ISSB consultation: Enterprise value ‘unsuitable’ for needs of asset owners

HSBC Bank’s £36 billion pension fund has slammed enterprise value as “unsuitable for the current needs of asset owners” in its response to the International Sustainability Standard Board’s (ISSB) draft climate disclosure standards.

“Enterprise value is a backward-looking, lagging indicator,” HSBC Bank (UK) Pension Scheme wrote in its submission to the consultation, which closed late last month. “Universal owners need a double materiality lens to inform critical, long-term decision making.”

The ISSB, which was launched in November by the IFRS Foundation with the task of developing a global baseline for corporate sustainability reporting, has from the outset been clear in its intention to base this on enterprise value rather than the “double materiality” approach being pursued by the EU. Enterprise value measures how sustainability impacts a company’s valuation, whereas double materiality also seeks to capture a company’s impact on the environment and society.

The first draft sustainability disclosure standards – one on climate and a second on general requirements – were put out to consultation by the ISSB at the end of March. By the time the process closed at the end of July, the body had received more than 1,300 comment letters.

Many of those from European investors and associations referenced the enterprise value versus double materiality debate.

HSBC’s pension fund argued that corporate practices which maximise enterprise value at the individual entity level “can contribute to additional costs, or externalities, which can negatively impact the enterprise value of other firms in the portfolio”.

Since universal owners “seek more than just entity-level enterprise value to understand the value and risks faced by their total portfolio”, the fund stressed the importance of disclosures capturing these external negative impacts.

‘Double materiality’

HSBC’s pension fund has a reputation as a sustainability pioneer, having been the first to invest in Legal & General’s ‘climate-tilted’ Future World Fund in 2016. It described the absence of a double materiality lens as an “omission” that leaves asset owners potentially exposed.

It argued that the point at which a sustainability issue appears on a company’s radar from an enterprise perspective is “far later than the point at which investors need to understand the potential impact of an emerging issue”.

“A failure to recognise this ‘double materiality’ concept with respect to sustainability risks is likely to result in too narrow a focus being applied on sustainability risks, which is backward-looking and only ‘one way’ with respect to the impact of sustainability risks on an entity but not the impact of the entity on its external environment,” the fund added in its submission, which was signed off by CEO Lisa Young-Harry and CIO Brian Kilpatrick.

By contrast, Norway’s trillion-dollar sovereign wealth fund, Norges Bank Investment Management (NBIM), gave its support to ISSB’s approach, which it said “captures all information that can result in changes to the entity’s enterprise value in the short, medium and long-term, including from the entity’s actions that result in impacts and dependencies on people, planet and the economy”.

HSBC’s concerns were echoed by other UK-based investors, including investment firm Cardano, which wrote that its “primary suggestion” was that the climate draft “needs to address real-world impact (or ‘double materiality’)”. Similarly, the Church of England Pension Board stated that the draft standards will not meet investors’ needs and are “likely to exacerbate the lack of attention paid to sustainability issues in the investment system”.

Europe’s largest asset manager Amundi offered a “pragmatic and efficient way” to address the ISSB’s lack of attention to impact, suggesting that companies be required to disclose “a set of metrics of impacts on environmental and social sustainability, based upon the 64 principal adverse impacts (PAI) indicators defined in the EU regulation (SFDR)”.

The UK’s Financial Conduct Authority (FCA), a member of the ISSB’s multi-jurisdictional working group on harmonising standards, noted however that the current drafts would already require the considerations of external sustainability impacts that affect enterprise value “over an extended horizon”.

In March, Martin Moloney, secretary-general of IOSCO, the global body whose members regulate more than 95 percent of the world’s financial markets, told Responsible Investor that he believed the difference between “double materiality” and enterprise value would “shrink” as governments get more committed to sustainability investment programmes. Increasingly, he said, “the sustainability of your business model will become material to the enterprise and to its financial value”.