Environmental, social and governance reporting has come into its own as a discipline, with most companies now issuing sustainability reports. What’s the board’s and executive team’s role in ensuring that these reports are responsive to investor needs?
An estimated 95 percent of the S&P 500 published detailed environmental, social and governance (ESG) sustainability reports in 2019. Most of these reports were submitted in a stand-alone ESG, sustainability, corporate responsibility or similar report. Of the remaining 5 percent of the S&P 500, most companies published some high-level policy information on their website.
The U.S. Securities and Exchange Commission (SEC) is focused on increasing the consistency and comparability of climate disclosures and has committed to developing a mandatory climate risk disclosure rule proposal by the end of 2021. If the rulemaking is completed this year, implementation would not apply to a Form 10-K until the 2022 annual report, at the earliest. If the process is not completed until well into 2022, the rule would probably not be implemented until the first quarterly 10-Q filed in 2023. Of course, no one will know for sure until the final rule is released.
ESG Reporting Is Nearly Ubiquitous But Haphazard – But it May Become Common Language Before Mandates or Standards Are Finalized
Underpinning all this activity is the intensive emphasis on sustainability investing by fiduciaries, asset owners and asset managers. Sustainability assets are on track to represent more than a third of the projected total assets under management by 2025. The pandemic and green recovery commitments in the U.S., the EU and China are expected to facilitate this continued growth in the capital markets.
And then there are the reporting frameworks the private sector has made available. More than 1,500 organizations globally, including over 1,340 companies with a combined market capitalization of $12.6 trillion and financial institutions responsible for assets totaling $150 trillion, have endorsed the recommendations for sustainability disclosure (PDF download) from the Task Force on Climate-related Financial Disclosures (TCFD). The Sustainability Accounting Standards Board (SASB) has seen a marked increase in reporting using its framework over recent years. According to BlackRock (PDF download), ESG data will evolve into a common language among issuers and investors over the next few years.
Bottom line: ESG reporting presents an opportunity for companies to share what they are doing to sustain the long-term interests of shareholders while also addressing the interests of customers, employees, suppliers and the communities in which they operate. It is responsive to the rapid growth in sustainable, responsible and impact-investing assets. Bucking this undeniable trend could mean a lot more than just being left behind. It can lead to high-profile proxy battles over ESG-related topics, threats to board seats, institutional investors redirecting capital elsewhere and brand erosion. That is why high-quality and transparent ESG reporting should be a board and executive team priority.
Topics to Consider
With emphasis on reporting beyond financial results rising across the globe, it is time for directors and executives to be as interested in the quality of these reports as they are in the traditional financial statements. To that end, following are six topics for boards and executive teams to consider now, if they haven’t already:
1. Have we formulated a compelling sustainability strategy supported by targets and goals for the future that enables us to convey a convincing sustainability commitment to the marketplace?
Directors and executives should understand how the company’s ESG strategy and initiatives compare to those of its competitors. For example, if they are setting a net-zero carbon goal by a specified date, should the company do likewise? It is important to integrate ESG considerations with the overall corporate strategy rather than be a mere appendage and afterthought to “making the numbers,” treating ESG reporting as equivalent to a compliance activity.
2. What story are we telling the street?
Directors and senior executives should understand whether the ESG storyline is resonating in the market and impacting the company’s valuation. They should contrast the company’s message to its peers, leaders and key competitors. For example, does the company articulate how ESG initiatives make a difference in executing the strategy and identify those areas where it sees the greatest opportunity for creating value? In many ways, a company’s chosen storyline and the actions it portrays around reducing greenhouse gas emissions; operating the business in a sustainable manner; improving conditions in the workplace; and enhancing diversity, equity and inclusion of the workforce – among other things – is a brand play.
3. What accountabilities have we set for ESG-related performance?
ESG performance should be integrated with financial and operational performance monitoring; otherwise, it may become an appendage and receive less C-suite attention. Performance expectations and metrics should be linked to incentive compensation plans to drive progress and establish accountability for results. Executive sponsorship of ESG initiatives is an imperative.
4. What are our ESG risks, and how well are we managing them?
ESG objectives and activities present new and unique risks and opportunities that should be considered in the company’s enterprisewide risk management (ERM) activities. Note that there is guidance on how to do this. ESG-related risks should be incorporated into public disclosures related to risk (e.g., the disclosure of risk factors).
5. Is our ESG reporting satisfying the needs of the investment community and other stakeholders?
Discussion is warranted regarding management’s process for engaging and understanding the expectations of ESG stakeholders. For example, institutional investors and asset managers having a stake in the company may have conveyed their expectations for reporting ESG performance as well as the ESG criteria they are using in following the industry. It is also useful to monitor the company’s ESG ratings and understand what makes them change.
6. What role should the board play in overseeing the company’s ESG activities and reporting?
The board should inquire as to the evolution of the company’s ESG strategy in view of market developments. In addition, directors should consider their review responsibilities for ESG reporting in the context of how the board approaches Form 10-K and other public reporting. ESG-related risks – the risks related to the execution of the strategy – should be included within the scope of the board’s risk oversight process.
