Sustainability reporting: The story beyond the pure financials

14 January 2021

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12 minute read

A recent survey[1] showed that 71% of the FTSE 100 companies and an even larger majority, 78%, of FTSE 250 firms are already reporting on how they link their key business activities with sustainability.

In order to show their stakeholders the progress they’re making in becoming a sustainable business 96% of the FTSE 100 and 87% of the FTSE 250 disclose a range of sustainability key performance indicators (KPIs). This study highlights the evolution of corporate reporting over the past decade: disclosures are now going well beyond profit and losses, detailing the environmental and social impact of business practices as well as capturing the progress a company is making on its sustainability journey.

This article outlines the steps corporates should take to establish a transparent, measurable and credible sustainability reporting, which not only forms the backbone of any sustainable debt issuance, but will also become the norm when new policies, such as the EU taxonomy, come into effect.

Jargon Buster

GRI: The Global Reporting initiative (GRI) was founded in Boston in 1997 – following public outcry over the environmental damage of the Exxon Valdez oil spill – with the aim to create a common language for organisations – large or small, private or public – to report on their sustainability impacts in a consistent and credible way. The first version of the GRI guidelines was launched in 2000 and has since been updated. The GRI is also partnering with the United Nations Global Compact to develop best practices for corporate reporting on the United Nations Sustainable Development Goals.

UNGC: The United Nations Global Compact (UNGC) is a voluntary business initiative, which brings together 8,000 business participants and 4,000 non-business participants, to provide a universal language and a framework for corporate responsibility

UN SDGs: In 2015, all United Nations (UN) members adopted 17 Sustainable Development Goals (SDGs) as part of the 2030 Agenda for Sustainable Development, a blueprint to achieve an inclusive, sustainable and resilient society and planet.

IIRC: The International Integrated Reporting Council (IIRC) is a global coalition of regulators, investors, companies, standard setters, the accounting profession, academia and non-governmental organisations (NGOs). The IIRC promotes communication about value creation as the next step in the evolution of corporate reporting.

SASB: The Sustainability Accounting Standards Board (SASB) was founded in 2011 to help businesses identify, manage and communicate financially material sustainability information to their investors. In 2018, SASB published a set of 77 industry-specific standards, which identify the minimal set of financially material sustainability topics and their associated metrics for the typical company in an industry.

TCFD: The Financial Stability Board established the Task Force on Climate-related Financial Disclosures (TCFD) to develop recommendations for more effective climate-related disclosures that could promote more informed investment, credit, and insurance underwriting decisions and, in turn, enable stakeholders to better understand the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks.

CDP: CDP is a not-for-profit charity that runs the global disclosure system for investors, companies, cities, states and regions to manage their environmental impact.

Stakeholders’ desire to understand the full impact of companies is growing

Sustainability reporting is not a new phenomenon. It has been on the periphery of corporate reporting for over a decade: in particular larger companies have been spearheading the move from a pure financial reporting style to company reports that also detail action on environmental protection, health and safety, diversity and inclusion, community giving and business ethics, to name a few. The Governance and Accountability Institute (GAI) reported in 2015 that approximately 81% of S&P 500 companies issued a sustainability report compared to less than 20% in 2011. By 2016, over 13,000 companies had produced more than 80,000 reports globally[2].

However, what was traditionally considered a voluntary disclosure on topics of general interest is now becoming a “must have”. Investors, in fulfilling their duty of care towards their own stakeholders, demand transparency from companies regarding their material sustainability risks and opportunities. Additionally, regulators and other market participants, including rating agencies, are calling for more authentic, measurable, credible and standardised corporate information to understand a company’s current and future sustainability preparedness.

At the same time, the public’s expectation of a company’s role in society is evolving. Businesses, in fact all organisations, are increasingly expected to not only reduce negative environmental and social impacts but also to contribute positively. Furthermore, the pandemic and recent concerns around racial justice and equality have put corporate sustainability performance into even sharper focus. Therefore, pressure is growing fast for companies to deliver sustainability disclosures, which satisfy the information needs of a variety of stakeholders such as customers, employees and its communities.

