Comprehensive Corporate Reporting - Momentum Grows
Financial Reporting Brief: February 2021
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Comprehensive Corporate Reporting – Momentum Grows
Building and strengthening investors trust in companies is always a core task of reporting.
In these times of great uncertainty that we are experiencing, the challenge to achieve and maintain trust and loyalty becomes ever more difficult. Some of these uncertainties may extend in duration but hopefully some might be considered capable of short to medium term resolution, although they will place severe demands on a company’s resources and may even cast doubt on the ability to survive.
The three that the majority will consider as the highest priorities are:
COVID-19 – has dominated economic and social experience for the past year and will continue to do so for much of 2021 and possibly further, but there is an end in sight with vaccination programmes, although the timing of these may be somewhat uncertain. The pandemic wreaks havoc for many companies, but there is an expectation that while the Global economy may take time to recover and the shape of recovery may be uncertain, it will ultimately recover. The pace of such recovery in different geographic and economic zones is likely to vary.
Brexit – numerous Irish companies have trading relations with the UK, and there are many entities where Brexit will have an impact on supply chains or other activity. For those companies, Brexit will give rise to additional difficulties and will need commitment by companies to familiarisation and a bedding-down period. Some companies will need to change their business model and/or market strategy, while some may unfortunately struggle with business continuity. The resilience and ability to adapt of Irish businesses have been evident before and we trust will be again.
Climate change – in overall terms of global significance, this is considered by most as being the greatest of uncertainties. This is particularly so because of its long-term nature and major difficulties with effective control and remediation. There are other Environmental, Social and Governance (ESG) factors that may also be potentially catastrophic.
The Risk of Climate Change
After more than a century and a half of industrialization, deforestation, and large scale agriculture, quantities of greenhouse gases in the atmosphere have risen to record levels. There is alarming evidence that important tipping points, leading to irreversible changes in major ecosystems and the planetary climate system, may already have been reached or passed.
The Global Risk Report of the World Economic Forum continued in 2020 to cite climate change as the biggest threat to the global economy.
The top five global risks were all environmental or climate-related:
- extreme weather events;
- failure to adapt to climate change;
- man-made environmental damage;
- biodiversity and ecosystem loss; and
- natural disasters.
In 2021, COVID-19 may be expected to feature strongly.
From disruption to our products, services, supply chains, markets and asset values, to the acceleration of policy and regulatory change, we are waking up to the drastic action necessary to protect humanity, our planet, and our livelihoods. Transition to a low-carbon economy will affect all.
Institutional investors have a fiduciary responsibility to their beneficiaries to ensure investment is in companies that create long-term value. Companies that have large emissions and insufficiently demonstrated transition plans are not likely to create such value.
Outcry for Improved Reporting
Major investment groups have been calling out loudly for improvements in corporate reporting.
Amongst the most notable outcries is the publication by The Institutional Investors Group on Climate Change (IIGCC) of 'Investor Expectations for Paris-aligned Accounts'. This is with reference to the United Nations agreement on climate change which was the result of a key meeting of almost 200 countries in Paris in 2015 – giving rise to the Paris Accord.
The group supports the momentum of improved sustainability disclosures and reports. It attaches more immediate importance to companies needing to reflect climate change effects in their accounting and corporate reporting. The IIGCC sets out five clear steps companies can take in preparing ‘Paris aligned’ corporate reports, as follows:
- An affirmation that climate risks are incorporated into the accounts;
- Adjustments to critical assumptions and estimates;
- Sensitivity analyses and their results linked to variations in judgements or estimates;
- Dividend resilience and implications for dividend paying capacity of Paris alignment; and
- Confirmation of consistency between narrative reporting on climate risks and the accounting assumptions.
If information is not being provided by reporters in these areas, the investor is very much within entitlement to question why and to press corporates for additional information.
The Importance of Disclosure
Corporate disclosure of climate related information has improved in recent years. However, there are still significant gaps, and further improvements in the quantity, quality and comparability of disclosures are urgently required.
In June 2017, the Task Force on Climate-related Financial Disclosures (TCFD), established by the G20’s Financial Stability Board, published recommendations to encourage financial institutions and non-financial companies to disclose information on climate-related risks and opportunities. The TCFD recommendations are widely recognised as authoritative guidance.
