Value Balancing Alliance: Going Beyond Financials

Christian Heller:

There's a total shift going on how your value of company and different drivers compared to the 16th century when financial accounting has been created in Italy. So what we are convinced is if you want to provide long-term value as a company, you need to take these factors into account in all of your decision-making processes.

Michael:

Welcome to Sustainability Leaders. I'm Michael Torrance, Chief Sustainability Officer with BMO Financial Group. On this show we will talk with leading sustainability practitioners from the corporate, investor, academic and NGO communities to explore how this rapidly evolving field of sustainability is impacting global investment business practices and our world.

Disclosure:

The views expressed here are those other participants and not those of Bank of Montreal, its affiliates or subsidiaries.

Michael:

Today, I'm speaking with, with Christian Heller, Vice President at BASF and CEO of the Value Balancing Alliance. The Value Balancing Alliance focuses on the development and standardization of a management accounting model to protect and create long-term value. It is designed to empower decision makers to optimize the total value contribution of their business. As a nonprofit organization, the Alliance enjoys assistance by the big five accounting firms, the OECD and The World Bank as policy advisors. Oxford university, Harvard Business School, and the University of Hamburg are providing academic foundations as lead universities for the initiative and stakeholders from government, civil society, business and financial markets and standard setting organizations support the activities of the Value Balancing Alliance. Before his current position, Christian was leading BASF's value to society program and had various roles in communications, sustainability and human resources, such as leading the human rights program of the company. Thanks for speaking with me today, Christian.

Christian Heller:

You're welcome. Happy to do so.

Michael:

Let's start off with a little bit about your background. You're CEO of the Value Balancing Alliance. How did you get into the field of sustainability and value based accounting? What was your journey to get to this position?

Christian Heller:

So, that was a longer journey and just starting a little bit more back, I was studying philosophy at university and I was always interested in economics and thinking about how you can provide incentives based on certain ethics to drive the economy and extras within the economy in a certain direction. And after my studying, I entered a chemical company called BASF, the global chemical company. And there I started to work in the human resources department, was responsible for social and labor standards. And when I was in the position to develop the human rights program of BASF, and then I entered, after a few other positions, the strategy department of BASF, and in the strategy department, I got the project which was how can we measure the purpose of the company of BASF, which was we create chemistry for a sustainable future. And the big question came up, how can you measure this for?

Christian Heller:

What is the real contribution of a company like BASF to drive and contribute to whatever sustainability is about? And this was really the starting point in the end to get into more detailed numbers, to get in much closer contact with the finance and controlling departments and to build up methodologies, in this case for BASF, which in the end, trying to capture the true value contribution of a company along the value chain. And as many other companies have started, at this point in time, similar processes, developing methodologies and this direction, this was then the step to take over the Value Balancing Alliance or creating it in the end with other companies together. And this is how I came into this position.

Michael:

And so now you're the CEO of the Value Balancing Alliance. Can you tell us about what the Value Balancing Alliance is and what its mandate is?

Christian Heller:

For sure. So the Value balancing Alliance is a non-for-profit organization, which is based in Germany, it's consisting of currently 16 international companies from different sectors and regions. And we are supported by the big four auditing firms on a pro bono basis. Everything what they're currently doing is developing methodologies, how you can better assess the performance of a company. So we call this from profit maximization to value optimization. Everything what we are developing will be made publicly available for free without any commercial interests by the Alliance. We are building on strategic partnerships with international organizations like the OECD, like The World Bank, like the EU commission, or like other business initiatives, such as the Capitals Coalition or The World Business Council, and also running an academic network.

Christian Heller:

Just to name two of the most famous universities we're working with business is a business called from Oxford and the Harvard Business School. Everything what we are doing here, all resources what we have is provided by our member companies and we are also funded, to a certain degree, from the European Commission. I think the interesting part for the Value Balancing Alliance is really that we are also working with secondments. So all the work what we are doing is really directly linked to our members and therefore really grounded in the practical life of businesses. And this is most probably one of the key differentiating factors what we have here within the VBA, as we call it short.