Three steps to transition from financial reporting to sustainability reporting

Whether preparing for a sustainability-linked financing or detailing environmental, social and governance (ESG) measures in the annual report, companies face a number of common reporting challenges and potential pitfalls, which can be grouped in the following three major areas that need to be addressed:

  1. Identifying key stakeholders and their specific information needs
  2. Aligning sustainability disclosures with broader business strategy 
  3. Moving towards measurable and impact-focussed reporting 

Below we look at each area in detail:

  1. Identifying key stakeholders and their specific information needs

Companies typically embark on their sustainability reporting-journey with an “outward-looking” perspective – mainly focussing on the impact of their business activities on the environment and society. Stakeholders, however, are also increasingly interested in “inward-looking” reporting that demonstrates how prepared a company is to address external sustainability risks and how its performance could be impacted by these.

To help address this need, many companies are looking at sustainability reporting standards for guidance. However, the sustainability reporting landscape is constantly evolving with new and competing reporting frameworks and benchmarks striving for dominance. The resulting “alphabet soup” of standards and frameworks – such as the the GRI, IIRC, SASB, TCFD and CDP – has created some confusion among publishers and users of reports as each standard can have different objectives and focus areas. Hence companies need to think carefully about which of these frameworks best suits their reporting objectives and the information needs of their various stakeholders. 

But there’s also good news for companies: efforts are underway to help achieve greater coherence, consistency and comparability between financial and corporate sustainability reporting frameworks and standards, mainly driven by the initiative “The Corporate Reporting Dialogue”[3]. What’s more, two of the most recognised standards, GRI and SASB, announced a strategic collaboration in July this year[4]. This could help many issuers, including those companies who are just starting their reporting journey. 

At the same time, companies should understand that standardised industry reporting guidelines are exactly just that: guidelines. As such, companies should not lose sight of tailoring their reporting to ensure they tell their full “sustainability story”. Once agreed on the key sustainability narrative, firms need to be aware that a “one size fits all” approach will not usually address the varied information needs of their stakeholders (investors and many others).

Therefore, sustainability reporting needs to happen with each stakeholder in mind. A PwC survey amongst corporates and investors showed that there’s still some work to be done: While 60% of companies believed their sustainability disclosures facilitate investors’ comparison of companies, 92% of investors didn’t agree[5]. To help with this task, corporate sustainability reporting teams have formed stakeholder panels to stay abreast of changing information needs as well as continuously evaluate the most efficient mediums and channels for disseminating this information.

  1. Aligning sustainability disclosures with the broader business strategy

Aligning the sustainability reporting with the broader business strategy isn’t always as straightforward as it first may seem, because often there isn’t just one business strategy but a strategy for each business division, geography, product or service. Each of those may well require a different sustainability approach and hence a different narrative with regard to its transformation to a sustainable business. This can present major challenges in particular for global corporations operating in multiple lines of business.

What makes a strong sustainability story? A strong sustainability disclosure isn’t necessarily one that can showcase the best performance but can evidence that a company fully understands its material issues and actively develops responsible business strategies that are aligned with its corporate purpose and strategy. This needs to encompass a clear articulation of the firm’s broader societal purpose, beyond maximising financial returns for shareholders.

At the same time, companies should be open about dilemmas they face on their sustainability journey and be transparent about, for example, future resource constraints potentially affecting their operations and positive and negative aspects within their value chain in terms of environmental, social and economic impacts. Many companies now address this by publishing clear position statements and reporting extensively on specific sustainability issues, risks and mitigating factors/actions.

  1. Moving towards measurable and impact-focussed reporting

During its infancy, sustainability reporting was often characterised by bold yet broad missions, commitments and selective sustainability measures. However, this is changing in the light of information users demanding access to more reliable, comprehensive and comparable data, as well as a clear and transparent articulation of a company’s value creation story and related risks. 

