Institutional investors have begun to adopt policies that threaten adverse votes against directors if companies do not make adequate ESG disclosures and improve ESG performance.
State Street Global Advisers stated at the start of February (see HERE) that it would be voting against directors among the ASX 100 if they were “laggards” on its proprietary “Responsibility-Factor (R-Factor)” rating. R-factor is a score for companies that draws on Sustainability Accounting Standards Board (SASB) and corporate governance codes such as the ASX Corporate Governance Principles and Recommendations.
BlackRock released a letter to CEOs in January (see HERE) that the world was “on the edge of a fundamental reshaping of finance”. Sustainability would now be core to investment, and BlackRock expected companies it invested in to report on sustainability metrics using the SASB standard.
Unfortunately, while both of these investors are adjusting their scrutiny according to companies’ performance against the SASB standard, it is far from the only one around. The sheer number of frameworks and standards may give companies pause – why align to one framework when it is possible that an international ESG reporting standard may yet be defined? Unfortunately, the pressure is such that companies cannot afford to wait.
Until now, this may have been a valid strategy. Especially considering some of the alignment efforts currently apace. For example, the World Economic Forum International Business Council (IBC) released a consultation draft in January 2020 (see HERE) – ‘Toward Common Metrics and Consistent Reporting of Sustainable Value Creation’ prepared together with Deloitte, EY, KPMG and PwC). This report proposes a common, core set of metrics and recommended disclosures that IBC members could use to align their mainstream reporting and, in so doing, reduce fragmentation and encourage faster progress towards a systemic solution, perhaps to include a generally accepted international accounting standard. There has also been work by the Corporate Reporting Dialogue organisation highlighting similarities between key reporting frameworks and standards.
However, given the “fundamental reshaping” in thinking within investment circles, it appears companies can no longer afford to sit on the fence. This is especially true since the 4th edition of the ASX Corporate Governance Principles and Recommendations includes recommendation 7.4, which states that a listed entity should disclose whether it has any material exposure to environmental or social risks and, if it does, how it manages or intends to manage those risks. In addition, the AASB re-released “Practice Statement 2 Climate-related and other emerging risks disclosures: assessing financial statement materiality using AASB/IASB” in April 2019, stating within it:
“Given investor statements on the importance of climate-related risks to their decision making, the impact of the materiality definition and APS/PS 2 is that entities can no longer treat climate-related risks as merely a matter of corporate social responsibility and may need to consider them also in the context of their financial statements.
The Australian Accounting Standards Board (AASB) and Auditing and Assurance Standards Board (AUASB) expect that directors, preparers and auditors will be considering APS/PS 2, when preparing and auditing financial statements for their next half and full year ends. Even though the guidance is not mandatory, it represents the IASB’s best practice interpretation of materiality and entities in Australia are already being subject to law suits regarding lack of disclosure.”
Therefore, companies not capturing and disclosing material ESG risks may be liable. So, for those who have been holding off, it is time to wade into what many call the “alphabet soup” of ESG reporting, and once reporting is happening, there will be measurable ESG indicators that can be used in executive remuneration.
For those new starters, here is a basic cheat sheet (not exhaustive) of major players in ESG disclosure for newbies.
While there is a stream of organisations providing guidance or ratings for ESG reporting, they are operating at different levels. Roughly, these are principles, frameworks, standards, and data aggregators/ratings.
Those organisations looking to start somewhere, might consider working towards compliance with a framework and a standard. This should improve ESG disclosures and therefore the data available for aggregators/rating creators, although some aggregators require direct submissions, such as the Carbon Disclosure Project.
Key principles are:
- United Nations Principles for Responsible Investment (PRI) encourages investors to use responsible investment to enhance returns and better manage risks
- United Nations Sustainable Development Goals (SDG) provides a shared blueprint for peace and prosperity for people and the planet, now and into the future. At its heart are the 17 Sustainable Development Goals.
Key frameworks are:
- Task Force on Climate-related Financial Disclosures (TCFD) was established by the Financial Stability Board in December 2015 to develop a set of voluntary, consistent disclosure recommendations for use by companies in providing information to investors, lenders and insurance underwriters about their climate-related financial risks.
- Climate Disclosure Standards Board (CDSB) is an international consortium of business and environmental non-governmental organisations that offers a framework for reporting environmental information with the same rigour as financial information.
- International Integrated Reporting Council (IIRC) is a global coalition of regulators, investors, companies, standard setters, the accounting profession, academia and non-governmental organisations aiming to have companies move beyond financials in reporting to provide concise communication about how an organisation’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value in the short, medium and long term. This is broader than ESG, and a CDSB or TCFD type framework could fit within the IIRC’s framework.
- Carbon Disclosure Project (CDP) is a questionnaire-based framework that could also be counted as a standard and a data aggregator/ratings provider. The data collected may be used as content for sustainability, annual or integrated reports. The main users of the information collected and scores given by CDP are institutional investors, purchasing organisations and policymakers.
Key standards are:
- Sustainability Accounting Standards Board (SASB) has developed a set of 77 industry standards, which identify the minimal set of financially material sustainability topics and their associated metrics for the typical company in a given industry. It is intended for use in communications to investors and financial stakeholders. This is the US standard.
- Global Reporting Initiative (GRI) is more popular in Europe. They were the first global standards for sustainability reporting. It is intended for use for a broad range of stakeholders, which means they are often used for the sustainability report as well as annual disclosures.
- ‘ISO 26000:2010 Guide on social responsibility’ helps clarify what social responsibility is, helps businesses and organisations translate principles into effective actions and shares best practices relating to social responsibility, globally. It provides guidance rather than requirements, so it cannot be certified to unlike some other well-known ISO standards.
The Corporate Reporting Dialogue investigates and promotes alignment between current frameworks and standards The participants released a report in September 2019 (see HERE) showing high levels of alignment between CDP, GRI and SASB for the TCFD’s illustrative example metrics, with 70% of the TCFD’s 50 metrics showing no substantive difference between the participants’ indicators. For the remaining 15 indicators, substantive differences are limited.
Key data aggregators/ratings providers are:
- Sustainalytics is used by CGI Glass Lewis
- ISS ESG is based on GRI, SASB and TCFD
- Bloomberg ESG analysis provides a basket of metrics
- States Street Global Advisors Responsibility-Factor (R-Factor) is based on SASB and relevant Corporate Governance Principles
- Asset Owners Disclosure Project (AODP) rates asset owners on their response to recommendations in TCFD.