What is a sustainability index and why are they important?
Our resident ESG consultant Sami Mustapha dives into exactly what sustainability indexes are, what the benefits are, and why they’re such a hot topic.
What is a sustainability index?
A sustainability index is an instrument used to measure the sustainability of a business across environmental and social factors. It provides non-financial data that can tell investors and stakeholders how a company is managed in a day-to-day setting and the importance that they place on environmental stewardship and social responsibility.
There are dozens of different indexes that businesses can disclose to, each providing their own parameters and levels of credibility amongst the public. The Dow Jones Sustainability Index and FTSE4Good are the most popular in Europe, whilst the MSCI KLD 400 Social Index has a large representation in the US.
Sustainability indexes are becoming increasingly important, not only as a measure of risk for investors, but also as a measure of environmental impact. In the face of aggravating climate change, it is paramount that businesses place sustainability at the forefront of their management.
Being able to benchmark your company against others as well as being subject to pressures from the public is also a valuable driver of sustainability in business.
What is a sustainability index used for?
Sustainability indexes are primarily used by investors who are interested in introducing sustainable investments to their portfolios. The rise in this interest is in part due to the fact that a business’ sustainability performance is a strong indicator of future performance.
A study by HEC Paris titled “Do Investors Actually Value Sustainability Indices?” analysed the impact on companies that are listed on the Dow Jones Sustainability Index. Their findings showed that the listed businesses had a higher percentage of shares held by long-term investors, as well as higher visibility amongst financial analysts.
How do sustainability indexes work?
Each sustainability index works slightly differently, all having a unique assessment criteria and methodology. The general procedure, however, involves a yearly disclosure cycle. This begins with an invitation for companies to participate in the disclosure process, which is often completed through a questionnaire. Participating businesses will have several weeks to several months to complete the questionnaire – depending on the sustainability index – and their answers will be analysed and scored according to each index’s methodology. Once all companies have been given a score, the results are made public and the cycle will begin again for the following year.
What are the benefits of having a sustainability index?
The benefits of having a sustainable index range from financial to non-financial, and benefit businesses, investors, and the public alike.
- Sustainability indexes are useful tools in benchmarking your businesses’ non-financial performance. Measuring your impact is the first step in improving it, and disclosing to a sustainability index allows your business to track progress and make credible plans for improvement.
- Sustainability indexes provide non-financial information on companies that give indications of future financial performance. This data is incredibly useful to investors who are looking for long-term, sustainable portfolios.
- Sustainability indexes make business sustainability data publicly available. With sustainability being of increasing importance to consumers, this helps members of the public to easily decide where they should spend their money, ultimately driving the market in a more sustainable direction.
Sustainability Indexes are measures of social and environmental performance within businesses. They help investors build sustainable portfolios and they help consumers spend their money in a sustainable way. Importantly, they also help businesses to track their own sustainability which is a crucial part of improving it.
To read more about the importance of measuring data in order to improve on it, check out this blog post on How IoT Can Make Buildings Efficient & Sustainable.