“Green economy” and “green finance” are common buzzwords these days as the world faces a deluge of environmental crises. But what exactly is a green economy, and how do we navigate the web of ESG impact measurement?

For any country that seeks green growth, the rise of interest in environmental, social and governance (ESG) values represents opportunities as well as risks, benefits and costs. In the pursuit of sustainable growth in the green economy, an effective and consistent quantitative system of measurement is critical for setting and meeting goals and keeping tabs on our progress.

According to Singapore Management University (SMU)’s Associate Professor of Finance Liang Hao, a

 “more transparent and reliable ESG impact measurement standard that can be integrated with financial reporting practice is becoming an increasingly important issue for companies, investors and regulators around the world”.

Prof Liang recently moderated a panel discussion on ESG Measurements & Standards, organised by SMU’s Sim Kee Boon Institute and Singapore Green Finance Centre on the side of the 4th annual Global Research Alliance for Sustainable Finance and Investment (GRASFI) Conference. He has also presented his findings on impact measurement and assessment, leveraged upon his working experience with industry partner DBS Bank, at the World Expo 2021.  

City Perspectives chats more with Prof Liang on how ESG standards help guide trillions of dollars of investment worldwide and curb the greenwashing problem, and ways in which organisations and policymakers can overcome hurdles to reliable and accurate measurements.

Identifying challenges faced in measuring and valuing impact

While there are frameworks aplenty being developed to track, assess and analyse ESG efforts, there is a lack of standardisation and comparability across these ecosystems. Numerous ESG ratings and metrics have been launched by third-party agencies in the hope of providing firm-level ratings and scores on ESG, but they fall short when it comes to transparency and are frequently criticised for not accurately reflecting stakeholder welfare. In addition, the way organisations choose to adopt these frameworks and implement them in corporate reporting poses another significant challenge to their usage.

Therefore, a key research focus of the team at the Singapore Green Finance Centre — an initiative of SMU and Imperial College Business School that conducts multidisciplinary research and talent development opportunities in the area of sustainability, climate and green finance — is on developing an impact-weighted account framework. The framework is an open-source standard for measuring and valuing impact, created in partnership with Impact Economy Foundation, Impact Institute, and Harvard Business School, and is publicly accessible by corporations, policymakers, investors and individuals.

And Prof Liang notes that while information and data transparency are often regarded as key challenges in ESG measurement, he feels that a more pressing concern lies in measurement methodology. This is because impact measurement is conducted by reporting organisations themselves, and they can decide the extent to which they are comfortable with disclosing their proprietary data.

“Ultimately, impact measurement is conducted by organisations that hold the data themselves,” notes Prof Liang.

“They are typically the end-users of impact measurement so they decide how much data they want to disclose or use to measure their own ESG impact.”

Methodology is yet another problem, especially in terms of determining the relevant scope of impact measurement and impact pathway. For example, when a bank lends to a palm oil plantation, a direct social impact may be that the workers receive salaries, while the indirect impact is that the workers can now fund a better education for their children, which in turn may enhance the life-long earnings of future generations.

The absolute impact is the impact due to the bank’s lending compared to a scenario that the palm oil plantation does not receive any financing at all, whereas the marginal impact is the difference between the outcomes of the bank’s lending compared to the scenario that the plantation receives financing from alternative banks or investors.

In this example, the key challenges lie in deciding the length of the value chain that should be traced to measure “indirect impact”, such as whether the welfare of the workers’ spouses should be measured, and not just that of their children. Furthermore, multiple factors may affect the measurement of “marginal impact”, such as differences in loan amounts and terms from one bank to another.

“This is just a very simple example and in practice we could have much more different indirect impact and reference scenarios,” admits Prof Liang.

“So you can imagine how challenging it is.”

Moreover, properly valuing an impact in standardised units is another major challenge. For example, carbon prices vary significantly across countries, so the monetary value for carbon emission will likely differ depending on where it is valued. The challenge is compounded by the valuation of social issues such as human rights, which cannot be measured by a natural unit and can be defined in infinite manners by different societies.

Back to basics
While there is no easy answer to designing a standardised framework, Prof Liang states that an appropriate ESG framework should be of a fundamental nature. That is, it comprehensively captures the welfare of various stakeholders across different capitals such as financial capital, manufactured capital, natural capital, human capital, social and relationship capital, and intellectual capital.

He adds: “These basic principles do not evolve so quickly.”

As regulations on what to be disclosed and what is considered as “ESG” rapidly evolve, more information becomes available. Such regulatory evolution also reflects a demand for accountability and transparency among consumers and investors in regions like Europe. This may lead to a change in the estimation of certain parameters from impact measurement.

“ESG frameworks and standards should be updated when regulatory requirements change, and when new information — such as an industry-wide controversy that negatively impacts investor perception — is disclosed,” says Prof Liang.

“But I think the fundamental frameworks would not change too much as regulations evolve. For example, the impact-weighted framework that we are co-developing is positioned to be a more general framework – it will be periodically updated to reflect the refinement of our estimation models and parameters, but the core idea remains the same: measuring and valuing impact across different capitals on various stakeholders.”

Uneven distribution of impact

While one would assume that stakeholders would be equally concerned about environmental, social and governance issues, the truth is that environmental issues, especially those concerning climate change, have garnered more action than other issues like social ones, says Prof Liang. This is in part due to increasing global attention on high-profile events such as the Paris Agreement and the UN Climate Change Conference (COP26) held recently, and intensive media coverage on climate change-related issues.

“Climate change is something that we all can feel,” adds Prof Liang.

“In contrast, many social issues such as workforce safety, gender inequality or the violation of human rights are not issues that everybody encounters on a daily basis, and they are more difficult to measure and standardise.”

Traditional governance issues, such as protecting shareholder rights, and ensuring the diversity and independence of a board structure, fair executive compensation, fraud and bribery, which are not trending as strongly as environmental problems, may also be overlooked as stakeholders have been discussing improving corporate governance issues for several decades now.

Moreover, there is a bias towards larger and more visible firms in making ESG commitments. For example, many multinational corporations such as P&G, Amazon and Microsoft have made ambitious net-zero commitments and most ESG ratings are also created for large listed companies on major equity indices.

However, private firms are increasingly invested in ESG. The rise of impact investing, which is mostly conducted by private equity investment targeting start-ups and private firms, also fuels ESG engagement by SMEs. As Prof Liang remarks, ESG engagement by SMEs can sometimes be more impactful, as such engagement has the flexibility to be focused and rapidly make changes within their organisations.

Currently, the rise in regulations by international bodies such as the EU Taxonomy for Sustainable Activities, Sustainable Finance Disclosure Regulation, Corporate Sustainability Reporting Directive, European Green Bond Standard, and Climate Benchmark in Europe helps combat greenwashing concerns among investors. The Monetary Authority of Singapore has also laid out the Singapore Green Finance Action Plan to support a sustainable Singapore and facilitate Asia’s transition to a sustainable future.

“There are many industry discussions and also many academic conferences on ESG, but they rarely intersect,” says Associate Professor Liang.

“This is what we are trying to do at the Singapore Green Finance Centre — to conduct more industry-relevant research, executive training programmes and collaborations with industry partners. At the end of the day, a sound investment strategy with both ESG and financial considerations well taken into account needs to be driven by rigorous analysis.”