Category Archives: sustainability

Auditor QuickQuiz Update

Our short auditor skills QuickQuiz has only been live for a few days and we have logged responses.  The number of respondents is smaller than anticipated but trends are appearing.

The Good:  Respondents understand follow through with sampling plans, are aware of the Fraud Triangle and know the role body language plays in interviews.

The Bad:  Most importantly, respondents have been unable to identify specific threats to auditor independence and they have demonstrated a lower-than-expected understanding evidence corroboration and hierarchy.  Other areas where knowledge improvements seem necessary are materiality determinations, awareness of basic audit terminology and the scope of a QA/QC review.

Keep those responses coming in, and thank you for taking a few minutes to complete it.

RY2016 Conflict Minerals Disclosure Analysis Now Available From Development International

Dr. Chris Bayer, PhD of Development International has released the latest comprehensive analysis of the SEC conflict minerals disclosures for the 2016 reporting year.  Elm Sustainability Partners is pleased to be one of the report’s sponsors this year.

The report is available to download for free.

 

A 1960s Economic Model for Sustainability Value

Innovation can create “extra-normal profits” – profits higher than the normal expected ROI based on the risk. But these extra-normal profits are short-lived and disappear once the innovation has been adopted by competitors, thereby equalizing the playing field. You may know these by the term “first mover advantage” – something intangible. But there is a 50 year old economic model for this, known by a far more difficult-to-pronounce name – Schumpeterian profits,  after German economist Joseph Schumpeter.

In April 2004, Yale Economics Professor William D. Nordhaus penned what has become a widely referenced Working Paper for the National Bureau of Economic Research (NBER). Then in 2015, Xie Fan School of Economics & Management at South China Normal University followed up with a study more specific to sustainability matters (more on that paper later).

To summarize Nordhaus, innovation generally leads to reduction in the cost of production without a concurrent reduction in the price charged for the product, meaning increased profit for the innovator until such time as others “appropriate” the innovation and create more or less equal competition. An example of this is patents – once a patent expires, other companies can sell essentially the same product, driving prices down, along with the “extra-normal” profits of the original patent holder. Very simply, the longer a company can hold on to its innovation on an exclusive basis, the longer it can maintain those higher profits. Nordhaus presents a formula for calculating specific values. Looking at historical data from 1948 – 2001, he estimated the Schumpeterian profits (i.e., the extra-normal profits only) to range from -1.3% (during the major recession of the 1970s) to a high of 6.3% of total corporate profits.

We reached out to Nordhaus to see if his paper has been updated and the applicability to sustainability. He answered that no update has been issued. His response about sustainability reflected a limited (and perhaps erroneous) concept of sustainability as relating primarily to environmental protection. This is important in one respect that we won’t delve into here (it relates to the social value of innovation), but in our view is less of a factor than the direct production cost reductions achieved from business-focused sustainability initiatives.

Xie Fan explored whether innovations related to CO2 emissions regulations in China had an economic development benefit as well as an environmental one. Fan’s summary states that

… first of all, the environmental regulation affects the total factor productivity growth in China’s pollution-intensive industries; in the second place, the environmental regulation does not promote producer’s scientific and technological innovation level in China’s pollution-intensive industries; in the third place, the environmental regulation has reduced Schumpeter profits in China’s pollution-intensive industries.

In the end, we see that both Fan and Nordhaus offer complementary  models for sustainability value. In our view, Fan’s point is that once an environmental issue becomes regulated, compliance innovation may not provide Schumpeterian profits, although this seems to contradict the famous Porter Hypothesis. Yet applying Nordhaus to discretionary sustainability business innovation, short term extra-normal profits are to be expected and can be estimated with his formula.  But doing so may also involve reducing transparency in order to maintain exclusivity of sustainability innovations.

All food for thought.

 

 

 

 

 

Make it Difficult or Make it Easy

Sustainability and CSR can be difficult concepts to grasp, especially when trying to make a business case for them. We ran across two contrasting philosophies in this regard recently.

