Follow the money. The catchphrase may well apply to measuring the impact a company has on sustainability.

Globally, companies are embracing the Sustainable Development Goals (SDGs) to create a positive impact while attracting investments from an ever-expanding base of responsible investors. But how can they align their decisions, operations, products and services with SDGs to maximize impact and investment?

Revenue-linked SDG alignment allows investors to align a company’s revenue streams to individual SDGs, as well as across SDGs with the help of a taxonomy. The function of the taxonomy is to facilitate the identification and classification of investable products and services which may help attain the SDG 2030 agenda. A benefit of such an analysis is that the SDGs provide a common framework for analyzing sustainable investing outcomes, thereby enhancing the scope of comparing outcomes.

Most revenue alignment solutions focus on the positive SDG impact a company creates through its products and/or services. However, the net SDG impact must be analyzed to better understand an investor’s exposure to materially significant risks and opportunities. For example, a company may derive revenue from affordable and nutritious food, a positive that is offset by selling packaged water in plastic bottles.

Ignoring negative attributions is likely to lead to inadequate risk management and overestimation of sustainable contribution. CRISIL GR&RS has deep expertise in developing bespoke solutions to assess the net revenue alignment of companies to one or more SDGs, entailing positive and negative attributions.

The process of estimating this net SDG alignment entails six major steps. For this, we must start with a good taxonomy that facilitates materially relevant research from an investor’s perspective. The final estimation of net revenue alignment allows investors to gain a holistic understanding of SDG-linked investment risks and opportunities.

Calculating a company’s net SDG revenue alignment

• Identify the taxonomy: Various institutions have developed taxonomies to enable analysis of a company’s alignment with SDGs. These include the Sustainable Development Investments (SDI) taxonomy of the SDI Asset Owner Platform and the IRIS+ tool of the Global Impact Investment Network (GIIN).  
  
  So why is taxonomy critical to the process? For that, we need to understand the use case of the taxonomy. In this blog, we will take a quick look at SDI and IRIS+.
  
  In SDI taxonomy, whether a company’s product or service enables the attainment of SDGs becomes a reference point to identify and recommend the company to investors. Companies with intermediate products or services in a supply chain may qualify as SDIs if these are (i) explicitly dedicated to the final product and associated SDG(s), and (ii) essential for the use of the final product.
  
  SDI facilitates an efficient investment management process since sustainability is decided in a consistent and rule-based manner. This leads to better-informed capital allocation decisions, effective portfolio monitoring and transparent reporting.
  

   

  Investment process	Asset allocation	Manager selection and monitoring	SDI reporting
  Investments can be classified as per their contribution to SDGs in a credible and consistent manner.	The SDI standard can inform investment allocation decisions.	Investors can use the SDI standard to select and monitor external managers	Investors can use the SDI classification to show allignment of the investment portfolio with the SDGs

  
  IRIS+ translates the SDGs into aligned indicators that investors can use within the investment management processes. The taxonomy is organized according to social and environmental ‘Impact Themes’ and cross-thematic ‘Lenses’ through which investors can frame strategic goals, portfolios and business models. ‘The IRIS Catalog of Metrics’ is aligned with SDG targets; every SDG target identified as investable has a related and comprehensive set of applicable IRIS metrics. (GIIN, 2022).
  

Use case of the IRIS+ thematic taxonomy (GIIN, 2022)

• The investment objective will decide the choice of taxonomy and approach to research:  
  
  • IRIS+ translates the SDG targets into a set of environmental, social and governance (ESG) indicators to enable the development of impact investing strategies and models
  • The SDI taxonomy focuses on identifying investable targets within the SDG framework instead of translating the SDG framework to a set of aligned indicators. 
  SDI is better for a purely quantitative investment analysis, where estimation of net revenue alignment is the only objective. IRIS+ is better suited to the needs of a reporting framework-aligned research objective.

• Analyze revenue segmentation:  Investors can assess a company’s revenue segments to find the percentage of revenue that each reportable segment has contributed. This facilitates an understanding of revenue drivers for any company and allows identification of the products and services influencing revenue generation within each segment.  
  
  Segment reporting allows investors to gauge the general health of each business division, along with a view of the overarching investment opportunities from an ESG standpoint. A company may be deriving a portion of its revenue from sustainable products/services but could still be generating most of its revenue through unsustainable channels. 
  
  Hence, revenue segmentation allows investors to screen companies based on broader revenue drivers, instead of focusing on merely a selected portfolio of sustainable products/services.
  
  

• Align products and services to the taxonomy: Revenue segmentation finalized, investors must look for answers to the following questions for each reported product and service:  
  
  • Does the product make a positive contribution or a negative contribution to one or more SDGs?
  • Is the assessment of contribution consistent with the chosen taxonomy and guidance?
  • Is the contribution substantial? To what degree?
    
  The answers will facilitate an understanding about the direction and magnitude of SDG alignment. 
  