Michael:

So we'll get into the how of the methodology in a moment, but let's start with the question of why. Why, in your view, should there be measurement and reporting of these kinds of broader factors beyond purely financial considerations, environmental and social impacts as part of financial accounting, in your view?

Christian Heller:

So what we need to take into account is that the business environment has fundamentally changed. So if we're talking about environmental aspects like climate change, like biodiversity, talking about health aspects like we are currently in the COVID-19 crisis and pandemic, we're also talking about social inequalities, migration. So we are also talking about how you value, really, a accompany. If you're looking at the current stock market, the new economy is much higher rated as the old economy or the industrialist companies. So there's a total shift going on how you value a company and totally different drivers compared, in the end, to the 16th century, when financial accounting has been created in Italy. So what we are totally convinced is if you want to provide long-term value as a company, you need to take this factors into account in all of your decision-making processes. And this is one of the key reasons why the VBA was founded by the members.

Christian Heller:

They want to measure their performance. They want to get much better and more robust data in the end for management accounting to make better decisions and to drive better steering within the companies. For sure, a second argument, it's all about comparability. And comparability not just for external stakeholders assessing companies with regard to their sustainability performance, what is increasing is really the interest of companies itself to compare themselves against the competitors. And this is currently strongly driven by finance people. This is quite an interesting movement, what we see here. And last but not least, for many of the companies here, we have top executives engaged in the overall process, and this is something also about legacy because they are in a really important and powerful decision within the economy and they really want to try, they want to do something good. They want to provide really something to the overall economy and society, which is moving on, which brings us to the next level.

Michael:

You mentioned management accounting. And I think that's a really important point that I find interesting about your approach. Am I understanding it correctly that you're focused on how corporate management themselves can do quantitative analysis around these broader impacts? And I distinguish that from a methodology that's focused on external reporting. Is that the case, that you're focused on this management accounting approach for internal decision making and benchmarking?

Christian Heller:

Yes. Correct. So we are really focusing on management accounting. We are really trying to harmonize and standardize measurement frameworks and measurement techniques around the whole aspect of sustainability and intangible. So we call, this in the end, natural, social and human capital aspects. And the main reason is really how you can inform management in a much broader and better way to make informed decisions at what level. Talking about investment decisions, talking about business strategies and so on and so on. And we're not just running quantitative figures, they are also monetizing non-financial aspects, like putting a price tag on Cu2, putting a price tag on health and safety or on further training and additional aspects. And the main reason for this one, this is the way how you can really integrate non-financial aspects in the direct decision-making processes of companies, because it's directly linked to the financial accounts and you can directly compare financial and non-financial data.

Christian Heller:

And this is really driving the sustainability agenda forward. Not even talking about that, money is the language decision-makers from business really understand. If you're talking to them in Cu2 equivalents or something else, this is not really driving the topic. The second main point, just to conclude on this one, when you're looking back into the company histories, so it's more than 20 years, companies have started to report about sustainability, but if the companies are really open and honest with themselves, there was no fundamental change with regard to their business models. And the main reason is because it was always not really linked to the decision-making processes, which are usually run in finance, controlling and accounting areas. And this is where we want to go to. And therefore also the monetization is key.

Michael:

So let's dig deeper into some of the elements that you've discussed. We'll start with natural capital. What, by your definition, is natural capital and how should it be measured and monitored by companies in accordance with the VBA approach?

Christian Heller:

So let me start maybe first providing a bit broader view on how we are defining the scope of the methodology, because I think this is important. We have two pillars with regard to the methodology. The first one is what you could call the inside out perspective. This is measuring externalities. What is the value contribution of your business model to your external environment, talking about your contributions to the broader economy, to the society itself and to the natural? And this methodology we are running across the value chain and here we are monetizing, in the end, externalities. This is what we call an impact statement. The second part of the methodology or second pillar of the methodology we are driving is about dependencies. In the end how are sustainability aspects effecting your enterprise value? And here we are talking much more about the traditional accounts and here we are thinking about a consistent extension of our financial reporting and accounting methodologies, bringing in human capital, bringing in natural capital, bringing in social capital, how is this extending your enterprise value?

