Getting ahead of the curve
Sustainability reporting on environmental, social, and governance (ESG) issues has traditionally been voluntary in the US. But given heightened regulatory and legal scrutiny, along with other market developments, the transparency and accuracy of sustainability reporting is becoming increasingly important. As a result, standalone sustainability reporting—which helps organizations set goals, measure performance, and manage change around ESG impacts—is accelerating.
- Market drivers and the reporting landscape
- A closer look at heightened risks
- The ESG information gap
- Steps to consider
- The call to action
Market drivers and the reporting landscape
Recent high profile incidents involving automotive, big box retail, and energy and resources companies highlight growing attention to public company nonfinancial disclosures—such as how ESG or sustainability topics are disclosed to stakeholders, especially investors. In addition, several developments have reinforced the movement toward more standardized, transparent, and meaningful ESG disclosures. A few of these developments include the climate change agreement reached at the 2015 Conference of Parties; ESG guidance issued in November 2015 by the World Federation of Exchanges; and a 2014 directive passed by the European Parliament on disclosure of nonfinancial information, which covered many aspects related to sustainability.
Multiple market drivers, along with the developments cited above, point to even more rigorous sustainability reporting and disclosure expectations ahead. Organizations, therefore, are looking for clearer standards for sustainability reporting and disclosure against which market participants will evaluate company sustainability performance.
Market drivers and the sustainability reporting landscape
A closer look at heightened risks
Broadly, ESG issues present three types of reporting-related risks to businesses:
- Legal and disclosure risk. The moderate pace of standardized ESG reporting in the US compared to other countries is thought by some to reflect fear that expanded disclosure may be used against companies in today’s litigious environment. A greater risk, however, could lie in the absence of reporting or for failing to implement a rigorous, disciplined reporting program that provides accurate and transparent information to stakeholders and authorities.
- Competitive risk. ESG performance is increasingly a consideration when deciding whether to buy a company’s products or to work for a particular company. Price and functionality, or pay and benefits, usually trump other considerations. But sustainability topics are progressively driving more of these considerations as a generation that’s coming of age amid environmental and economic strains and continuing global strife assumes buying power and investment decisions.
- Market valuation risk. A top question among corporate board members and executives regarding the value of ESG initiatives and disclosure is whether such investments add shareholder value. Recent research shows that US sustainable investment grew from $1 out of every $9 of assets in 2012 to $1 out of $6 in 2014, according to investment banking firm Morgan Stanley. And firms that actively pursue improvements in ESG metrics tend to have lower costs of capital and higher operational and stock price performance.1 In addition, Harvard Business School research found that “firms with good performance on material sustainability issues significantly outperform firms with poor performance on these issues, suggesting that investments in sustainability issues are shareholder-value enhancing.”2
1 “Sustainable Reality: Understanding the Performance of Sustainable Investment Strategies,” Morgan Stanley, March 2015.
2 “Corporate Sustainability: First Evidence on Materiality” working paper, Mozaffar Khan, George Serafeim, Aaron Yoon, Harvard Business School, Copyright © 2015.
The ESG information gap
Corporate directors and executives may feel they are receiving mixed signals regarding the importance of ESG topics to investors. They can be swamped with questionnaires and surveys from investors, ratings agencies, media outlets, and others regarding their company’s ESG performance. Yet the topic is seldom raised on quarterly earnings calls. This disconnect is not altogether surprising considering the strong focus on financial performance that is characteristic of earnings calls. There may simply not be time for ESG topics to come up, especially if management is not proactively communicating how ESG topics drive corporate performance and translate into value.
The lack of inquiries, however, can create a troubling information gap, where in many cases corporate executives—especially CFOs—are not prioritizing these issues at the same level as investors may be. Investors often look to third-party ratings and data providers to gain access to ESG data sets, generated primarily through company survey responses (or lack thereof), external research, and other inputs. Given this survey-driven ESG information value chain, companies are subject to increasing risk if their corporate leaders are not confident in the accuracy and reliability of those multiple ESG survey responses.
Steps to consider
For corporate decision makers, this is not the time to sit back and watch the sustainability landscape progress while waiting for a single harmonized standard or clear mandate for sustainability reporting and disclosure. Whether starting a sustainability reporting program or refining an existing one, corporate decision makers, including CFOs, may benefit from the following considerations:
Understand material topics and report more effectively
- Develop a stakeholder engagement strategy to contribute to a better understanding of material ESG issues
- Actively engage with internal and external stakeholders to continually evaluate the relative prioritization and trade-offs of ESG issues
- Secure high-level executive buy-in, support, and feedback around ESG disclosure initiatives
- Create a centralized inventory of current and emerging sustainability reporting and disclosure developments, as well as relevant regulations
- Develop a sustainability strategy and reporting program that clearly articulates the organization’s sustainability strategy, risks, and opportunities and performance on material ESG topics
Establish credibility and build trust through transparency
- Prepare sustainability disclosures in accordance with established sustainability standards and reporting frameworks (e.g., GRI, SASB, CDP, or DJSI, among others) and make ESG information publicly available
- Design and maintain well-documented and thorough internal reporting processes, controls, and procedures for ESG disclosure
- Establish and publicly communicate ESG targets and key performance indicators
- Engage the internal audit function to serve as an important component of the ESG management reporting system
- Obtain external assurance to increase stakeholder confidence in the integrity and reliability of ESG reporting
The call to action
Scrutiny around how companies conduct business is intensifying as investors, regulators, and consumers seek more details on and 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 improve 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.
Taking steps now to prepare for more rigorous reporting and disclosure demands from investors and the capital markets, as well as regulators and customers, will help companies meet evolving 21st-century expectations.