Understanding of the Intersection of Sustainability Reporting, Regulations and Value Creation
With the rise of ESG & Sustainability reporting, some multinational companies have struggled to align their reporting efforts with the various regulatory frameworks, and to leverage the resulting data to drive improvements and create value. In this article, we provide insight into how companies can better extract value from these efforts.
Is sustainability reporting necessary? What are the benefits? What does the trajectory look like? In this article, we will try to provide some guidance answering these key questions.
Non-financial reporting officially began, in 1973 with the launch of the International Financial Reporting Standards (IFRS), as a voluntary response to stakeholder demands for information regarding external factors such as the economy, environment and society (as well as individuals which may be affected) and their relationship with corporates. However, in the current market it is predominantly driven by a number of forces, including investor and societal demand, and most importantly new regulations for companies to disclose non-financial and more specifically sustainability-related disclosures.
With the onset of several new regulatory requirements for the disclosure of sustainability or ESG information, companies are expected to fortify their monitoring of such issues and subsequent reporting efforts. However, while this type of regulatory pressure is increasing in prevalence for companies, many are struggling to understand the value of reporting which often results in a lack of intentional and meaningful disclosures. The aim of this work is to provide insight on the background and value of sustainability reporting as well as the related regulatory requirements, focusing on Europe regionally (including the UK and Switzerland), as the beginning of a series on sustainability reporting requirements globally.
The fundamentals of sustainability reporting
Non-financial reporting started as the disclosure of basic information by companies including KPIs, e.g. the number of employees, number of operational sites, etc. However, in recent years, it has expanded to include a wide range of issues in the sustainability and ESG universe, including corporate performance on such issues and the related impacts to stakeholders.
While uncommon at first, the use of Corporate Responsibility, Sustainability, ESG and Integrated Reports are now commonplace norms amongst corporates for the reporting of non-financial information. Furthermore, the reports typically include quantitative and qualitative information on the company’s commitment, actions and progress towards addressing material issues which are likely to impact their financial and operational performance while also taking into consideration their external impacts.
In an effort to provide guidance to companies deciding on what information to disclose, there have been a number of sustainability and climate-related frameworks and standards established within the market, including the GRI, SASB, CDP, IR, and TCFD framework, amongst others. Companies should review and assess which standards or framework is the best fit for their business and reporting practices.
In addition to these standards and frameworks there are several market actors such as stock exchanges, rating agencies, consultancies and more which have developed voluntary guidelines on ESG reporting. However, there is still plenty of work to be done in terms of ensuring that reporting is transparent, uniform and comparable amongst companies.
Overview of regulatory landscape
One of the downsides of sustainability reporting from a stakeholder perspective is that information can be hard to compare from company to company, making it difficult for users to fully utilize. These issues can leave stakeholders and more specifically investors with a lack of reliable information on sustainability related risks which companies are exposed to. Within this context, regulators have been making an increased effort to establish new and enhance existing reporting requirements.
While such regulations are increasing in frequency globally, countries in Europe have been particularly successful at implementing a mature landscape of sustainability reporting regulations. The following table provides a snapshot of significant regulations for the European region.
Over the past five years, there has been a dramatic increase in the attention paid by policymakers to sustainability issues as governments attempt to meet global climate change objective such as the Paris Climate Agreement (2030 Agenda, Net-Zero, etc.) and UN SDGs. To this end, several regulations have been proposed and put into effect to enhance transparency on non-financial and sustainability-related disclosure.
Value of sustainability reporting
In addition to the use of ESG information by investors and key stakeholders in order to measure a company’s sustainability performance and ability to adapt to any risks and changes in the environment it operates in, sustainability reporting provides a smorgasbord of benefits. The following can all result from the disclosure of ESG information:
Increasing transparency and mitigation of greenwashing
By committing to the development of sustainability reporting practices and increased disclosure, companies are enhancing the level of transparency regarding the availability of non-financial information, exhibiting ethical and trustworthy behavior. Increased transparency has become highly valued by public stakeholders and investors ad has shown to be a useful tool in mitigating greenwashing by companies.
Improving attractivity and access to capital
Overall firms that are more transparent and perform well on material ESG issues have had greater access to capital (with lower cost in some cases) as investors are increasingly using ESG data in consideration for investments. ESG data can be used to either screen out low ESG performance companies (which may be subject to risks) or to seek high ESG or “green” performers, increasing the attractivity of companies with high disclosure as well as their ability to attract long-term investment.
Amplifying corporate performance and competitive advantage
Reporting on sustainability-related topics increases awareness on and integration of such themes into various areas of a company such as its strategy and goals which has been shown to improve operational efficiency, competitiveness, and long-term corporate performance, increasing return on stocks and future profitability, and generating value for shareholders. Additionally, companies which tailor their strategy and operations to address the sustainability issues most relevant to their business have been shown to outperform competitors.
Ensuring regulatory compliance
As governments are increasingly adopting regulations for sustainability-related disclosures, companies that establish clear processes for identifying, measuring, and managing ESG factors will be better equipped to quickly respond to regulatory developments and reduce compliance risks. Non-compliance can lead to significant regulatory, financial, and operational risk, and has the potential to damage company reputation. Hence, remaining ahead of disclosure regulations and being prepared to quickly adapt to them through established reporting processes and mechanisms is highly important considering the rapidly changing market.
Strengthening stakeholder engagement and reputation
The commitment of companies to disclose ESG information to stakeholders, set targets and improve performance on material factors demonstrate a company’s ethical alignment with international sustainability standards and best practices and the overall commitment to long-term value creation, enhancing their credibility and corporate reputation. This can also lead to strengthened sustainability culture amongst employees as well as the ability to attract talent as the younger workforce is increasing its focus on such factors when seeking employment.
Next steps and what would this look like?
As mentioned, along with the intensification of regulatory pressure with respect to both existing and new sustainability-related disclosure legislation, there is also a wide range of international frameworks and standards, and market specific requirements which guide companies in their reporting journeys. Companies should be aware of existing and upcoming requests and structure their reporting processes and disclosures accordingly.
Furthermore, rather than taking a box-ticking approach to corporate reporting, companies should focus on impact over output and ensure that their report depicts an accurate storyline of the company’s past and future, tying their ESG performance with specific improvement targets for the short, medium and long-term. This strengthens the integration of sustainability topics into the company’s overall strategy.
As a company begins to monitor and report on ESG performance it may identify key risks and opportunities such as the opportunities to reduce use of resources (water, energy, waste, etc.) from an environmental point of view (POV), hire additional females reaching equal employee gender rates from a social POV, or even reduce incidents of data breaches from a governance POV… The list is endless, however what remains clear is that in this new market, companies will need to begin or enhance their corporate reporting and optimize on all the benefits that come with it in order to remain competitive, promising the creation of a global landscape of corporate responsibility over-achievers.
Reporting should be neither the key driver nor the corporate’s goal for sustainability. A report should successfully communicate a company’s strategy, commitments, and performance. Better reporting can lead to better strategies and vice versa.