Christian Heller:

Coming back to your question with regards to the environment. So, for example, if you're looking at the whole direction of what we currently see at the investors and the financial markets from a products perspective, climate change is one of the key drivers which is demonstrating if a company is really taking long-term value creation into account. If you're thinking about reporting standards, if you're thinking about ratings, if you're thinking about all these organizations like CDP or CTSP or methodologies as introduced by the TCFD, all about climate, future modeling, how climate might affect your business.

Christian Heller:

And I think here we need much clearer guidance for companies, how you measure, first of all, your impact on the environment. So how is your business model impacting climate change directly? And the second part is what does this really mean in the end for your company? It makes a huge difference in the future where you're building up a new site and how you're exposed to certain weather patterns, which will change in the next years due to climate change. And this is what companies need to take into account when they're thinking about long-term value creation, not just for stakeholders, also for their own enterprise. So we are also talking about the financial bottom line in the end.

Michael:

And what about on the human and social capital dimensions, how would you describe what those are? How do they fit into those two pillars? And what's the methodological approach that the VPA is taking?

Christian Heller:

So I'll give you two examples, which is also reflecting the two pillars of the methodology we are running. Starting with what we call the impact statements or the impact on the society based on the business model. If you're thinking about the company, it will not exist if there's no purchase power in the market, or if there's no infrastructure in the market. Nevertheless, as of today, we are still seeing wages and taxes within the company just as cost drivers. So the logic what we have as companies is to reduce wages and taxes to the number of zero, if we can, to provide more profits or in the end to provide more dividends to shareholders if you're a stock listed company. But if you think this through, if there are no wages anymore in the market, if there are no taxes in the market, so governments and consumers don't have purchase power and this we need to shift around, we need to think about different value drivers.

Christian Heller:

This is the fun part of the methodology we are running that we take human wellbeing as the key yardstick to measure performance into account and wages is equal to purchase power, and is something positive you need to think about. The second thing or the second pillar, if we're taking now, let's say, the extension of our financial reporting into account, again, taking the aspect of human capital. So all expenses what you have with regard to training are currently treated as costs, but still our employees, in the end, the key asset to create long-term value, to run innovation, to try and further develop our businesses. And this is the point that we are now starting to think about methodologies how you can make the employee an asset in the whole equation, an asset in your balance sheet and asset in your P and L.

Michael:

And in terms of shareholder value, I'll move on to that next. I mean, shareholders are people too, and they obviously have those types of interests themselves. A lot of asset owners are pension funds that are actually the pensions of teachers and workers. There's not an inherent disconnect, and it's a straw person argument to say that shareholders are only interested in the financial side, but how would you say what you're focused on and this methodology is related to shareholder value and the more traditional idea of the maximization of financial value for the corporation? Is it related, and if so, how?

Christian Heller:

So if you're looking at most recent studies, what you see is companies taking sustainability into account or purpose driven companies, or long-term thinking, however you call this in the end, you can demonstrate that, at least in the long run, share price and dividends are better performing compared to companies who are not taking this into account. And if you're looking at the whole also movement in the financial market talking about long-term investments, talking about impact investments, talking about social sustainability, green bonds, whatever, you see that also the financial market is taking this fully into account more and more day by day.

Christian Heller:

And what we are trying to contribute here with our methodology is a consistency, how you measure performance and how you can also demonstrate this performance to the external world. Just providing you one example again, when we're talking about human capital, companies should report about human capital, but we are totally free how to do so. Talking about training hours, training pay days, competencies gained, whatever, and what we are doing within the Value Balancing Alliance, we are harmonizing these measurement techniques or measurement frameworks so that as an investor you can really directly compare company to company as they used to with regard to financial accounts.

Michael:

Now, what about the interest of governments? There's a lot of focus of government on using finance and corporate governance in order to achieve policy objectives. And these include things like climate change or addressing human rights and supply chains. First of all, theoretically what would the interest of governments and policymakers and regulators be in the kind of framework you're developing? But then also just more empirically, what engagement have you had with governments and regulators on your framework, and has there been a dialogue or an interest in the work you're doing?

