2018) Rethinking Impact to Finance the SDGs; UNEP FI and Sustainable Development Goals (SDGs) (2020); and Schoenmaker, D (2020) The Impact Economy: Balancing Profit and Impact, Bruegel. Banking for Impact (BFI) is at the forefront of this effort. As a consortium of banks (ABN AMRO, Danske, DBS and UBS) and impact experts (Harvard’s Impact Weighted Accounts Initiative (IWAI) and the Impact Institute), BFI aims to define a comprehensive and cost-effective method for impact measurement and valuation (IMV) to allow for the quantification, valuation, attribution and aggregation of impacts.
Firms who start to measure impact are better able to grasp the challenges their clients face.
The benefits for financial firms
IMV is crucial in understanding the changing needs of clients. Firms who start to measure impact are better able to grasp the challenges their clients face and transform their service offering to create solutions to help manage them. They understand where value is created and destroyed, make decisions that are aligned to clients’ interests, and ultimately generate higher returns for both shareholders and society. For example, Solvay, a leading global chemicals company, used IMV to analyze the potential environmental impacts of its product applications. They could identify those that were better for the planet and incorporated this information in their business planning process. As a result, in 2016-2018 Solvay increased average volume growth from these solutions by 4% (source: Serafeim, G; Dessain, V; and Mette, MF (2020) Sustainable Product Management at Solvay, Harvard Business School Case 120-081).
IMV improves long-term decision making. By converting environmental and social impacts into monetized units, they can be assessed in relative terms alongside financials. Senior leaders can properly gauge value creation while managing trade-offs. And as in the case of Harvard IWAI’s environmental study, investors, clients, employees, governments and society can understand which companies are better utilizing their resources.
In addition, greater impact transparency allows us to expand on the traditional view of materiality – how the environment and society impact enterprise value – by also measuring the impact of financial firms on people and planet. Referred to as “double materiality”, this perspective is becoming important to regulators – as highlighted by the European Commission’s proposed Corporate Social Reporting Directive (CSRD). With a better understanding of impact, FIs benefit by having more information to proactively manage foreseeable challenges. BFI members will acquire critical knowledge about the data, metrics, and frameworks needed for this changing regulatory landscape.
As an industry, we are in an excellent position to support this complex exercise. FIs have extensive experience, resources, and tools to measure risk and return which can be leveraged in evaluating social and environmental impacts. Additionally, we can facilitate funding to areas of the economy that create the most societal value and away from those where value is destroyed to increase our economy’s ‘true return on investment’. By joining forces with BFI, FIs can steer the development of metrics that create a more sustainable economy, while simultaneously reaping the benefits.
With a better understanding of impact, financial institutions benefit by having more information to proactively manage foreseeable challenges.
A call to action
In the near term, Banking for Impact will build concrete impact measurement guidelines for FIs, underpinned by the Impact-Weighted Accounts Framework (IWAF), to which BFI is an active contributor. BFI’s tailored guidance for FIs will include impact definitions, a standard classification list to support comparability and benchmarking, as well as substantive guidance for compiling and presenting high-quality impact information. As this framework becomes available, BFI encourages all banks to further test its robustness and provide constructive feedback to further develop and scale impact accounting across the industry. If we succeed, we will mobilize capital to the most positively impactful sectors and businesses, creating a better form of capitalism – one that benefits people, planet and the economy.