Companies are recognising that their sustainability disclosures are crucial in helping investors, rating agencies and other stakeholders to understand and assess the future risks and opportunities of their business activities as well as how these activities are aligned with market standards and taxonomies (such as the EU Taxonomy, and, in time, a social taxonomy). Furthermore, delivering comprehensive sustainability disclosures can also give companies a unique advantage in differentiating themselves and in turn access broader capital pools at more favourable pricing.

Equally, companies have started to acknowledge that sustainable business practices not only satisfy investor demands but also improve staff satisfaction and retention[6] as well as attract the fast growing number of customers, who are seeking to do business more responsibly. As such, CEOs increasingly declare sustainability to be their personal responsibility, aiming to embed ESG thinking into their company’s DNA and corporate language and setting the agenda from the top. However, challenges remain in how this is delivered internally within an organisation. Any investor relations, finance, marketing or sustainability team having to get input and agree on corporate messaging will appreciate the difficulty in ingraining sustainability considerations across multiple diverse functions. 

Finally, looking at whether – and how – to combine financial and sustainability data, the direction of travel is clearly moving towards merging financial with sustainability reports with some finance teams taking more ownership over sustainability reporting. However, sustainability metrics, which by their nature can be more aspirational, stretching and sometimes “softer” than traditional financial metrics, don’t always align well with traditional financial targets and reporting. Hence some firms are choosing to produce a sustainability supplement as part of their annual report with cross-references between the two. 

Understanding sustainability as a company-wide project, which requires a dedicated programme management team as well as project teams with representatives from all corporate functions, is the most effective approach. While some might be hesitant to invest in additional headcount, the interdependent financial, reputational and risk benefits of a transition to a sustainable business far outweigh the costs of a suitably staffed project management office, which also delivers on the sustainable reporting requirements.   

Reporting and direct investor engagement should go hand in hand

While for some sustainability officers it can be tempting to “hide behind” ESG agencies and reporting standards, companies shouldn’t consider producing a sustainability report to be a substitute for proactive investor engagement. Ideally, they go hand in hand. Several companies, in fact, first spoke to their investors before determining their panel of ESG agencies and focus areas in their sustainability reporting.

There are multiple channels for engaging with investors on sustainability matters:

Informal channels

At NatWest, we are regularly organising one-to-one “ESG speed dating” sessions, either in the form of a single-company roadshow or as part of a conference for larger groups of companies and investors. One-to-one sessions not only offer privacy to tackle the more sensitive topics but can also be a good platform to deliver some “soft factors” to investors, the “body language” of the management so to speak, such as the enthusiasm and sustainability expertise of a firm’s senior decision makers.

For the “long tail” of smaller, ESG-focused investors sustainability webinars are a useful format for outlining particular aspects of a company’s sustainability strategy. While more time-efficient in set-up, they do require careful follow-up with individual attendees to obtain richer feedback.

Formal channels

Various companies have developed their own investor and stakeholder ESG surveys. These tend to centre on sustainability topics that are considered the most relevant to their company, and hence should be in the focus for external reporting. If conducted regularly (at least once a year), these are useful for companies to get a sense for the ESG aspects they should emphasise.

Equally, more advanced ESG investors have developed their own in-house questionnaires in order to ask portfolio companies about their sustainability approach. This allows them, at least partly, to dis-intermediate ESG information intermediaries. They link directly to the investment parameters of the investor as a whole or indeed a specific portfolio. 

Making sure “green” is understood universally: the EU Taxonomy

The EU Taxonomy is one of the most significant developments in sustainable finance and will be a key policy, if not the most wide-ranging policy for investors and issuers. It’s designed to help investors, companies and issuers transition to a climate-resilient economy by providing a common language and uniform criteria to identify the extent to which economic activities may be considered environmentally sustainable.