Christian Heller:

What you definitely see is that policymakers and regulators are also looking into new measurement techniques and methodologies in the end with the main ambition to create transparency about the contribution of companies. And what's quite interesting is that more and more regulators are trusting the financial markets to drive business. So it's not the real economy or the corporates which we are addressing directly, we're now going, in the end, via the financial markets to set incentives with regard to capital allocation to drive the real economy. This is a development what we currently mainly see also in Europe and coming now back to your question, how we are engaging with policy makers and regulators, and here we have two main processes running. The first one is directly being engaged with the European Commission. So the European Commission is currently running three main processes where we are fully involved. The first one is what is called the Non-Financial Reporting Directive, in short NFRD. This is, in the end, a further development of a reporting standard about sustainability for European based companies.

Christian Heller:

And here we are trying to feed in our methodologies, in the end, again, harmonization of measurement. The second aspect relates directly to the financial market. So in Europe, a legislation is in development, which is called the taxonomy. And the taxonomy will request from financial market players that we are looking with regard to their product in the market, like in insurance, like in credit, how is this credit or insurance linked to environmental criteria at the client? Is the client, so to say, or the project of the client taxonomy aligned? For example, take a power plant, is this based on coal or is this based on wind energy? And here we will expect that incentives are also coming up that you get in the end cheaper rates and so on for credits, insurances when it's taxonomy aligned. So here we have a direct price. The third aspect with regard to the EU commission, we are mandated by the EU to develop what is called natural capital accounting principles.

Christian Heller:

And this is linked to this non-financial reporting directive. This is also partly linked to the taxonomy work. In the end, this is about harmonizing measurement frameworks, how you can integrate natural capital directly into decision-making processes within companies in the end with the key ambition to get this European idea of the queen dealer, thus creating the economy fully implemented. Next to the EU, we are working quite closely with the OECD. And the program which is called Business for Inclusive Growth. This is all about inclusive value chains and here we're supporting the OECD and the program to develop impact based methodologies, how you can assess inclusive value chains.

Michael:

In the North American context, maybe there's not as concerted of a regulatory initiative happening right now, but there is a lot of discussion about using things like disclosure and financial markets to increase awareness of environmental and social impacts. What can you say about your work in the North American context and the potential relevance of the Value Balancing Alliance's methodology in that context? Is there an uptake? Is there more resistance? Is there less understanding? What are you finding in that geography?

Christian Heller:

So we see for North America over the last, let's say, 18 months an increasing interest, not just from the business side, also from the academic side. Starting with the last one, if you're looking currently at the Harvard Business School, they're running a program which is called Impact-Weighted Accounts Initiative. And this in the end is you can call it a sister initiative to the Value Balancing Alliance. The Value Balancing Alliance is a business driven initiative. The Impact-Weighted Accounts Initiative at the Harvard Business School is a more academic driven initiative. But we're building on the same methodologies in the end with the same objective, how you can measure and value in monetary terms, the real value contribution of companies. I also see a stronger interest by North American companies in the work we are doing so we are now getting approach by US-based or Canadian companies on a really regular with huge interest in the work what we are doing.

Christian Heller:

And we are looking forward also to create a VBA local chapter in Canada with a few companies in the end to bring our methodologies and thinking to Canada and further develop this with Canadian companies for the specific context the Canadian companies are doing business in. What might be interesting as well is how the Biden administration is taking up the notion of sustainability and driving this into the business area, just talking about the New York Stock Exchange and the SEC, most probably we will see regulation coming up to figure out the disclosures for stock listed companies in the US going in this direction in the next months to come.

