December 2020 User View by Richard Howitt, former European Parliament Rapporteur on CSR and Chief Executive at the IIRC
WHILE 2020 will go down in history as the year of Covid-19, it will be written up in the accountancy and financial management textbooks of the future as the year in which a decisive shift took place towards the standardisation of environmental, social and governance (ESG) reporting.
The first impetus has come because of Covid itself. Not simply can the pandemic be seen as a classic example where system risk can so quickly translate in to cataclysmic economic consequences for business and the economy, but the response should also give us real hope on how the system itself can be galvanised in to taking action in response.
The further shift towards digitalisation and the unprecedented speed in the science of developing vaccinations, demonstrate the huge potential of humankind to meet the existential challenges before us. The idea of a green recovery with business finance being made contingent on climate action, has been seen in among others the Canadian Infrastructure Plan and the 30% of the European Union (EU) €750bn recovery fund earmarked for climate action.
All of this has to be measured robustly to be effective. It is the EU’s commitment to update its non-financial reporting rules alongside new European ESG standards, which has made the swiftest progress during the year. The project task force established to consider standards will produce its final report next month and a firm commitment has been made to issue a legislative proposal to update non-financial reporting rules (of which I declare an interest as the original mover) in March 2021.
For readers of Materialitytracker, this means the European Commission’s determination to press forward with its concept of ‘double materiality’ is certain to become an established part of the reporting landscape. The exact definition between financial and stakeholder materiality in the legislation will be crucial, as will the requirement to report the materiality determination process itself.
The year started with an initiative for standardisation launched with the World Economic Forum (WEF) Toward Common Metrics and Consistent Reporting of Sustainable Value Creation set of indicators. It’s true test will be how many, how quickly and how well, these are adopted in reporting by members of the 140-member International Business Council.
The Statement of Intent in September from voluntary sustainability and integrated reporting frameworks and standard-setters – CDP, CDSB, GRI, IIRC and SASB – marks the next stage in their collaboration. Like the WEF, these partners prefer the concept of ‘dynamic materiality’, where sustainability topics can be incorporated in financial reports, when and where they impact value creation for the enterprise.
In December, the announced merger of SASB with the IIRC to form the Value Reporting Foundation, means there is now a ‘Big 4’ in both the financial and non-financial reporting world.
A detailed analysis on these different approaches to materiality was given by Donato Calace in the previous User View of Materialitytracker. The real significance could come with the commitment in the Statement of Intent, towards a comprehensive corporate reporting system. This is suggested to involve the creation of a new Sustainability Standards Board, in proposals already published by the global accountancy community. The idea was explicitly endorsed as a potential option, when the Trustees for International Financial Reporting Standards (IFRS) initiated their own consultation on developing standards for sustainability reporting in September.
With the International Organisation of Securities Commissions setting up its own Board-level Task Force in April to improve corporate sustainability disclosures, it shows the efforts to make sustainability a financial reporting issue, have made progress this year beyond any other. Progress towards the International Auditing and Assurance Standards Board publishing guidance on the assurance of what it calls external, extended reporting has continued in 2020. Audit requirements will increasingly become centre stage, and the exposure draft of the final guidance is likely to be published in 2021.
All of this comes before a new Biden administration in the USA may well move towards a Net Zero carbon commitment, new sustainable investing obligations for pension funds and mandatory reporting on the recommendations of the Task Force for Climate-related Financial Disclosures.
Increasing investor pressure for clarity, consistency and comparability in company sustainability reporting is a crucial driver in all these developments. It is also reflection on new obligations on investors themselves, including Europe’s new Sustainable Finance Disclosure Regulation due to take effect next March, as well as the new Reporting Framework published by the Principles of Responsible Investment (PRI) in November, with its extra emphasis on real-world impact. Despite the Covid crisis, 2020 saw funds continue to flow strongly in to ESG investment vehicles. For the first time Europe saw a forecast of ESG funds over-taking mainstream funds in less than five years.
If there is one abiding concern in all this flurry of activity, is that research studies still show that sustainability reporting continues to focus too far on policies and processes, and far too little on outcomes and impacts. Even where targets are set, in only a small fraction of companies are they aligned to Paris and the Sustainable Development Goals (SDGs). Too seldom does the ‘sustainability context’ principle enter the materiality debate, with its emphasis on defining impact in the context of planetary and societal boundaries.
Methodologies on measuring and integrating impact have continued to be developed during the year, including in the Impact-Weighted Accounts Initiative, the Value Balancing Alliance and the Impact Management Project. I have been involved in advising on new social indicators which have been drawn up by the World Benchmarking Alliance, and in a new UN Research Institute for Sustainable Development project on the next phase of SDG performance indicators.
If there is a race to set ESG reporting standards, it may not be tension between different definitions of materiality which holds us back, but continuing concern about the maturity and reliability of non-financial reporting metrics. Stakeholders may also be forgiven for listening to the welter of business declarations about the purpose of corporations and stakeholder capitalism, wondering if their own stake has been truly recognised in all these processes.
Meanwhile, from a big increase in imported goods being seized by U.S. Customs and Border Protection where they result from forced labour, to the imminent proposal of a mandatory Human Rights Due Diligence law for the European Union, to the urgent necessity to address Scope 3 emissions reporting, this year may also have been the tipping point when companies are fully persuaded of the need to address the whole value chain in their reporting. From the perspective of South Africa and other emerging markets, these might be the most important developments of all.
What can we make of all these developments as we approach the end of 2020?
ESG standards are coming, for certain. If you’re not following these debates and actively taking part in them, you really should be. The number of different initiatives towards standardisation is itself confusing, but the drivers behind them are common to all, and ultimately will move towards greater coherence. If you haven’t already realised that risk involves not only company and market but also society and planet, the time to do so is now.
Professional debates about metrics may be completely legitimate, but cannot be used as an excuse to delay absolutely essential progress in determining – and managing – value, using a multi-capital or sustainability perspective. Investors are fundamentally changing and the argument is no longer about whether they are the prime users of the report, to one of how the rise of ESG is properly harnessed in the new era of disclosure. Expect assurance to become integral to all these debates.
The impact of the company and the need to report it applies across the whole value chain and within the context of global boundaries and thresholds. Overall, recognise that the systemic challenges which have provoked all these developments during the past year, became even greater in 2020.
Covid meant that the more ambitious carbon targets we all hope for in COP26, were postponed for another year. Meanwhile despite the sharp fall in emissions as economies shrunk because of the pandemic, meteorologists report global warming 1.2 degrees above baseline, still making this one of the three hottest years in history. The economic consequences of the pandemic have seen the first rise in global poverty in over twenty years. Schools have been closed, women have born the brunt of additional domestic work, in many countries health controls have been used as political cover to increase repression. This is a year when many of the UN SDGs have actually gone backwards.
Looking back at 2020, we should all use the holiday season to ruminate on the words of Mahatma Gandhi: “The future depends on what we do in the present.”
The author is Strategic Advisor on Corporate Responsibility and Sustainability, Business and Human Rights, Senior Associate at Frank Bold LLP and Board member at the think-tank r3.0. He is former European Parliament Rapporteur on Corporate Social Responsibility and Chief Executive at the International Integrated Reporting Council. He can be reached at https://www.richardhowitt.com and Twitter: @richardhowitt