The first is this Sustainability ROI notebook – an excel spreadsheet that one could call extremely thorough, if not overly complicated. We haven’t used it in practice, but we read through it thinking about our past experiences in quantifying actual economic value of sustainability/CSR initiatives. The spreadsheet is more likely to be helpful to the inexperienced than sustainability veterans. And while it could be useful in organizing one’s thoughts and numbers, it is not something we would recommend presenting to management. Which takes us to…

This article, while not specifically about sustainability/CSR, is wholly on-point. Simplicity, brevity and conciseness wins points. We have written many times about presenting sustainability in a way that is meaningful to the audience (e.g., management) rather than to a sustainability practitioner. It may be helpful to have details such as those in the Sustainability ROI notebook available to you, but your audience is unlikely to ask in such depth.

Einstein is credited with saying “The definition of genius is taking the complex and making it simple.” That’s pretty smart.

 

 

 

 

Is The Money Moving Away From Sustainability?

Sustainability professionals just got a kick in the gut, or a boost in confidence depending on how you look at it.

Jason Karp of Tourbillon Capital, a $3.7 billion hedge fund, wrote a letter to investors earlier this summer stating “One of today’s greatest market inefficiencies may stem from the scarcity of capital devoted toward long-term, fundamental investing.” He continued, “People are just paying significantly more for assets without any fundamental improvement in those assets… big multiples got bigger while fundamentals remained the same.”

We’ve all known about short-termism for some time, but this got me thinking – just how far has equities valuation moved away from business fundamentals? And if disparities between stock price and the company’s underlying fundamentals continue as Karp cautions, might that call into question whether foundational principles of sustainability value are valid? This could be an existential crisis for the concept of sustainability.

There are differing schools of thought about equities valuation, including the “efficient market” and behavioral economics. The efficient market theory is similar to Adam Smith’s invisible hand – the market analyzes all available information about a company and the stock price quickly adjusts in response. Behavioral economics theorizes that stock prices are a result of imprecise impressions and beliefs – human emotions and gut feelings rather than formal analyses.

On one hand, it could be argued that increased sustainability transparency helps an efficient market and should provide a “feel good” basis for less rational decisions short term (i.e., behavioral economics). Numerous studies over at least a decade have generally shown inconclusive results at best.

Yet sustainability is inherently a long-term view and business fundamentals are also a reflection of a company’s anticipated future. Karp’s comments demonstrate the difficulty sustainability practitioners have had in attracting management attention.

The same thinking is mirrored in recent comments from Tim Koller, a principal in McKinsey & Company’s New York office.  When asked about sustainability, he said

I think we have to separate the mechanics of valuation from what managers should be doing to maximize a company’s value and how investors react to the whole thing. For hundreds of years, the value of a company has ultimately come down to the cash flows it generated. That’s what you can spend as an owner, whether you’re a private owner or whether you’re a shareholder in a large company.

Now, there have been periods of time when people said, “Oh, the rules are changing.” For example, during the dot-com bubble, all of a sudden, people said, “Traditional methods of valuation don’t make sense anymore—look at all these companies with high valuations that have nothing to do with cash flow.” Well, ultimately, it was the lack of cash flow that brought those companies’ valuations back down.

That sums it up pretty well.

But lets be honest here – $3.7B really isn’t that big a fund so its’ sphere of influence is limited. Still…

 

Is 2017 the Time to Think About 2021?

This may sound like a US presidential election campaign, but thankfully it’s not. The EU conflict minerals directive is now final and reporting is required beginning January 1, 2021 – three and a half years from now. If you aren’t familiar with the upcoming EU conflict minerals due diligence and reporting obligations, take a moment to read what we think is a good, plain-language overview.

We have had many conversations about what the EU Directive means for companies right now. Below is a table of the more common discussion points that may be helpful to those grappling with whether to begin program development and implementation now or wait until the deadline is closer.