Michael:

So VBA is focused on management accounting approaches, which has a primarily, or at least initially, internal management decision making focus. But it's obviously naturally aligned with all of the external disclosure frameworks that exist around similar topics from the global reporting initiative, CDP, Sustainable Accounting Standards Board, International Integrated Reporting Council, and one of the recent developments that we're watching very closely is the movement of the International Financial Reporting Standards, IFRS, to establish a sustainable standards board that might seek ways of aligning and converging and uniting for a unified framework around disclosure. Where do you see that type of work going and how would the VBA fit into a world where there is more of a unified approach to external types of sustainability reporting?

Christian Heller:

So, first of all, let me make this clear, the Value Balancing Alliance, our mandate is not to create a new reporting standards. This is what you mentioned already, really about management accounting and measuring performance. And I can speak here for my member companies as well. We are really supportive about this development that we have international standards in place with regard to non-financial reporting. So international companies have been exposed to more and more upcoming standards with regard to reporting, a few you mentioned, these are just the reporting initiatives. You can also take into account the rating agencies or requests by single investors, or depending on where you are in the value chain, you'll receive customer requests, supplier codes of conduct and so on and so on with regard to your sustainability performance, which you don't receive with regard to your financial performance. And what we as corporates really seek for is an internationally accepted standard with regard to non-financial reporting.

Christian Heller:

And therefore there's a huge support of the IFRS movement and we are really happy that organizations like CDP, CASB, IIRC are supporting this process within IFRS. For us it's more than clear that the frameworks were already existing with regards to reporting, but also whatever the IFRS might come up with, this will be also a framework for us where we are providing the methodologies for measurement. This is more than clear. So if you're building on what is out there, and one of our key values within the Value Balancing Alliance is connectivity. So we are staying really close to this initiatives, we are in ongoing discussions how we can support this overall movement.

Christian Heller:

So a huge support of this process. What I expect, let's call it more hope, but I hope that in two to three years we see at least the first drafts from the to be created sustainability standards board under the umbrella of IFRS with regards to non-financial reporting. And I hope that in a few years' time there is this one standard in place companies are reporting against similar to financial reporting. This would be in the end, the key ambition which we need to follow.

Michael:

And will VBA be participating in the work of the IFRS? Are you able to say?

Christian Heller:

We are already in contact with these organizations, including IFRS. And in the end, what you're trying to do is building on the frameworks of reporting, and then as said before, feeding in measurement methodologies, how you can consistently measure, assess and value the performance of companies along sustainability criteria, such as greenhouse gases, air pollutions, biodiversity, health and safety, further training, international labor standards and so on and so on. So the measurement needs also to be consistent because in the end you need to get the foundation right to create robust data, otherwise reporting does not make lots of sense.

Michael:

How do you see this being integrated into regulatory systems? Is that the direction that this is going? Do you think that one day there will be regulatory requirements for disclosure by companies alongside what was already required for financial types of accounting and disclosure, or do you think that it would actually stay and remain a voluntary type of approach, but perhaps there would be such stakeholder pressures on it that it would be almost de facto obligatory? How do you see it evolving?

Christian Heller:

When you're looking around the world on a country basis, but also on a regional basis, like within the European Commission, you already have legislation in place, which is requesting disclosures from companies with regard to their sustainability performance. And I expect that we have this on a similar scale or level to financial reporting in a few years time, and we're talking about non-financial aspects. So I think this process is in place. This process is moving. The big challenge is going to be how do we measure this in a consistent way and how do we get this in a really pragmatic way integrated in our current systems at the company level. So many companies are doing this already, so I think it's not such a huge step to move on, but it needs to be consistent and needs to be pragmatic.

Michael:

One of the things that I was interested to learn about from you, Christian, in our lead up to this interview is the mandate of the VBA and that you foresee the mandate being exhausted at some point when you've achieved your objective. Can you tell us a little bit about that and what the future holds for the VBA, what your objective is and what will happen when it's achieved?

Christian Heller:

So the VBA is mandated to be alive in the end until the end of 2023. The main reason is we want to deliver something. We don't see ourselves as an initiative which will last for decades and just developing methodologies. And I think this is one of the unique selling points and what makes the VBA so interesting, everything what we are developing as methodologies is directly piloted by the member companies. We have just finished our first piloting round end of 2020 and we are now currently selecting and discussing the learnings and the results of this piloting, but we can really demonstrate, and this was successful for all member companies, we can really demonstrate the methodologies we are developing can be applied and implemented at the corporate level, but also in decision-making programs like for CapEx decisions, OpEx decisions, this strategies. So the pragmatic applicability is key for the Value Balancing Alliance.

