Frequently Asked Questions
Sustainability-orientated innovation (SOI) – also called green innovation or eco innovation – is any innovation undertaken for either the primary or secondary purpose of achieving environmental- sustainability benefits. SOI includes innovations undertaken to lower resource or energy consumption, lower GHG emissions or other forms of pollution, implement circular or restorative business models, protect biodiversity, etc.
The urgency and importance of the sustainability imperative faced by all humanity needs no introduction. To meet this great challenge, we must harness our collective ingenuity and energy to innovate solutions that solve many sustainability problems. This challenge cannot be left to government or nonprofits – the contribution of the private sector is absolutely essential if we are to achieve the transformation we need at the scale we need, in the short time frame we have left to do it.
While sustainability has been important for a long time, there is a new awareness and urgency in the corporate world. This is driven by recent alarming reports from the IPPC and IEA that stress the need for urgency climate actions within the next decade, big new government initiatives such as the European Green Deal, and new regulatory actions such as the Securities and Exchange Commission requiring public companies to disclose more information about how they are responding to climate change threats. The courts and investment community are also exercising pressure: Just this past May a Dutch court ordered Shell to lower emissions, and pro-climate-action activist shareholders succeeded in winning seats on the Exxon board. Companies are starting to see sustainability not as an imposed cost, or window-dressing to puff up an ESG program, but as a competitive edge and path to profitability. Banks are increasingly reluctant to finance fossil-fuel projects but trillions of dollars are pouring into green financing. Furthermore, boards are being advised to build sustainability incentives into CEO compensation.
In this general climate of concern, one would hope that most organizations see the urgent need for improving their processes and products to be more environmentally sustainable. However, particular events may spur individual corporations into improving their SOI capabilities and performance:
- A change in government environmental regulations that mandates major changes to a company’s products or operations
- Adverse media attention for environmental performance and/or challenges by shareholder activists who demand improved environmental outcomes
- Increased priority attached to environmental performance by large institutional shareholders (in the case of public companies) or major family shareholders (in the case of private companies)
- Receiving a poor rating on an environmental report or ESG rating that makes the company less attractive to investors
ESG stands for Environmental, Social and Corporate Governance. It may be viewed as the set of nonfinancial issues of greatest concern to shareholders. ESG is an outgrowth of the responsible investing movement and both institutional and individual investors are increasingly taking ESG considerations into account when making investment decisions. There is evidence that good ESG performance is positively correlated with good financial performance, and vice versa.
The Environmental term in ESG refers to resource usage, waste generation, and the effects of corporate activities on the planet in general. Green-house gas (GHG) emission reduction, transitioning to sustainable energy sources, reduction in plastic and other waste, and protecting biodiversity are corporate initiatives to improve the Environmental part of ESG. SOI done right will yield the outcomes in these areas that will improve a company’s environmental performance.
The international investment community has been actively mobilizing around ESG in recent years. Over 3,000 institutional investors representing over USD 100 trillion in assets are already signatories to the Principles for Responsible Investment (PRI), a set of ESG-related investment principles, thereby pledging to incorporate ESG into their investment decision-making. In the United States, over $17 trillion (one third) of professionally managed assets are currently invested in line with ESG considerations. Individual investors, in particular the younger Millennial and Gen Z generations, are also increasingly emphasizing investments that align with their values. Such investors incorporate ESG considerations into their individual investing decisions. The same trends are playing out in the job market, with younger workers being more willing to take a pay cut to rather work for a socially responsible company.
At this time, ESG reports are published voluntarily by companies. ESG ratings are provided for securities by various independent ratings organizations. MSCI and Sustainalytics (now part of Morningstar) are considered the biggest in terms of coverage. Other major providers of ESG ratings include Bloomberg, FTSE Russell, Institutional Shareholder Services (ISS), CDP (a charity), S&P, and Moody’s. The Global Reporting Initiative (GRI) is a comprehensive disclosure standard used in corporate sustainability reporting.
Because they are not yet mandated by regulators, ESG ratings are not standardized but vary depending on the provider due to the use of different methodologies, metrics, data and weighting. The fact that there is no single ESG score has been creating considerable confusion in the market. Breaking down the various ESG ratings into environmental (E), social (S) and governance (G) factors and their subcategories is the best way to analyze the presently available ESG ratings. The U.S. Securities and Exchange Commission (SEC) under chair Gary Gensler is currently looking at making new rules regarding climate change reporting. A major reason for the SEC to step in is to improve decision making through standardized metrics.
Regardless of the particular environmental (E) factors measured by raters, innovation in the form of SOI will be needed to improve a company’s performance on those metrics. A strong SOI capability therefore becomes a prerequisite for success at innovating the outcomes that are captured in environmental reports.
The purpose of innovation is to bring forth valuable and desirable outcomes. If a company improves its SOI capabilities and addresses the barriers to SOI in its organization (SOI capabilities and barriers are both assessed in SustainnovationTM) it will be much more likely to succeed at producing the kind of sustainability benefits that do get captured in standard sustainability reports, e.g. GHG reductions.
Some reports, such as GRI’s Disclosure 306-2, also specifically tests for activities related to business model innovation and value-chain collaboration for the purpose of reducing waste.
In short, SustainnovationTM is an assessment tool that helps companies understand how to get better at innovating for the specific outcomes that do get measured in standard environmental-sustainability reports. In addition, some of the innovation practices measured by SustainnovationTM may be directly relevant inputs for particular reporting regimes.
As public pressure mounts on governments, they are setting ever stricter mandates for environmental sustainability. Only companies that have the ability to innovate towards these outcomes, i.e. are able to do SOI well, will be able to successfully overcome the challenges posed by such new mandates.
There are by now many international agreements and treaties that entail working towards sustainability. The two most important are the UN Sustainable Development Goals (SDGs) and the Paris Agreement to combat climate change. (The 26th UN Climate Change Conference (known as COP26) will be held in Glasgow from October 31 to November 12 this year, and more commitments may result from that.)
In 2015, the member states of the United Nations adopted the 2030 Agenda for Sustainable Development, containing 17 SDGs. The SDGs are a broad set of goals comprising not only environmental sustainability goals, but also socio-economic and social-justice goals such as “no poverty,” “zero hunger,” and “gender equality.” Several SDGs are directly related to environmental sustainability and these will rely heavily on SOI in order to be reached:
- SDG 7. Affordable and Clean Energy
- SDG 11. Sustainable Cities and Communities
- SDG 12. Responsible Consumption and Production
- SDG 13. Climate Action
- SDG 14. Life Below Water
- SDG 15. Life On Land
The Paris Agreement (2015) on climate change was adopted by 196 parties (countries), and it went into effect in 2016. It is a legally-binding international treaty with the goal of limiting global warning to “well below” 2° Celsius, preferably 1.5° Celsius, above preindustrial levels. Countries who signed the agreement commit to reducing their total greenhouse-gas (GHG) emissions as soon as possible. The Paris Agreement relies on future technological innovation to achieve its goals, and it incorporates a vision of both developing new technologies and transferring them around the world.
To the extent that companies can improve their SOI capabilities, they will be much more likely to contribute to the relevant SDGs and to the attainment of the Paris GHG targets committed to by their respective countries.