  Let us consider SDG 12 (Responsible Production and Consumption) through the SDI taxonomy lens. SDG 12 has 11 targets (12.1 to 12.8 and 12.a to 12.c). However, as per the taxonomy, not all the targets are ‘investable’ from the perspective of an institutional investor. 
  
  And this is because all SDG targets do not offer tangible investment opportunities and tangible outcomes. Take, for instance, SDG Target 12.6 (“Encourage companies, especially large and transnational companies, to adopt sustainable practices and to integrate sustainability information into their reporting cycle”) and SDG Target 12.7 (“Promote public procurement practices that are sustainable, in accordance with national policies and priorities”). It is worth noting that encouraging and promoting sustainable operating practices are policy objectives; not investment objectives. Therefore, these targets are not materially significant for investors.
  
  However, when we map a company’s products and services to one or more SDGs to assess investment-linked metrics such as revenue alignment, classification through a taxonomy facilitates actionable decision making. According to the SDI taxonomy, a company can be considered to contribute positively to SDG 12 only if it contributes to one or more of the following ‘investable targets’ (SDI Asset Owner Platform, 2023):

Table 1- Investable targets for SDG 12 (SDI Asset Owner Platform, 2023)

• Estimate positive revenue alignment with the SDGs: A company can be considered to positively contribute to one or more SDGs if it contributes to the ‘investable targets’ within the chosen taxonomy, whether through its products and services, or its supply chain efforts. The degree of positive SDG alignment is measured through the percentage of revenue the company derives from these aligned activities.  
  
  In some cases, a single revenue segment may contribute positively to more than one SDG. For example, revenue from precision agriculture-related products and services can be mapped to both SDG 2 (Zero Hunger) and SDG 12. In contrast, there might be sub-segments within a reportable segment that do not contribute to any of the SDGs, neither positively nor negatively. To ensure accuracy, it is important to maintain consistency with the rules of the taxonomy throughout the estimation process. In many cases, due to limited information on the revenue contribution of individual products to a segment, investors may need to make estimations from analytical assumptions.
   

• Estimate net revenue alignment with the SDGs: Beyond positive alignment, it is important to measure the negative impact of the products and services from an SDG standpoint. This can be achieved by identifying the activities, products and services that have a negative impact, and then quantifying the percentage of revenue linked to these. 
  
  Let us consider the agricultural sector as a case in point. For tractor original equipment manufacturers (OEMs), the sale of energy-efficient engines can be considered a key indicator of sustainability performance. If the OEM’s revenue is sourced from engines that are not energy efficient, the degree of negative SDG alignment can be measured through the percentage of revenue the OEM derives from such sales.
  
  Moreover, depending on the nature of the business, some segments may only be contributing negatively in terms of SDG alignment. For example, some tractor OEMs may be manufacturing turf equipment, such as commercial lawn and golf course equipment. This does not represent positive alignment with any SDG; instead, it may indicate a negative alignment if inefficient engines are used in such equipment, leading to greenhouse gas emissions.
  
  The net SDG alignment can be calculated by subtracting the negative revenue alignment from the positive revenue alignment.
   

• Align SDG based on the DNSH rule for non-contributing product segments: Once done with the above-mentioned steps, analysis may reveal certain revenue segments are neutral to some of the SDGs in that they neither contribute positively nor have a negative impact. CRISIL GR&RS applies the Do No Significant Harm (DNSH) rule to all such SDGs to test alignment and facilitate wholesome investment research.
  
  This can be accomplished through a deep dive into the company's initiatives linked to these selected SDGs along with a controversy check to account for the adverse impacts of operations or products and services. This principle is not applied to SDGs that are not materially relevant for the company. It is also important to note that the presence of controversies is not enough to determine whether a company has cleared the DNSH rule. In some cases, controversies may indicate isolated incidents and not systemic issues. 
  
  The analysis in the DNSH process is largely qualitative and research outcomes can be divided into ‘reasonably complied’, ‘partially complied’ and ‘did not comply’ to indicate compliance with the DNSH rule. For example, a company may be increasing well-being through multiple safety initiatives, while also facing an increasing recordable incident rate and/or safety violations due to short-term production and/or regulatory pressures.
   

Conclusion

There is no consensus on measuring the contribution an investment makes to specific SDGs, making it hard for asset owners to compare one SDG-aligned fund to another (Hawker, 2021). However, using SDG-linked revenue alignment as a key indicator improves the scope of comparing sustainable investment outcomes and allows investors to judge the degree to which a company is aligned to one or more SDGs, irrespective of size or sector.

The solutioning approach described above mitigates the risk of green-washing and protects investors by deciding the sustainability of investments in a credible and consistent manner, from taxonomy selection to DNSH compliance. The process of estimating net revenue alignment, from revenue mapping to calculation of positive and negative attributions ensures there is no overestimation of SDG alignment, or underestimation of the potential downside of an investment.