Pros

Cons

Third party service provider costs are low at this time due to maturity of conflict minerals reporting in US Program implementation costs and effort not yet necessary
Limited incremental costs for EU companies already reporting conflict minerals information to US customers or the SEC Program implementation costs and effort not yet necessary; regulatory uncertainty exists until member states adopt their own supporting mandates.
Flexibility in reporting Reporting format unknown at this time; regulatory uncertainty exists until member states adopt their own supporting mandates.
Potential competitive advantage may be gained with customers and corporate reputation Market awareness may be low currently, so investment now may not show a return
Acquire experience and correct program errors and gaps in advance of legal deadline, reduce risk of fines, penalties, customer pressure and reputational damage Further options and third party information sources likely to develop and improve over time, leading to better reporting at legal deadline

 

Feel free to contact us with any questions.

New Advanced Auditor Training Program for HSE/CSR Auditors

Elm Sustainability Partners and Elm Consulting Group International have launched a new training module for senior-level and experienced health, safety, environmental and social auditors seeking to improve their auditing skills and get updates on timely topics related to non-financial auditing and technology.

It is also relevant to those buying HSE/CSR audit services who are looking to improve the quality of audits they receive.  After this course, buyers can identify specific areas of audit practice improvements to request of their providers.  Alternatively, these buyers may wish to require their external HSE/CSR auditor to complete this training themselves.

A partial list of what is covered includes detailed review and practicum concerning:

  • auditor independence standards and managing impairment threats
  • audit criteria requirements
  • audit and evidence limitations
  • evidence hierarchy, weighting and corroboration
  • fraud, forgery and tampering – including new concerns brought about by technology
  • interviewing skills including fraud examination and FBI techniques
  • discussions of US Department of Justice Criminal Division Evaluation of Compliance Program criteria (2017), the June 1, 2017 US Public Company Accounting Oversight Board (“PCAOB”) auditor reporting standard on Critical Audit Matters and EU Non-financial reporting rule
  • audit QA/QC considerations

Each participant will take a pre-test to establish a knowledge baseline and identify specific areas for improvements.  Exercises are administered throughout and a post-test will conclude the session demonstrating the advanced competencies gained.  HSE/CSR regulatory and other technical topics will not be covered as this is not a regulatory update session.

Elm Principals are BEAC Certified Professional Environmental/Health/Safety Auditors (CPEA), have served on the Board of Directors of The Auditing Roundtable (recently merged into the Institute of Internal Auditors (IIA)) and BEAC, and have trained thousands of internal and external HSE auditors over the past three decades.

Contact us to learn how you and your team can take advantage of this unique program.

New Social Auditor Certification in the Works

We have been vocal in our concerns and criticisms concerning social/CSR auditing.  And we have ourselves been criticized for that. Fair enough.

The Association for Professional Social Compliance Auditors (APSCA) has released for public comment its draft Code of Conduct and Auditor Competency Standards – available here.

We support APSCA and its work towards improving the entire “ecosystem” of CSR auditing.  Anyone with a dog in this hunt should click on the link above and submit comments.  APSCA is keen to obtain input from as wide a range of stakeholders as possible to help become as credible as possible.  Given the breath of subject matter that is being demanded of CSR auditors by buyers of their services, there is a great deal of overlap in APSCA’s draft into environmental health, safety, transportation and other technical areas.

No Indication of Conflict Minerals Cutbacks in SEC FY2018 Budget

SEC Chairman Jay Clayton presented the FY2018 budget for the Securities and Exchange Commission to Congress today.  The conflict minerals disclosure was not specifically mentioned but the budget did contain some interesting details:

  • More than half of the Commission’s total headcount is assigned to enforcement activities of various types.
  • The SEC has not launched any new research initiatives to gather feedback from investors on the usefulness of disclosures since FY2012.  Apparently, the actions of Michael Piwowar concerning the conflict minerals disclosure were not based on formal research from the SEC itself about investor views.
  • The number of filings reviewed by the Division of Corporation Finance for CY2017 was 4900, and is expected to remain the same for CY2018.  Sarbanes-Oxley requires the SEC to review company filings at least every three years, so perhaps there is some level of review by the SEC of conflict minerals disclosures, even if no enforcement actions have (or apparently will) resulted.

