LORRAINE McCANN of EY looks at the increasing importance of environmental, social and governance risks in corporate reporting.
Over the past 40 years, reporting has evolved significantly as organisations seek to meet ever-increasing investors’ demands for more information. However, research indicates that investors feel disclosure shortfalls remain, especially in the reporting of strategy, risks and future performance. In addition, non-financial information, which is often disclosed in a multitude of ways, isn’t always comparable between organisations.
As part of EY’s most recent annual investor survey (Tomorrow’s Investment Rules 2.0), 64 per cent of institutional investors said that companies do not adequately disclose their environmental, social and governance (ESG) risks. This result is alarming, and it forces us to reflect on the current state of reporting and what we need to do to improve it.
The reporting model needs to move to a more connected, holistic and integrated approach
With the range of reports that companies are now required to prepare (e.g. annual reports, directors’ reports, remuneration reports, corporate governance statements, etc.), it’s clear that businesses face an increasingly challenging reporting environment as they look to respond to increasing regulatory requirements, and address rising stakeholder expectations.
Many organisations have reacted with a “more is more” approach, creating reporting fatigue, confusion and information overload as stakeholders, and particularly investors, sift through extensive information to find what they are looking for. This is not a sustainable approach and investors are now telling us they want better data, not more data.
The reporting model needs to move to a more connected, holistic and integrated approach. Companies working to respond to this are aligning their reporting with their corporate strategy and sending consistent, clear and concise messages to their key audiences by connecting their financial and non-financial (“sustainability”) disclosures. These companies not only understand the drivers for increased reporting – they are also looking at non-traditional reporting models to meet regulatory requirements and increasing stakeholder demands.
What’s driving the increase in sustainability reporting?
Two key forces are driving the increasing financial and sustainability reporting are increasing stakeholder demands and regulatory requirements.
Stakeholders, predominately investors, are demanding more disclosure on the management of sustainability issues and risks, to offer a more complete picture of performance.
As highlighted in Tomorrow’s Investment Rules 2.0, the percentage of investors who use a structured, methodical evaluation of ESG data, and the percentage of those that consider non-financial data relevant to all sectors, almost doubled between 2014 and 2015. This demonstrates that investor demands for increasing ESG data are only going to increase so it’s essential that organisations are prepared for this.
The EU has introduced a Non-Financial Reporting Directive which requires Public Interest Entities (PIEs) to disclose a non-financial statement in the management report (or a separate non-financial report). The non-financial statement should include relevant information on the company’s policies, main risks and outcomes relating to environmental matters, social and employee aspects, respect for human rights, anti-corruption and bribery matters, and diversity in their board of directors. The Directive came into effect on 1 January 2017 – applying to more than 6,000 organisations in the EU – however we know that many companies are not sufficiently prepared to comply with its requirements.
But how do investors get a more complete picture of performance?
Investors are starting to question how they can get the non-financial information that they consider most useful to their investment decision making — that is, information tied to companies’ visible, measurable performance.
The International Integrated Reporting Council (IIRC) is one organisation helping investors and issuers achieve this goal. In 2013, the IIRC released the Integrated Reporting Framework, which helps companies produce integrated and connected reports that link their financial, ESG and other non-financial disclosures to their expected performance and plans for value creation.
Integrated reporting is a concept that has been created to better articulate the broader range of measures that contribute to long-term value and the role organisations play in society. Central to this is the proposition that value is increasingly shaped by factors additional to financial performance, such as reliance on the environment, social reputation and human capital skills among others. This value creation concept is the backbone of integrated reporting and where we believe the future direction of corporate reporting is headed.
When asked to rank a wider range of format types used to communicate non-financial information, investors’ strong enthusiasm for integrated reporting is clear, and it is on the rise. In our latest investor survey, 71 per cent of respondents saw integrated reports as essential or important, up from 61 per cent on the previous year. In fact, integrated reports ranked second only to companies’ annual reports (without specification as to whether they are integrated annual reports or not).
Connected reporting helps bridge the gap between the varying requirements of stakeholders, while at the same time, meeting regulatory obligations. The key guiding principle of connected reporting is consistency
How can investors get the consistent and comparable information they need?
Investors repeatedly say that they do not receive enough accurate, standardised non-financial information relevant to companies’ risk and performance assessment, as evidenced by our research.
There are many reasons for the poor and uneven reporting of ESG and other non-financial risks and opportunities by issuers. Investors explain that issuers often cite cost, or perceived cost, as a reason for their inadequate disclosure of ESG and other non-financial information.
With the introduction of the new directive in 2017, the consistency and accuracy of ESG information is an area that we believe will come under much greater attention going forward. Typically, this non-financial data has not fallen under the same level of scrutiny as financial data, leading to a risk of data inaccuracies and credibility risk. There will be an increasing reliance on third parties to review or audit non-financial data prior to reporting to reduce the risk of data inaccuracies and increase credibility and transparency in reporting.
What are the risks of disaggregation and benefits of integration?
The key risks associated with a misaligned approach to corporate reporting include release of inconsistent, confusing and potentially contradictory information, disclosures often being prepared and distributed via siloed channels, no clear sense of the overall performance picture, different governance mechanisms, and release of reports that are fragmented and difficult to follow.
We see many benefits to improved corporate reporting, including greater access to capital, managing social licence to operate, responding to stakeholders’ expectations, allowing for consistent and transparent reporting, more streamlined use of company resources in preparing reports, and enhanced reputation among both internal and external stakeholders.
What’s the way ahead?
Corporate reporting will continue to evolve and as we have seen, it’s driven by a range of factors including the complex global business environment, the increase in data, the frequency of reporting, the type and depth of information required, new reporting regulations and requirements, and the evolving purpose of and need for information.
We need to challenge the traditional reporting model to provide stakeholders with meaningful and relevant information. There is a growing interest in connected, integrated reporting, that is aligned to corporate strategy and sends a consistent, clear and concise message that better connects with the intended audience, whilst providing a thorough picture of the organisation and its risks and opportunities.
Connected reporting helps bridge the gap between the varying requirements of stakeholders, while at the same time, meeting regulatory obligations. The key guiding principle of connected reporting is consistency. D
Lorraine McCann is senior manager and leader, Climate Change and Sustainability Services, with EY Ireland.