Christian Heller:

What we want to demonstrate until the end of 2023 is yes, we can develop methodologies, but even more important, how you integrate sustainability thinking directly in decision-making processes. And this will become more and more relevant because when you're talking about sustainability you're also talking about trade-offs. Until today, companies just used to steer their business along one indicator, which is profits. And now more and more other indicators like your carbon footprint, or like your biodiversity footprint, you need to take into account. And this means trade-offs. So what we are doing within the VBA, we are providing the methodologies, we're testing the methodologies to get better data and to inform the decision makers how you can deal with this trade-offs. And here we just want to demonstrate it's feasible, it's possible, and the methodologies we are creating will be transitioned to another organization, whatever this might be, maybe within IFRS, we will see, but for us, the key mandate is develop new methodologies, test and pilot this and demonstrate feasibility.

Michael:

And what stage are you at in that journey? How far along are you?

Christian Heller:

So I'm coming back to the two pillars for the methodology I introduced. Just for remembering, impact statement, measuring and monetizing externalities, and what we call the integrated account. This is more of an extension of the enterprise value. So with regard to the impact statement, the measurement for externalities, we have finalized our first methodology. We will publish the first version within the next days. And this version was piloted successfully by all our companies. So the next six months, and this part of the pillar, where we defer the development of the methodology, getting in the learnings, extending the methodologies for additional indicators, for example, core labor aspects and so on. And then in the second half of the year, the piloting starts again. With regard to the second pillar of the methodology, we have started to develop the first concepts and I'm quite sure that also in the second half of the year, we will go into the piloting round with all my member companies that we have the complete methodology covered in piloting.

Michael:

So it sounds like you're well underway and 2023 is the objective, so we'll look forward to seeing all the work that you'll be doing between now and then. Just as a final thought then for our listeners and our listeners are often investors interested in responsible investment, business people who are working on sustainability, what would you say to these types of people about the VBA and what they should be thinking about if they want to be leaders in sustainability?

Christian Heller:

So I hope that what we can demonstrate with real figures in the end, that you can make sustainability performance as comparable as financial performance, and that we can also provide the results in metrics or in data, which can be easily taken up by investors. So we are talking about monetary values for sustainability performance. We also hope that we can provide a much better picture or perspective on the business opportunities and the business risks in the long run for companies so that investors can make a much better evaluation of the value creation of the future. When you're asking me what is the easiest way to move on and to integrate sustainability, for me it's really about build on what's already out there, look at best practice examples and get in direct contact with companies or investors who are driving this forward because this is the easiest thing to learn.

Michael:

Excellent. Well, thank you very much for your time, Christian.

Christian Heller:

You are more than welcome. Thanks for having me.

Michael:

Thanks for listening to Sustainability Leaders. This podcast is presented by BMO Financial Group. To access all the resources we discussed in today's episode, and to see our other podcasts, visit us at bmo.com/sustainabilityleaders. You can listen and subscribe free to our show on Apple Podcasts or your favorite podcast provider. And we'll greatly appreciate a rating and review and any feedback that you might have. Our show and resources are produced with support from BMO's marketing team and Puddle Creative. Until next time, I'm Michael Torrance, have a great week.

Disclosure:

The views expressed here are those of the participants and not those of Bank of Montreal, it's affiliates or subsidiaries. This is not intended to serve as a complete analysis of every material fact regarding any company, industry, strategy or security. This presentation may contain forward looking statements. Investors are cautioned not to place undue reliance on such statements, as actual results could vary. This presentation is for general information purposes only, and does not constitute investment, legal or tax advice and is not intended as an endorsement of any specific investment product or service. Individual investors should consult with an investment, tax and or legal professional about their personal situation. Past performance is not indicative of future results.