Insights

Financial Reporting Brief  

February 2018  

This month’s article "Reporting on Climate Change and Sustainability - A Major Challenge" comments on the challenge of sustainability and, in particular, climate change and the need for transparent high quality reporting.

Reporting on Climate Change and Sustainability - A Major Challenge

Storms in recent months in Ireland have been at a level of ferocity and extremity that have it seems never been seen before. On a local basis, this is a stark wake up call to the extremities of climate change which have been seen on a global basis. These events have had a dramatic impact and included:

  • More than 40 million people affected by massive floods across India, Bangladesh and Nepal with 1,300 killed and at least 1.5 million homes destroyed or damaged.
  •  Hurricane Irma decimating the Northern Caribbean and Florida with over 30 dead and hundreds of thousands homeless.
  •  An unrelenting heatwave in California reaching over 100 degrees and leaving six dead.

While the growing impacts of climate change are bad for people in the developed world, including Ireland, many in developing countries have it much worse, given the increased vulnerability, lack of resources and capacity to adapt.

The risk climate change poses to businesses and financial markets is real and already present. It is more important than ever that businesses lead the way in understanding and responding to these risks – and weighing up the opportunities – to build a stronger, more resilient and sustainable global economy.

How does the world of financial reporting play its part in bringing transparency to the challenge of sustainability?

ESG Risks – Transparency Required

Environmental, social and governance (ESG) risks increasingly demand attention. The business context for ESG impacts and risks is evolving rapidly and challenging corporate executives to translate global megatrends such as climate change, resource scarcity and population growth into tangible risks and opportunities for their business to manage. ESG impacts are generally longer–term in nature, and in many cases, beyond the direct control of a company. The linkage of ESG impacts to business value becomes more challenging for accounting for sustainability of performance and growth. At the intersection of sustainability and financial reporting, the Chief Financial Officer (CFO) is usually the person most qualified to define and communicate how a company’s management of ESG risks contributes to value creation.

Sustainable Reporting

Sustained and superior performance depends, in part, on supporting decision making by effectively measuring and reporting a pragmatic and relevant set of financial and non-financial metrics. There are many potential metrics such as those to evaluate ESG factors, resource efficiency, business model resilience, innovative capacity, brand strength and corporate culture. Most companies who measure non-financial metrics disclose a subset of that information in a separate sustainability report in the Annual Report. The challenge faced by companies is how to determine what information to disclose.

Communicating with Investors

It is important that entities establish credibility and build trust through transparency. A strategy for meeting this challenge is likely to be along the following lines:

  • Prepare sustainability disclosures in accordance with established sustainability standards and reporting frameworks e.g. The Global Reporting Initiative on Sustainability (GRI), to make information publicly available to communicate the company’s command of ESG topics, risks and opportunities impacting its business and driving value for stakeholders;
  •  Design and maintain well documented and thorough internal reporting processes, controls and procedures for ESG disclosure to help improve the value of reporting;
  • Establish and publicly communicate ESG targets and key performance indicators;
  • Engage the internal audit function as an important component of the ESG management reporting system by enhancing the reliability of ESG reporting;
  • Obtain external assurance to increase stakeholder confidence in the integrity and reliability of ESG reporting.

Created in line with the objectives of financial reporting and rules on non-financial reporting firmly in mind, the GRI seeks to offer companies a framework for reporting ESG information with the same rigour as financial information.

Climate Change – A Major Issue

The Task Force on Climate-Related Financial Disclosures (TFCD) which was set up by the Financial Stability Board to develop voluntary, consistent climate-related financial risk disclosures has published its final recommendations for effective disclosure of climate-related financial risks. The four widely adaptable recommendations on climate-related financial disclosures that are applicable to organisations across sectors and jurisdictions were widely supported, as follows:

  • Governance –  Disclosure of the organisation’s governance around climate related risks and opportunities;
  • Strategy - Disclosure of the actual and potential impacts of climate-related risks and opportunities on the organisation’s business, strategy and financial planning;
  • Risk-management – Disclosure of how the organisation identifies, assesses and manages climate related risks;
  • Metrics and targets – Disclosure of the metrics and targets used to assess and manage relevant climate-related risks and opportunities.

The World Business Council for Sustainable Development (WBCSD) has released the CEO Guide to climate-related financial disclosures. The new Guide sets out clear actions that CEOs can take to align their organisations with the recommendations of the TFCD. The WBCSD very clearly recognises that we need a much wider view of the economy to be presented in financial reporting, incorporating ESG factors. This will better inform financial decision-making over the long-term, while making business more accountable for the environmental and social impact of their operations.

Conclusion

Whether directly or through the links of the supply chain, all entities are subject to the impact of ESG risks and ultimately the consumer will be subject to price risks, supply chain volatility and scarcity of resources.

Security around how companies conduct business is intensifying as investors, regulators and consumers seek more details and a deeper insight into the effect of business operations on the environment, society and regulatory compliance. More rigorous analysis and disclosure of ESG performance will be essential for companies to maintain consistent credibility and trust among an expanding set of stakeholders and, at the same time, drive performance in a manner that can be transparently evaluated by internal and external stakeholders.

The Deloitte publication ‘How CFOs can manage sustainability risk and find long-term value’ gives us an opportunity of reading about examples of how issues evolve to become sustainability risks and call on corporates to advocate sustainable business practices and transparent ESG reporting. 

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