The EU Taxonomy sets performance thresholds (“technical screening criteria”) to help parties identify environmentally friendly activities and access green financing. It applies to:

  1. Financial market participants offering financial products in the EU, including investment funds, portfolio managers, and occupational pension providers;
  2. Large companies who are already required to provide a non-financial statement under the Non-Financial Reporting Directive; and
  3. The EU and Member States, when setting public measures, standards, or labels for green financial products or green (corporate) bonds.

Under the EU Taxonomy, environmentally sustainable activities must:

  1. Make a substantive contribution to one of six environmental objectives or be enabling or transitional activities. The six environmental objectives are:
    • Climate change mitigation
    • Climate change adaptation
    • Sustainable use and protection of water and marine resources
    • Transition to a circular economy
    • Pollution prevention and control
    • Protection and restoration of biodiversity and ecosystems
  2. Do “no significant harm” to the other five environmental objectives, where relevant;
  3. Meet minimum safeguards, including Organisation for Economic Co-operation and Development (OECD) Guidelines on Multinational Enterprises and the UN Guiding Principles on Business and Human Rights[7].

Financial market participants and companies will be required to complete their first set of taxonomy disclosures, covering activities that substantially contribute to climate change mitigation and adaptation, by 31 December 2021[8]

While the policy is not binding for non-EU financial market participants (unless they are active in EU markets), recent publications have suggested that those may still want to make their own disclosures in line with the EU Taxonomy and that non-EU investors, too, could embrace the policy as a helpful tool to gauge whether an investment contributes to an “environmental objective”[9]

As such, the EU Taxonomy will likely influence international reporting frameworks and country policies over time. For example, Japan’s Transition Finance Study group has already proposed the creation of a “transition taxonomy”, while Canada and Malaysia are reportedly developing their own classification systems for corporate environmental activities[10]. 

Policies such as the EU Taxonomy will help enhance the understanding of what exactly defines sustainable business practices and how good sustainability performance looks like. Looking back, the past few years have already shown that the thinking around the role of companies is changing significantly and fast. And many companies have taken this on board already, publishing reports that are a far cry from the look and feel of traditional financial reports, shining a light on so many more facets of corporate citizenship.

 

Corporate clients who would like to discuss this topic further should contact:


Dr Arthur Krebbers, Head of Sustainable Finance, Corporates or
Varun Sarda, Head of ESG Advisory

 

Read the further articles in this series:

#1: Sustainable finance – a success story of change

#3: The role of ESG ratings

#4: Sustainable finance product suite flourishes

#5: Structuring a sustainable use-of-proceeds debt instrument

#6: Structuring a sustainable KPI-linked instrument

 

[1] https://www.pwc.co.uk/sustainability-climate-change/assets/pdf/bpta-sustainability-award-report-2019.pdf

[2] https://www.cpajournal.com/2018/07/30/the-current-state-of-sustainability-reporting/

[3] https://corporatereportingdialogue.com/corporate-reporting-dialogue-shows-high-level-of-alignment-between-major-global-reporting-frameworks-on-tcfd-recommendations/

[4] http://www.theaccountant-online.com/News/gri-and-sasb-announce-collaboration-8023427

[5] https://www.pwc.com/us/en/services/governance-insights-center/library/esg-environmental-social-governance-reporting.html

[6] https://knowledge.wharton.upenn.edu/article/how-companies-tap-sustainability-to-motivate-staff/

[7]https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/200309-sustainable-finance-teg-final-report-taxonomy_en.pdf

[8] https://www.unpri.org/pri-blogs/eu-taxonomy-final-report-2020-starts-a-decade-of-action-on-climate-change/5547.article

[9] https://corpgov.law.harvard.edu/2020/06/10/the-ripple-effect-of-eu-taxonomy-for-sustainable-investments-in-u-s-financial-sector/

[10] https://corpgov.law.harvard.edu/2020/06/10/the-ripple-effect-of-eu-taxonomy-for-sustainable-investments-in-u-s-financial-sector/

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