Financial Reporting Brief March 2017

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Financial Reporting Brief

March 2017

Our featured article for March is 'Long-Term Value Focus – ESG Reporting' with Brendan Sheridan commenting on the continuing evolution of corporate reporting towards a greater focus on wider value creation.

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Long–Term Value Focus - ESG Reporting

“Not everything that counts, can be counted, and not everything that can be counted, counts.”

A quote credited to Einstein which has recently been included in a Deloitte publication which comments on the future development of corporate reporting. It comments on the need for awareness that simple measures of profitability are no longer sufficient to keep investors and stakeholders informed with increasing demands for more insight into the value creation process and the impact a company can have within its environment at a number of different levels.

There is growing recognition that organisations should have a broader societal purpose beyond profit. While shareholder return will remain crucial for business, there is an expectation that the focus will broaden from pure shareholder value creation to wider value creation meeting community – based ideals of society.

To create an environment that not only fosters investment but promotes trust in business to the benefit of all society, globally respected corporate governance standards play a significant role in attracting the flow of capital. Strong governance is a foundation for sound business practices and quality, transparent reporting to all stakeholders.

Corporate Governance Code
Hot off the presses with regard to corporate governance is the announcement by the UK Financial Reporting Council (FRC) that it will carry out a fundamental review of the UK Corporate Governance Code. The review will take account of recent developments including the work done by the FRC on corporate culture and succession planning. The review will build on the Code’s globally recognised strengths developed over the past 25 years and be responsive to the growing demands on the corporate governance framework.

Recent evidence indicates that while executive pay and linkage to performance, and the composition of corporate boards, are high priority governance issues, the most pressing issue for many is to have boards focus on long-term value and its significance to the interests of all stakeholders. There is a growing realisation that organisations must move increasingly away from a focus on short-term profits to longer – term value creation.

Integrated Reporting
For most this means companies should embrace a wider view of corporate reporting with the quest for a more joined-up and efficient approach to ensuring stakeholders receive clear messages. A major question going forward is whether integrated reporting responds adequately to this call and whether it receives sufficient support in the global corporate community and marketplace. A nagging issue for many organisations is that reporting is a compliance issue and does not place adequate focus on communication to key stakeholders. The burgeoning increase in size of annual reports driven by regulatory and other pressures is one consequence of this. These issues need to be addressed.

To achieve effective integrated reporting there must be integrated thinking. Integrated thinking is the active consideration by an organisation of the relationships between its operating and functional units and the capitals that the organisation uses or affects. These capitals are not only financial but also include social and relationship, human, intellectual, manufactured and natural, with the various connections and interdependencies that exist between them.

Integrated reporting brings together material information about an organisation’s strategy, governance, performance and prospects. This is done in a way that reflects the environmental, social and governmental (ESG) context within which it operates. It provides a clear and concise representation of how an organisation demonstrates stewardship and how it creates and sustains value.

ESG Reporting
Investors are becoming increasingly alert to the need to routinely analyse ESG information alongside other financial and strategic information in order to gain a better understanding of companies’ future prospects. Companies need to be aware of the importance of high quality ESG information, and engaging investors on sustainability related issues. By disclosing the information that investors want, companies can provide reassurance that they are effectively managing business risks and identifying opportunities.

Varying practices have been in use by companies with regard to their reporting in this area. Investors are looking for a standard approach on how companies report to improve comparability and other factors. The London Stock Exchange Group (LSEG) has taken a lead with guidance on how companies should report. The LSEG guidance focuses on what they consider to be the priorities for ESG reporting practices:

  • The relevance of ESG factors, such as climate change implications, to a company’s strategy and how it plans to reduce the impact, or possibly gain benefit from them;
  • A clear explanation from companies on what the impact will be of ESG factors on their businesses, and how such factors could implement financial performance;
  • ESG data that companies provide should be clear, consistent and based on global standards.
    Standards for ESG reporting are varied and include those put forward by the Global Reporting Initiative and the UN Global Impact, among others;
  • The outlet for ESG reporting could include a company’s annual report or a stand-alone report, with the relevance and significance of the disclosures to the investors being top priority;
  • How to deal with global regulations; and
  • How to communicate on a company’s exposure to green products and services.

There is also a separate perspective set out on ESG standards for a company seeking to raise debt financing.

Climate Related Disclosures
There is an ongoing flow of sustainability and integrated reporting developments with organisations including, amongst others, the Sustainability Accounting Standards Board, the Global Reporting Initiative, and the Climate Disclosure Standards Board being very active.

In December 2015, at the request of G20, the Financial Stability Board established an industry-led Task Force on Climate-Related Financial Disclosures with a mandate to design a set of recommendations for consistent disclosures that would help financial market participants understand their climate-related risks. The Task Force published its recommendations in December 2016 with the Task Force emphasising the significance of risks related to climate change and expressing concern that it is perhaps the most misunderstood risk facing organisations today. The recommendations share four key features which support their voluntary adoption by reporting organisations – insofar as they are:

  • Adaptable by all organisations;
  • In a form compatible for inclusion in financial filings; 
  • Designed to provide decision-useful, forward looking information in financial reports; and
  • Focused strongly on risks and opportunities.

The Deloitte publication “Thinking Allowed – Climate-Related Financial Disclosures” looks at issues involved and how companies and audit committees might respond to the challenges to integrate the implications of climate change in their corporate reporting effectively.

Conclusion
As the environment in which organisations operate changes, corporate reporting continues to evolve to meet expectations. Companies should continue to question themselves as to whether their annual report goes further than being only a compliance exercise. Does the report provide a clear sense of how long-term sustainable value is created, and the key components of creating value?

Be sure your annual report provides the information that counts!

Reporting – A Need to Focus on Long–Term Value Creation

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