However, there continues to be significant concern regarding implementation of the TCFD recommendations and in its third annual status report, since their introduction, it expressed the following concerns:
- Nearly 60% of the world’s 100 largest public companies support the TCFD, report in line with the TCFD recommendations, or both –the remaining 40% have not as yet shown such support;
- Continuing progress is needed to develop adherence;
- One in 15 companies reviewed disclosed information on the resilience of its strategy; and
- Asset manager and asset owner reporting to their clients and beneficiaries, respectively, is likely insufficient.
Further evidence of the need for improved reporting is the report published by the Climate Disclosure Standards Board (CDSB) ‘The State of EU Environmental Disclosures in 2020’, based on analysis of the disclosures made by the fifty largest companies in the EU. In a previous article, we commented on the corresponding report for 2019.
While the CDSB report recognises strengths in corporate reporting, it also highlights continuing weaknesses and expresses concern that improvement
is needed to the current non-financial regulations in order to mitigate the
underlying causes of such weaknesses. Weaknesses identified include:
- Only 18% of companies adequately disclosed their resilience to different climate scenarios;
- Only 4% of companies disclosed physical and transition risk over different time periods;
- Application of dual materiality did not improve the quality of disclosures;
- Only 48% of companies did not disclose the environmental aspects of their business plan;
- All companies provided disclosure on GHG emissions, but only 10% disclosed metrics on bio-diversity.
The EU non-Financial Reporting Directive (NFRD) has in recent years laid down the rules on disclosure of non-financial and diversity information by ‘large’ companies. The NFRD requires ‘large’ companies to include non-financial statements in their annual reports.
The EC has committed to reviewing the NFRD. The objectives of this review are two-fold: first, to improve disclosure of climate and environmental data by companies to better inform investors about the sustainability of their investments and, second, to incorporate new regulatory changes which embrace the European Green Deal.
IFRS Foundation – The Driver
The Trustees of the IFRS Foundation (IFRSF) have published a consultation paper on sustainability reporting to determine:
- whether there is a need for global sustainability standards;
- whether the IFRS Foundation should play a role; and
- what the scope of that role could be.
The Foundation is in a strong position to lead the development of global sustainability standards by broadening its current remit beyond the development of financial reporting standards and use its experience in international standard-setting, its well-established and supported standard-setting processes and its governance structure. The IFRSF intends to build on existing developments and collaborate with other bodies and current initiatives and progress towards a comprehensive corporate reporting framework.
A new Sustainability Standards Board could operate alongside the International Accounting Standards Board, collaborating with other bodies and initiatives in sustainability, focusing initially on climate-related matters. The International Organisation of Securities Commissions (IOSCO), which was a major driver of global adoption of IFRS, has expressed strong support for sustainability reporting initiatives.
Although there is a lengthy consultation period, many leading organisations and institutions have already submitted their comments, generally expressing support and urging timely action to implement a global development plan and avoid fragmentation. Comments also express the need to move forward to other ESG areas within a reasonable timescale and to strengthen financial reporting to reflect the financial implications of sustainability issues.
In their response to the consultation, the Chairs of the European Supervisory Authorities agree that improving data availability and public disclosure by corporates is a key element to foster sustainable growth.
A previous article commented on the coming together of five major organisations a few months ago with publication of a statement of intent to work towards a comprehensive corporate reporting framework.
The first phase has sprung into action with the publication of a prototype climate-related financial disclosure standard. The prototype demonstrates how it, together with the TCFD recommendations, can be used to provide a running start for development of global standards that enable disclosure of how sustainability matters create or erode enterprise value. It provides insight into how such an ambition can be achieved by building on content that already exists. Sustainability reporting can be a complementary enabler of change since it creates a financial incentive for companies and their investors to improve performance on some sustainability matters as much as they possibly can.
The International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB) have announced their intention to merge and become the Value Reporting Foundation. This will be a unified organisation intended to provide investors and corporates with a comprehensive corporate reporting framework across the full range of enterprise value drivers and standards.
The merger responds to the ever increasing calls from global investors and corporates to simplify the corporate reporting landscape by having a globally aligned reporting system. They intend to maintain the IIRC framework and the SASB standards, and the plan is that the Foundation will be formed by mid-2021.
There is some way to go before the ambition of a comprehensive corporate reporting framework is realised, with significant work to be done.
In the meanwhile, much can be done by companies to provide disclosure and information to investors and others which will help in maintaining their trust and loyalty. A potentially good starting point is to follow the principles underlying the practical steps outlined in the IIGCC report on alignment with the Paris Accord.
Further insight into the matters commented on in this article are in the following:
Monthly Reporting Pack - January 2021
Irish/UK GAAP & Related Developments
IFRS & Related Developments
Legal and Regulatory Developments