Over the past 10 years, investors around the world have come to expect more detailed and useful reporting of nonfinancial performance information. A combination of the growing evidence of the link between commerce and climate change, a number of high-profile examples of poor corporate governance, and a new appreciation for the social impact of business has led investors to increase their focus on environmental, social and governance (ESG) risk.
Social media has played its part, too; in terms of reputational damage, it is far harder for corporates to avoid the spotlight today. Everyone is accountable.
Investor focus on ESG represents a long-term transition rather than a short-term trend. The more investors ask questions on ESG issues, the more they understand the core risks to business these factors can represent.
In general, companies have shown some improvement in identifying nonfinancial topics that matter to investors and the metrics that most accurately measure progress and performance. However, what is needed now are globally recognized standards for nonfinancial reporting.
There is currently an array of standards, guidelines and frameworks that have been created by global bodies, including: the International Integrated Reporting Council (IIRC); the Global Reporting Initiative (GRI); the Climate Disclosure Standards Board; and the Task Force on Climate-related Financial Disclosures. Influential national bodies, such as the US-based Sustainability Accounting Standards Board (SASB), are also important. And, of course, the EU’s Non-Financial Reporting Directive requires larger public interest entities to include annual nonfinancial statements on sustainability and diversity.
But there is no one globally accepted set of standards that is appropriate across all forms of nonfinancial information. As things stand, investors are not always in a position to compare companies on a like-for-like basis. This is because there is no clear information network that allows them to meaningfully compare businesses on ESG topics. If companies are disclosing different types of data and using different measurements, it makes it almost impossible to establish comparisons or to identify trends. In many instances, governance risk is better reported than social and environmental risk. This imbalance also needs to be addressed.
Without doubt, companies should be incentivized to provide clearer and more consistent information to investors. This is why globally recognized standards for nonfinancial reporting make perfect sense. Investors who are increasingly aware of ESG-related risks are going to view companies that comply with these standards more favorably than those that are less than transparent about how their business is governed and their environmental and social commitments.
Over time, those companies that do not comply with globally recognized standards will likely see investors increasingly sell out of their assets. And significantly, these companies will find it harder and more expensive to raise capital. This will be a strong incentive to act.