Beyond ESG: Quantifying hidden impacts and investor risk in the FTSE 350: Route2
How sustainability accounting and performance metrics company Route 2 used impact accounting to reveal what ESG misses, uncovering £1 trillion in negative impacts
Route2 collaborates with businesses, investors, and governments to quantify Value2Society™ (V2S™), a new metric of performance, forging links between financial performance and sustainability, and a yardstick for total value creation.
Objective
Investors face major issues with traditional ESG reporting, including incomplete data, data based on subjective assessments, and a focus on outputs rather than impacts. This leads to sustainability investments that misalign or misrepresent the risks companies face.
For example, in response to gaps in company reported data, some ESG data providers will use industry average disclosures as proxy data. However, according to the Sustainability Accounting Standards Board (SASB), 90% of known negative events are not disclosed either in SEC filings or sustainability reports, implying the worst impacts remain hidden using this method.
In addition, a 2022 study by Carnegie Mellon University’s Nicholas Muller suggests that because traditional ESG methods often focus on physical emissions rather than the financial costs associated with them, indexes using this approach often overemphasize greenhouse gases (GHGs) within their assessment of pollution and thereby overlook the significant monetary damages caused by air pollution.
Route2 data addresses these issues by valuing the impact on stakeholders into a common monetary metric through consistent impact pathways and processes and an established total capital accounting framework, helping investors better assess the risks companies face from future regulations and reputational damage.
Its impact accounting solution, Value2Society (V2S), provides a comprehensive way to measure the wider value a business creates, considering both positive and negative impacts. It goes beyond traditional economic metrics like Gross Value Added (GVA) by incorporating the social and environmental impacts that ESG data often overlooks. To do this, V2S translates key impact indicators (e.g., CO2 emissions) into monetary terms using impact valuation methodologies developed in-house at Route2. These valuations consider the changes in different forms of capital — financial, manufactured, social, human, and natural—and their effects on the well-being of various stakeholders like employees, customers, governments, and society at large.
In this case study, Route2 explores how its V2S metrics can be used to generate company profiles for investors to address several shortcomings in current ESG data.
Application
Route2 applied its V2S metric across 32 internally developed core impact indicators across the various forms of capital to the companies in the FTSE 350 index (see Table 1 below). This enabled us to quantify the broader impact of business operations on external stakeholders and align investors with the impact of the sustainability factors at play.
To generate V2S scores for each company, Route2 used both company-specific disclosures and broader geo-sector financial data.
Step 1: Modeled estimate – Route2 first created an estimated V2S profile for each company using extended input-output modeling to reflect the impacts of a company’s operations, including its supply chain, based on industry and regional data.
Step 2: Incorporating company disclosures – Company-specific disclosures were then added to refine the V2S profile and provide a more accurate understanding of a company’s real-world impacts.
Using a combination of modeled data supplemented with sustainability disclosures, Route2 was able to quantify and uncover the impact of these companies’ operations and supply chains on the environment and society. These profiles offer a comprehensive, transparent, and comparable view of each company’s sustainability credentials.
Findings and outcomes
- Route2 identified a total of £355 billion (or £2,000 in net positive impact or V2S per £10,000 revenue) generated by companies in the FTSE 350, dominated by GVA – the profits, wages, and taxes paid by companies.
- It also found significant negative impacts, including over £1 trillion (or £6,000 in external costs per £10,000 revenue) across other forms of capital. In other words, more than 73% of the overall value generated by the index is derived from depleting social and natural capital.
- The largest contributors to this depletion include corruption, land rights violations, air pollution, waste flows, and GHGs – with companies in the Metals & Mining and Oil & Gas sectors, including Glencore, Shell, and BP, at the top of the list, costing society billions.
- Route2 integrated the gamma ratio – an assessment of a company’s relative contribution to industry-level environmental and societal damage compared to its market capitalization – with V2S scores to explore the best and worst-ranked companies within industry sectors. A higher gamma ratio indicates greater societal harm relative to the value created. Route2’s early analysis of industry-neutral portfolios shows that those composed of companies with lower gamma ratios outperformed others. While these findings are still preliminary, they suggest significant benefits for investors prioritizing sustainability in their strategies. For example:
- Companies with higher gamma ratios, like Tullow Oil, are more likely to face financial risks from stricter regulations and stakeholder backlash, whilst those with lower ratios may be better positioned for long-term growth.
- Endeavour Mining was identified during the analysis as the worst performer within the metals and mining industry group on the corruption indicator when normalized by revenues and the gamma ratio. Following Route2’s analysis, the stock suffered a price shock in early 2024 when the CEO was removed amid a probe into an irregular payment.
Future work
Future developments are planned to improve Route2’s investor data offering. Currently, the V2S analysis used within the investor data focuses on upstream (supply chain) and direct operational impacts, with downstream impacts quantified on a case-by-case basis. Future versions of the model will quantify the full value chain impacts.
V2S currently relies on national-level data sets. In 2024, Route2 collaborated with the Satellite Applications Catapult to incorporate Earth Observation data into its modeling approaches, improving its ability to assess impacts such as land-use change and pollution at a more local and granular level.
With these enhancements, Route2 aims to provide a new form of ESG data that can enhance traditional risk-return models by adding an important impact dimension, guiding capital flows toward more sustainable outcomes.
Route2 and IFVI are collaborating to explore the complementarity and application of IFVI’s impact accounting methodologies and value factors into Route2’s platform and service offering, further supporting the advancement and harmonization of impact valuation approaches across the market and empowering its users with decision-useful insights.
