Environmental, Social and Governance (ESG). Three key words that are going to drive significant changes in corporate reporting.
There currently exist a plethora of voluntary and diverse corporate reporting frameworks, some of which a number of, mainly large, companies have chosen to adopt. However, the reporting is inconsistent due to the differing requirements of those frameworks, and because they are voluntary, there is inconsistency in their application together with a perceived (and real) risk that companies will focus on metrics that portray them in a positive light, leading to suggestions of so-called greenwashing. Change is coming, with companies under increasing pressure to demonstrate greater commitment to longterm, sustainable value creation which incorporates the wider demands of people and planet.
In September 2020, the International Business Council of the World Economic Forum published a white paper which sets out 21 core, and 34 expanded, metrics, drawn where possible from existing standards and disclosures that could be reflected in mainstream annual reports of companies on a consistent basis across all industries and countries. Elsewhere, on a regional basis, the European Commission is revising its Non-Financial Reporting Directive, and a Project Task Force of the European Financial Reporting Advisory Group (EFRAG) has been working on the potential establishment of an EU non-financial reporting standard setter.
Companies that make themselves part of the solution will have the opportunity to develop and maintain sustainable business models which thrive in the short, medium, and long term
As the world looks ahead to emerging from the Covid-19 pandemic, there is increasing focus on another global imperative: climate change. From a straightforward commercial perspective, this should be high on the agenda for all companies, in particular those in more significantly affected industry sectors. To attract funding from investors and lenders, businesses will need to demonstrate how their operating models are sustainable in the short, medium and longer term. This is not something for the future; investors are demanding it now. Many governments are also driving change, by developing and implementing policies that are designed to encourage (and in some cases require) businesses to take substantive steps towards the longterm goal of a zero carbon economy.
Many investors are calling for companies to be transparent about the effects of climate on their current and future activities. The reality is that, unless businesses embrace the need to build climate change into their strategy and planning, they will pay higher costs of capital or, in some cases, will not be able to raise capital at all. In some industry sectors, such as natural resources, tourism, transport, and agriculture, the need to demonstrate how entities have sustainable business models in the context of climate change is with us already.
In February 2021, Mark Carney, former central banker and currently the UN Special Envoy for Climate Action and Finance, was quoted as saying that “the scale of investment in energy, sustainable energy and sustainable infrastructure needs to double. Every year for the course of the next three decades, $3.5 trillion a year, for 30 years. It is an enormous investment opportunity.”
Many companies incorrectly perceive that the implications of climate change will be relevant only at some point in the future and, therefore, not necessarily something to be built into decisions made today. However, the bottom line is this: Companies that make themselves part of the solution, by starting their transition to a low carbon economy sooner rather than later, will have the opportunity to develop and maintain sustainable business models which thrive in the short, medium, and long term. At the same time, they will create significant value for investors. Those that do not will become increasingly uncompetitive. With investors focusing on how well prepared companies are for climate change and seeking to identify which of them will be on the right and wrong side of climate history, the message is clear.
Recommendations of the Taskforce for Climate-Related Financial Disclosure
The Financial Stability Board established the Taskforce for Climate-Related Financial Disclosure (TCFD) in 2015 to develop recommendations (the Recommendations) for more effective climate reporting. It was an industry led group, with global membership drawn from large banks, insurance companies, asset managers, pension funds, large non-financial companies, accounting and consulting firms, and credit rating agencies.
The aim of the Recommendations, which focus on four areas—Governance, Strategy, Risk Management, and Metrics and Targets—is to promote more informed investment, credit and insurance underwriting decisions, and improve stakeholders’ understanding of climate-related risk and opportunities.
Globally, over 1,500 companies have already adopted the Recommendations with some jurisdictions announcing the introduction of mandatory adoption. The Recommendations have been mapped across all major non-financial reporting frameworks already in existence, including GRI, CDP, the IIRC, CDSB, and the G20/OECD Principles of Corporate Governance. Consequently, even if a company is already reporting information under another existing framework, the Recommendations can be integrated into its existing disclosure systems and practices without conflict.
The Recommendations were designed to be capable of being adopted by all companies, regardless of sector and geographic location. They describe information that companies should disclose to help investors, lenders and other stakeholders better understand how companies view and manage climate-related risks and opportunities. In addition, companies are encouraged to clearly state their material climate-related risks and opportunities in the short, medium and longer-term.
It is recommended that the disclosures are made in mainstream (i.e. public) annual financial filings and should be aligned with legal and regulatory requirements that, in most G20 jurisdictions, require material information to be included in financial filings, including material climate-related information.
Most information included in annual financial filings is subject to an assessment of materiality. However, because climate-related risk is a non-diversifiable risk that affects almost all industry sectors, many investors consider it requires special attention. The Recommendations note that, when they are assessing a company’s financial and operating results, many investors want insight into a company’s governance and risk management. Consequently, disclosures in the Recommendations about those two areas should be made regardless of their materiality.
For disclosures related to strategy, and metrics and targets, disclosures should be included in annual financial filings when the information is material. Companies in the non-financial groups and associated industries above a certain size (in excess of $1 billion in annual revenue) are encouraged to disclose this information in other reports when it is not material. However, the Recommendations caution against a premature conclusion that climate-related risks and opportunities are not material because a company perceives certain of the risks to be long-term in nature.