 

Conflict Minerals is Dead! Long Live Conflict Minerals!

The deadline for filing the CY2016 SEC conflict minerals disclosure has now passed, although there are likely to be a few late filers. It is too early to glean anything from the filings and at least three analyses will be conducted, including the Development International study, which is the most comprehensive of them. We all anxiously await these reports.

The future of the SEC disclosure requirement is murky and there is a chance that this may be the last year of mandated filing in the US. Many clients and others are asking us questions about the future of conflict minerals, and what the past results have been. These are our thoughts.

Looking forward, we do not know what is in store for the SEC rule. There are many moving parts politically and publically. We will know what happens when it happens. I’d like to think there will be adequate advance notice to those impacted, but even that is not assured.

But the review mirror tells a story too. While aspects of the rule’s impact are hotly debated, one thing is indisputable – it resulted in much greater visibility into material sourcing and other companies deep in supply chains. This has allowed some companies to reduce business risk by optimizing their supply chains – concentrating spending power or diversifying their supply base to manage potential disruptions. Companies identified that, unbeknownst to them, entities sanctioned by the US Department of Treasury Office of Foreign Asset Control (OFAC) may have been present in their supply chains. Supplier audits/screening improved in many cases.  Appropriate auditor qualifications in light of global reliance on audit results has also become a major question in the scheme of things.

Of course, the rule brought human rights abuses in the DRC and other countries out of the shadows and into the light of the public. But has the population of the DRC benefitted? Experts continue to argue both sides of the question. Without taking sides, earlier this year we attempted to evaluate one major criticism of the SEC rule – that it directly resulted in hundreds of thousands, if not millions, of jobs lost in the 3TG mining sector. The question we posed ourselves was what impact did the 2008 – 2010 global economic recession have on artisanal and small miner (ASM) job losses which are currently attributed only to Dodd-Frank Section 1502? Did the timing of 1502 coincidentally occur at a time when mining jobs were already in decline because of pre-existing macroeconomic conditions?

Our intent was to rely on existing literature rather than creating original research as this was an unfunded effort on our own part. After a few months, we ran into two insurmountable obstacles:

  • The existing DRC-specific literature we found does not acknowledge or give any consideration to potential impacts of the 2008 – 2010 global economic recession. Yet analyses from The World Bank, the World Economic Forum (WEF) and the International Finance Corporation (IFC) demonstrate that global economic downturns play a major role in commodity prices and mining jobs worldwide, including ASM.
  • The DRC has a uniquely major informal economy which some literature indicated accounts for up to 80% of the country’s total economic activity annually. There is a significant gap in available information on DRC’s informal economy and what is available was sometimes inconsistent with other data on the same matter or irrelevant to our study.

We found only two sources referencing global 3TG price influence on prices paid to DRC ASMs.  Other data supported the position that a very large number of ASM miners in DRC move between multiple jobs based on income potential, so when ore prices were low in the past, miners moved to agriculture or other income sources. There was a meaningful amount of anecdotal information supporting the hypothesis that several factors other than Section 1502 (such as the DRC’s own taxation and mining policies) had a direct effect on DRC ASM job losses within the timeframe of interest, but we were not willing to rely on non-empirical information. We put down our pen (or mouse) and moved on to other things.

So the debate will continue.

There have been developments beyond just the SEC rule. The European Union adopted their own version of a conflict minerals due diligence rule that impacts a different class of companies and goes into effect in 2021. And the application of the OECD Due Diligence Framework is expanding into other materials (such as cobalt) and other geographies. At the moment, that appears to be just the beginning of that trend and that future is unknown as well.

In the end, what can be said about Section 1502 in consideration of it’s possible end? It all depends on your perspective, but it ain’t over till it’s over.  And it ain’t over.