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New initiatives from the World Economic Forum and IFRS Foundation support the case for globally accepted sustainability reporting standards.
In brief
- Investors, insurers, banks, leading companies and standard-setters are calling for convergence and global guidance on sustainability standards.
- Now is the time to consolidate, bringing together the knowledge and experience to develop a global set of sustainability standards.
- Global standards can contribute to transparency, comparability and consistency, and are urgently needed.
Sustainability reporting has attracted increasing interest in recent years. In making investment decisions, for example, institutional investors are relying more on nonfinancial data, including sustainability metrics, alongside traditional financial statements. Insurers, asset managers and banks have also called for improved quality and consistency in sustainability disclosures to enable them to make business decisions with relevant and reliable information.
Moreover, the COVID-19 pandemic has highlighted the importance of sustainable and resilient business models to support the economic recovery strategies of companies, along with insightful reporting to provide stakeholders with a clear understanding of those models when making informed investment and other related decisions. The pandemic has also raised awareness of the inextricable links between the environment, society and the regulatory and policy environment.
These developments all point to an urgent need for a more robust sustainability reporting framework. So what progress has been made to reach this goal and what more needs to be achieved?
Global guidance is required on sustainability reporting
Over recent years, there has been a proliferation of sustainability reporting initiatives often involving nonfinancial information. A plethora of frameworks, methodologies and metrics for sustainability reporting has been developed to meet the evolving information needs of the investment community and in response to the broader public expectations of the role of businesses in society.
However, the very existence of multiple frameworks and methodologies with different perspectives contradicts the greater goal of global standards. Global standards would enable stakeholders to assess and compare inter-company sustainability reporting in a much more meaningful, effective and efficient way.
The private sector broadly is calling for more organization, convergence, and global guidance in this space, as evidenced by the recent initiative from the International Business Council (IBC) of the World Economic Forum. On 22 September 2020, the IBC, in collaboration with the ‘Big Four’ accountancy firms, published a white paper – Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation.
This white paper discusses a refined set of environmental, social and governance metrics under four pillars: the principles of governance; planet; people; and prosperity. It established 21 core and 35 expanded metrics and disclosures that map to the UN Sustainable Development Goals. The white paper reflects the hard work over the past two decades, and the commitment to work towards a joint vision, of the leading voluntary framework providers and standard-setters, namely, CDP, the Climate Disclosure Standards Board, the Global Reporting Initiative, the International Integrated Reporting Council and the Sustainability Accounting Standards Board.
A plethora of sustainability frameworks, methodologies and metrics has been developed to meet investor needs and in response to broader public expectations of the role of businesses in society. However, the existence of multiple frameworks and methodologies with different perspectives contradicts the greater goal of global standards.
Setting global sustainability standards
The IBC metrics are an impressive achievement, but they are only the start. Now is the time to consolidate, bringing together the knowledge and experience gained over the years to develop a global set of sustainability standards.
Leading the way on this journey is the International Financial Reporting Standards (IFRS) Foundation (the Foundation), with its trustees issuing a consultation paper on sustainability reporting on 30 September 2020. This asked stakeholders whether the Foundation should play a role in setting global sustainability standards and, in addition to its current role as a financial reporting standard setter, whether its standard-setting activities should expand into this area.
A sustainability standards board (SSB) has been proposed by the trustees that would be governed by the Foundation provided that certain conditions are met. These requirements include support from and interaction with stakeholders, governance structure, recruitment, resources and funding, and synergies with financial reporting.
The Foundation is well placed to form and oversee a sustainability reporting standard-setter in a manner that would meet those requirements for success as well as other key criteria. As such, the EY organization supports the trustees’ recommendation to be involved in this process through the development of an SSB that will promulgate global sustainability reporting standards and facilitate a greater nexus between financial and nonfinancial information. This will help companies report on their long-term value to investors and other stakeholders, including society at large.
One key observation is that the Foundation has so far focused on financial reporting, making it paramount that the governance structure has a balanced composition of oversight boards and the appropriate technical know-how in sustainability reporting. Therefore, for the sustainability project, the Foundation will need the staff and members of the governance bodies involved to have strong technical skills and experience in the various aspects of sustainability reporting.
Capital markets vs multi-stakeholder approach
Currently, the mission of the Foundation is to deliver robust, reliable and transparent information as input for the decisions of the primary users of general-purpose financial statements. Given this background, some stakeholders have suggested that the proposed SSB should focus on producing information about the effects of relevant events on the company, as this would support the decisions of the same primary users (the capital markets approach).
However, other stakeholders have gone further to suggest developing sustainability standards that would also require a company to disclose its impact on the wider environment. The disclosures are typically about issues that are material to multiple stakeholders’ understanding of a company’s effect on its environment (the multi-stakeholder approach).
There is a natural inclination to focus on the sustainability information that is most relevant to investors and other market participants, hence, the capital markets approach. But the acceptance and commitment of a set of global standards require input from a broad range of constituents. The responsibility for sustainability is broad and the capital markets approach cannot provide the entire picture on sustainability.
The distinction between the capital markets approach and the multi-stakeholder approach will blur over time as the links between externalities and direct or indirect effects on the future cash flows of the company become clearer. And, as societal and financial values further converge, investors will realize that while the effect of the company on the environment may not have direct cash-flow consequences today, it may lead to regulations, actions and behaviors that will affect the company’s long-term value and viability.
Therefore, making a distinction between what is relevant to investors and what is relevant only to other decision makers will become increasingly difficult. If the capital markets approach is adopted, the issue should be reconsidered once the standard-setter has gained some experience in setting sustainability standards.
Assurance on sustainability reporting
Another important issue is whether the sustainability information to be disclosed should be auditable or subject to external assurance. The trustees of the Foundation commented that to achieve globally consistent sustainability reporting practices, sustainability information reported by companies will ultimately need to be subject to external assurance.
The aim of the SSB should be to develop global sustainability standards that can be evaluated using an appropriate professional standard so that they result in relevant, complete, reliable, neutral and understandable information. To avoid confusion for users, comparability between the level of assurance for sustainability engagements and the level of assurance to be applied in the audit of the financial statements is critical.
However, recognizing that reasonable assurance on sustainability reporting, at least in the short term, maybe challenging due to the relative lack of maturity and suitable skills, the provision of limited assurance might be a temporary approach. This would require a minimum level of work effort (including substantive testing) that should result in a reasonable level of assurance in the mid to long term.
A company’s long-term value and resiliency are increasingly seen as tied to the value it can deliver both to investors and a broader group of stakeholders, including society at large, rather than just its historical financial performance.
The need for a new approach on sustainability reporting
Sustainability and sustainability reporting have become key in today’s business environment. Stakeholders are increasingly relying on nonfinancial information provided by companies to make informed decisions. A company’s long-term value and resiliency are increasingly seen as tied to the value it can deliver both to its investors and a broader group of stakeholders, including society at large, rather than just its historical financial performance.
Sustainability reporting standards can contribute to transparency and consistency in the way that companies report. These arguments are a timely reminder that there is an urgent case for the development of a globally accepted set of standards for sustainability reporting and a comprehensive global framework.
Summary
There is an urgent need for a more robust sustainability reporting framework based on global standards. A proliferation of sustainability reporting initiatives has evolved in recent years, but the existence of multiple frameworks and methodologies with different perspectives can lead to confusion. New initiatives from the World Economic Forum and the IFRS Foundation reinforce the case for common metrics and global standards, which would enable stakeholders to assess and compare inter-company sustainability reporting in a more meaningful, effective and efficient way.