These considerations could warrant reexamining committee charters and assessing the expertise to which the board has access. In addition, some companies are disclosing the board’s oversight role with respect to ESG matters.
Additional Areas of Interest
The above six items provide the foundation for a comprehensive conversation regarding ESG strategy, risks and reporting as well as the board’s oversight responsibilities. Following are six additional matters that should be of interest in the boardroom and C-suite:
7. How are we pushing accountability for results down through the ranks?
As companies formulate plans to achieve long-term goals, it is necessary to time-phase those plans with near- and intermediate-term targets that directionally lead the company down the path toward the long-term goals. This process makes the expectations for execution real when people are assigned ownership of specific tasks and targets, particularly when linked to performance assessments and compensation. Simply saddling someone at corporate with the full responsibility without engagement of business owners is highly unlikely to lead to success.
8. Can we integrate our ESG reporting with financial reporting?
ESG investments and initiatives enable key strategies, create new sources of revenue and achieve operating efficiencies – affecting both present and future financial returns. Thus, it may be more meaningful to investors to integrate ESG reporting into financial reports, quarterly earnings calls and investor roadshows consistent with the convergence of investor interest in both financial and ESG performance. While implementation is likely to be challenging initially, such alignment may result in meaningful time and cost savings.
9. What reporting framework(s) are we using, and why?
With the proliferation of standards in the market and various frameworks in play, reporting against multiple frameworks may be necessary to address investor needs for common metrics to compare and contrast performance. The use of an established framework, such as the SASB, is an effective way to avoid “greenwashing,” or the overstatement of ESG efforts. That said, it will be interesting to see what the SEC mandates on the climate front later this year. Until a universal framework is adopted, the practice of reporting against multiple frameworks may evolve to one that is expected.
10. What have we done to ensure that our ESG-related disclosures are reliable?
Directors should gauge management’s confidence that the company’s disclosure controls and procedures are effective as they relate to ESG metrics and reporting. This may be an opportunity for the internal audit function to include important aspects of the company’s ESG reporting in the audit plan to provide assurance to management and the board as to the fair presentation of the underlying data.
Note that the CEOs and CFOs of companies traded on U.S. exchanges sign a statement every quarter in an SEC filing certifying the effectiveness of the company’s disclosure controls and procedures. The scope of such controls and procedures includes ESG metrics, measures and reporting. A sharper emphasis on ESG should lead to process automation, enterprise resource planning system updates and use of focused dashboards.
11. Does – and, if not, should – our independent auditor have a role in ESG reporting?
Only 6 percent of S&P 500 companies received an ESG-related assurance from a public company audit firm. By contrast, 47 percent of companies had such an assurance from an engineering or consulting firm (“other provider”) that was not a CPA firm, primarily for greenhouse gas emissions metrics. Increased investor reliance on ESG reporting may elevate the importance of independent attestation over time, particularly for companies active in the capital markets. For example, in a securities offering, underwriters may request comfort letter attestation for selected ESG disclosures.
12. How has the COVID-19 pandemic affected our ESG reporting?
With the pandemic’s effects on customer behavior, workplace design, global supply chains and relevant communities, the focus on ESG matters has shifted for many companies. For example, the approach to social issues around health and safety, the distributed workplace and employee wellness has changed. Companies are revisiting their approach to addressing their carbon footprint as the market transitions from the pandemic. The question is, how are these and other pandemic-induced impacts altering the company’s discussions of ESG strategy and initiatives, including the balancing of short-term needs and decisions with long-term resilience?
The above discussion applies to companies issuing sustainability reports. As noted earlier, 95 percent of S&P 500 companies issue these reports; thus, some of them are not issuing these reports. And there may be many others as well that are below the S&P 500 threshold. For such companies, the board should inquire of management as to why a report is not issued, because (like it or not) the company has become an outlier.
More important, what are the repercussions of not issuing an ESG report? Are competitors issuing them? Are major shareholders raising concerns about the lack of expected disclosures? Is the company’s stock valuation affected by the company’s lack of transparency?
And don’t forget private companies! It is inevitable that ESG considerations will impact them in regard to long-term loans; property and casualty insurance renewals; customer and supply chain requests; regulatory requirements; and employee interest, safety and retention.
The world has changed such that it is a cliché to assert that sustainability reporting is here to stay. What companies had best do now is focus on how they will carve out a leadership role in this brave new world, one that will resonate with investors, attract talent and retain customer loyalty, execute with intention and tell investors a differentiating story.
 For example, the following frameworks show varying usage based on a survey of the S&P 500 by Governance & Accountability Institute (usage noted parenthetically): the CDP (formerly the Carbon Disclosure Project) (65 percent), the Global Reporting Initiative (GRI) (51 percent), the United Nations Sustainable Development Goals (UN SDGs) pursuant to the 2030 Agenda for Sustainable Development (36 percent), the Sustainability Accounting Standards Board (SASB) (14 percent) and Task Force on Climate-related Financial Disclosures (TCFD) recommendations (TCFD report) (5 percent). Other standards are available or under development.