Financial Reporting Brief February 2019

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Financial Reporting Brief

February 2019

This month’s article 'Corporate Communication – More than the Financials' comments on the increasing need for corporates to focus on non-financial ESG information as well as the financial statements.

Corporate Communication – More than the Financials!

‘While sustainable profit flows from the pursuit of a broader social purpose, translating it into something that is measurable in as simple and understandable way as we measure profit is not a small challenge’.

This is the introduction to one of the main sessions at the recent World Economic Forum (WEF) at Davos and highlights in bright lights one of the great challenges to be confronted by all engaged in corporate communications. Metrics that measure this remain the ‘soft underbelly’ of corporate communications. The ensuing WEF discussion revolved around how capital market participants can come together to make the worlds’ financial systems more resilient for achieving sustainable value creation and long-term societal wellbeing.

The EU Non-Financial Reporting Directive, which has been brought into legislation by Member States, becomes effective for many Irish companies for financial periods beginning on or after 1 August 2017. Our calendar year end reporters will therefore be obligated to deal with this for the first time in their 2018 year end reporting, albeit that many will have already commented voluntarily on the main topics in previous annual reports with some adopting the requirements early.

The stated aim of the Directive is to boost corporate transparency and performance as well as encourage companies to embrace a more sustainable approach to doing business, and enabling sustainable finance. Companies must develop their disclosures with ‘stakeholders’ in mind. The European Commission has published guidelines to help companies disclose information required by the Directive.

The Deloitte IFRS in Focus comments and provides observations on the EU Directive and the Guidelines published by the European Commission.

The increased recognition of the need for effective non-financial reporting to meet the corporate communication challenge has recently been given added impetus by a number of developments including:

  • IOSCO Statement on disclosure of ESG matters by issuers
  • IIRC publishes report – ‘Achieving balance in the integrated report’
  • SASB issues industry-specific sustainability accounting standards
  • EC expert group issues report on disclosure of climate-related information

IOSCO – Disclosure of ESG matters
IOSCO, the International Organisation of Securities Commissions, has published a statement setting out the importance for issuers of considering the inclusion of environmental, social and governance (ESG) matters when disclosing information material to investors’ decisions, with Principle 16 requiring issuers to provide full, accurate and timely disclosure of financial results, risk and other information which is material to investors’ decisions.

ESG matters, although characterized as non-financial, may have a material short and long term impact on the business operations of the issuers as well as on risks and returns to investors and their investment decisions.

IOSCO encourages issuers to assess risks and opportunities in the light of their business strategy and risk assessment methodology. Issuers are also encouraged to give insight into the governance and oversight of ESG-related material risks. Issuers can provide such insight, for example, by disclosing the methodologies they follow in their risk assessment, and the steps taken, and/or action plans to address the risks they have identified.

Investor interest in ESG disclosure is growing and the presence of ESG matters in investment strategy is valued and does influence investor investment and voting decisions. Information considered of particular importance are the issuer’s approach to long-term value creation, the nature of strategic and financial risks, and the way the issuer intends to manage them.

Integrated Reporting – Achieving Balance
The IR Network, in its report ‘Achieving Balance in the Integrated Report’, expresses concern that the level of trust between organisations, either public or private, and their stakeholders may well be at one of its low points in history. A call for transparent, credible and quality reporting, as a critical component of accountability and stakeholder engagement, is vital to rebuilding trust.

In striving to achieve balanced reporting, an organization needs to firstly critically reflect on whether its current reporting is a true picture of performance and outcomes, secondly, renew the commitment to balanced reporting by those charged with governance, and, thirdly ensure it has the processes and systems in place to produce the quality and balance in reporting that is expected.

Reporting that focuses on positive information with the understatement or omission of negative information is perceived to be a less than transparent reflection of the organisation’s performance and outcomes. Stakeholders may rightly say that the reporting is unbalanced, and question the integrity of such reporting.

Balanced reporting is not a choice, it is an imperative in building trust with stakeholders, and is a fundamental element of the governing body’s duty of accountability. It is the duty of those charged with governance to ensure that the information reported presents a true and fair reflection of the affairs of the organization. The governing body sets the tone on transparency: the unambiguous and truthful exercise of accountability.

The IR Framework requires a statement of responsibility from those charged with governance to be included in the integrated report with the focus on integrity and compliance with the overall spirit and content of the IR Framework.

SASB – Industry Accounting Standards
In November 2018, the Sustainability Accounting Standards Board (SASB) issued the world’s first set of industry-specific sustainability accounting standards covering financially material issues in 77 industries.

The standards aim at providing investors with in-depth information about the impact of a company’s actions on society and the environment – they come at a time of increased investor concern about companies’ business practices.

The standards are global in nature and contain concepts that are important for investors and businesses around the world. They include the subset of sustainability factors considered most likely to have financially material impacts on the typical company in an industry.

SASB standards support robust, investor-grade reporting in a range of communication channels, including financial filings, sustainability reports, annual reports and corporate websites. SASB aims to help market participants unlock the full potential of more consistent, comparable and reliable sustainability-related information. SASB reporting should provide support to more stable, resilient markets.

Publication of Sustainability Accounting Standards represents a major milestone in corporate reporting.

EC – climate-related disclosure
The European Commission (EC) has published its first report on companies’ disclosure of climate-related information. It contains recommendations that will allow the EC to update its non-binding guidelines on non-financial reporting with specific reference to climate-related information, in line with the recommendations of the Task Force on climate-related Financial Disclosures (TCFD) established by the Financial Stability Board. It marks another step in the implementation of the EC’s action plan on sustainable finance.

The report extends to 48 pages, providing introductory information and background in such areas as the role and benefits of climate-related disclosure and the Financial Stability Board’s objectives for climate-related financial disclosures. It then goes into the principles and rationale for reporting in the area and provides a number of proposed disclosures.

The report distinguishes between three types of disclosure

  • Type 1 disclosures - those that companies should disclose (high expectation that all reporting companies disclose them)
  • Type 2 disclosures – those that companies should consider disclosing (expected of companies with significant exposure to climate-related risks and opportunities)
  • Type 3 disclosures – those that companies may consider disclosing (additional or innovative disclosures that provide more enhanced information)

The report contains proposals for disclosing not just how climate change might influence the performance of a company, but also the impact of the company itself on climate change.

A review by the Climate Disclosure Standards Board (CDSB) of company reporting under the EU’s environmental reporting law has found that less than half (44%) of the largest European companies explain in their management reports how their business models are affected by climate change or environmental challenges.

While climate change was one of the major topics under review at the Davos World Economic Forum, many commentators expressed concern that unless urgent action is taken to ‘bend the curve’ on rising greenhouse gas emissions climate change is inevitable.

Current weather extremes from USA to Australia would seem to add considerable support to this concern. 

Conclusion
For corporate leaders, going through the process of assessing their climate change and other environmental risks and factors as a key part of their ESG review is a vital strategic tool for navigating to a sustainable economy.

Investors have a strong desire for enhanced reliability and comparability of ESG information and disclosures, in order to facilitate a more accurate assessment of risk and, accordingly, more informed investment decisions.

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