What are the standards for corporate sustainability? Fox Rothschild’s Maureen Mitchell offers insight into the most commonly used standards and how companies should go about setting goals.
Companies are increasingly viewing sustainability as a necessity in achieving their business objectives. According to the Governance & Accountability Institute, in 2011, just under 20 percent of S&P 500 companies reported on their sustainability, corporate social responsibility, ESG (environment, social, governance) performance and related topics. By 2017, the number of S&P 500 companies reporting rose to 85 percent.
But how sustainability is defined is subject to wide debate. How it is measured is even more nebulous. As more and more companies are seeking to define themselves, their brands and their business models by measuring their performance on a variety of nonfinancial metrics, many questions emerge, such as what standards apply? and What are the disclosure requirements?
Since disclosure of corporate sustainability performance in the United States is primarily done on a voluntary basis, most companies prepare reports that rely upon environmental, social and governance (ESG) standards issued by a number of independent agencies, NGOs and other organizations. Even with these standards in place, however, there is a troubling lack of consistency in type, extent and quality of disclosure. This lack of consistency creates a challenge for investors seeking to analyze and compare the disclosures when making investment decisions. A review of the most widely used sustainability standards illustrates these challenges.
Overview of Sustainability Reporting Standards
One of the most widely used comprehensive sustainability reporting standards has been issued by the Global Reporting Initiative (GRI). GRI is an international, independent organization helping businesses, governments and other organizations report sustainability standards. The GRI standards are interrelated and contain three universal standards comprised of a foundation, general disclosures and management approach, as well as a number of topic-specific standards related to economic, environmental and social topics.
Companies using the GRI standards for preparing a sustainability report may choose between “core” – a minimum level of information needed to understand the nature of the organization, its material topics and related impacts and how these are managed – and “comprehensive” – which requires the organization to report more extensively on its impacts by reporting all the topic-specific disclosures for each material topic covered by the GRI standards.
A different approach is used by the Sustainability Accounting Standards Board (SASB), a nonprofit organization that publishes industry-specific sustainability accounting standards. SASB maintains standards for 77 industries across 11 sectors using an industry classification system. Topics include business model and innovation, leadership and governance, human capital, social capital and environment. While the existence of industry-specific disclosure standards helps address inconsistencies between competitor companies, the SASB standards focus on financially material issues. As a result, they may not include nonfinancial information sought after by investors with more altruistic goals. The SASB also focuses on United States companies and industries.
The United Nations has also sought to guide nonfinancial reporting by participating companies. The United Nations Global Compact (UNGC) Guide to Corporate Sustainability invites organizations to align their strategies and operation with 10 core principles related to human rights, labor, environment and anti-corruption measures. Signatory companies to the Global Compact commit to file an annual communication of progress (COP) containing a statement of continued support of UNGC, describing the practical actions taken to implement the 10 core principles and measuring the company’s performance regarding specific targets or performance indicators.
Yet another approach to grading sustainability efforts is found in the CDP (formerly the Carbon Disclosure Project) global disclosure system that enables companies and local governments to measure and manage their environmental impacts by completing a program-specific questionnaire. CDP then analyzes and scores the company’s performance based on an individual methodology for each of its programs, and third parties like Bloomberg and Google Finance publish the scores.
Inconsistent Standards Lead to Inconsistent and Unreliable Results
Despite increasing participation in these sustainability standards programs, the challenges of inconsistency persist. The varying approaches to disclosure illustrate the range of options available. Different standards capture certain information, but omit other key metrics. Furthermore, when companies have the freedom to self-select the details that are deemed material, it is apparent that marketing and public relations objectives at times outweigh the disclosure of specific, significant information. On these nonfinancial topics, the lack of objective and accurate measurement tools is yet another challenge. Consequently, comparison between firms, even those in the same industry, is frequently incomplete and uncertain.
Even when a single sustainability standard is used and measurement tools exist, there is no standardized format. This requires careful review and analysis of annual reports to extract key metrics and present them in a more accessible format. This has led to companies receiving questionnaires from investors, customers and other stakeholders interested in filling information gaps. But these methods are costly, cumbersome and do not result in broad distribution of the requested information.
The growth of sustainability reporting clearly reflects increased appreciation for the value of being perceived as a sustainable business. Companies often cite the market-based approach, reflecting priorities of consumers, employees, investors and other stakeholders, as a major motivator. Benefits include attracting the best talent (as well as socially minded customers and investors), thwarting activist intervention and achieving competitive success. Implementing sustainability initiatives also can help achieve measurable progress in reducing operating and manufacturing losses.
Voluntary vs. Mandatory Reporting – Finding a Balance
It is reasonable to assume that sustainability reporting will continue to increase and improve in the near future. Robust debate about alternatives to the voluntary ESG reporting model are taking place. Some jurisdictions, such as South Africa, China, Denmark, Finland, Indonesia and the European Union, are moving toward mandatory ESG disclosure. In these jurisdictions, proponents argue that without a legal obligation requiring reports to comply with clear and comprehensive reporting standards, there is a risk that stakeholders will never be able to have faith in either the accuracy or the meaningfulness of these reports.
Financial regulators and stock exchanges are on the front lines of mandatory reporting guidelines. In contrast to the market-driven approach, these initiatives tend to focus on financial consequences for environmental concerns. For example, the Securities and Exchange Commission issued guidance in 2010 on the materiality of climate change risk (see Commission Guidance Regarding Disclosure Related to Climate Change, 75 F.R. 6290 (Feb. 8, 2010)). To date, the mandatory ESG reporting requirements are limited, which is not surprising given the lack of consensus on how to define and measure sustainability performance.
One option gaining traction is the “comply or explain” approach. Recognizing that reporting on ESG issues may vary across corporate practice, ownership structures, market structures and corporate governance regimes, companies may opt between issuing a compliance report or explaining in the annual accounts why compliance was not achieved. Jurisdictions in developed economies have reported relatively high levels of compliance using this approach. A major benefit of the “comply or explain” approach is greater flexibility in its introduction and implementation. Companies have the ability to determine the feasibility and cost of compliance and opt out of compliance when the costs are too great.
One thing is clear: Sustainability is here to stay. Public demand for nonfinancial information is too great for this issue to be ignored. Companies that have not yet started their own sustainability initiatives would be well advised to begin their research and implementation efforts.