Today, many investors that seek traditional financial data also want information on environmental, social, and governance (ESG) issues.
With the ability to select among thousands of investment options, both institutional and individual investors are showing a preference for companies and funds that reflect good citizenship. Socially responsible investments are among the fastest-growing category of investment assets.
To meet customer demand, products such as Thomson Reuters’ Asset4 provide in-depth environmental, social and governance information on over 4,000 companies to help institutional investors, investment managers, and financial analysts incorporate ESG data into their decision-making. Long-term investors, such as pension funds, have expressed interest in the relationship between ESG activities and an investee’s ability to create and maintain value. Moreover, as younger professionals enter the financial arena, social responsibility may reach greater prominence as an investment screen.
At the same time, accounting standard setters have been next to silent with respect to incorporating ESG information into financial reporting. Neither the Financial Accounting Standards Board (FASB) which writes U.S. financial reporting standards (U.S. GAAP) nor the International Accounting Standards Board (IASB) which writes international financial accounting standards (IFRS) have made sustainability reporting a priority on their respective agendas.
On the U.S. regulatory front, the SEC’s progress on incorporating some ESG data into regulatory filings has been limited to two areas, climate change and so-called conflict minerals.
First, in response to institutional investor demands for better climate-change disclosures, in 2010, the SEC issued Release No. 33-9106, Commission Guidance Regarding Disclosure Related to Climate Change. This release outlines how existing regulations apply to the disclosure of risks related to climate change in regulatory filings. The SEC’s enforcement, however, has been minimal. In early 2014, Ceres, a non-profit advocacy organization that works with the corporate and investor community, released the findings of its study concerning SEC action on climate change. The report concludes that although disclosure related to climate change by U.S. public companies has been weak, the SEC has responded with only a handful of comment letters regarding the lack of information in corporate filings.
Second, in 2012, following a mandate in the Dodd-Frank Act, the SEC adopted Release No. 34-67716, Conflict Minerals, that requires public companies to disclose information about their sourcing of tantalum, tin, gold, and tungsten from mines in the eastern Democratic Republic of the Congo, which has been torn apart by civil wars and insurgencies. The covered metals are used in a variety of industrial and consumer goods, including electronics, jewelry, and gas lines. In April 2014, the Court of Appeals for the District of Columbia upheld most of the rule. The Court, however, agreed with claims that the rule’s mandatory disclosure violates free speech. In November 2014, the Court granted the SEC’s request to rehear the case.
Internationally, other countries are moving ahead with mandatory ESG disclosure at a more rapid pace than the U.S.
Leading the way is South Africa. King III, adopted in 2009 to the country’s corporate governance code, legally endorses the issuance of sustainability reports by all organizations. The Johannesburg Stock Exchange has made compliance with King III mandatory for all listed companies. More recently, in 2014, the European Commission issued a directive for the reporting of sustainability data that effectively applies to the 6,000 largest European entities. As these standards are developed and implemented worldwide, entities with international operations or securities listed on foreign exchanges may be required to comply.
Beyond government regulation, organizations throughout the world have attempted to establish reporting objectives and guidelines to respond to the perceived gap between traditional corporate reporting and the increased demand for sustainability data.
These organizations include the United Nations Global Compact’s Principles of Responsible Investing, the Prince of Wales Accounting for Sustainability Project, Ceres, the Organization for Economic Cooperation and Development (OECD), and the International Organization for Standardization (ISO).
The CDP, formerly the Carbon Disclosure Project, another nongovernmental organization, gathers and summarizes climate-change and other environment-related information submitted by corporations and local governments.
In the last few years, however, due to highly active stakeholder engagement and sufficient funding, the development of corporate sustainability reporting has primarily come together around the work of two organizations, the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB).
At the end of May 2014, GRI announced organizational governance changes and proposed revisions to its due process for setting standards. One of its proposals is to establish a Sustainability Reporting Standards Board and encourage formal acceptance of its standards by regulators.
Following the lead of these groups, many of the world’s largest organizations, including U.S. based companies, now issue sustainability reports. Many reports refer to the GRI standards. KPMG LLP’s 2013 Survey of Corporate Responsibility Reporting found that 78 percent of companies that issue sustainability reports worldwide refer to the GRI’s guidelines.
The GRI launched its first set of guidelines in 2000 and its most recent set, called “G4,” in mid-2013. Around the same time, GRI and CDP agreed to collaborate and harmonize their reporting guidelines.
Through its standards, GRI aims to help entities identify, summarize, and report the most material ESG information that affects decision-making by the organization’s stakeholders. Some reporting entities follow the GRI format strictly; others do so informally.
Although reporting entities within the scope of the European Commission’s April 2014 directive can use any international, European, or national guidelines that they consider appropriate, it is expected that many will voluntarily adopt the GRI framework.
These ESG reports are, for the moment, separate documents from the financial reports issued for investor use. For that reason, sustainability reports are frequently referred to as nonfinancial reports.
Typically, sustainability data is gathered, summarized, and reported by a team that is separate, in many respects, from an entity’s finance and accounting team. Another European organization, the International Integrated Reporting Council (IIRC), complementing the work of GRI, has endeavored to develop an integrated framework that captures the effects of an entity’s sustainability activities on its financial results and capital.
In the U.S., following in the work of GRI and the IIRC, the SASB is actively developing standards for ESG reporting. Unlike the GRI guidelines, however, the SASB’s standards integrate with the structure of current SEC filings. The SASB’s standards largely focus on the addition of a new segment within the management’s discussion and analysis section of the Form 10-K, or 20-F for foreign filers, so that relevant sustainability information goes directly into the hands of investors.
The SASB’s approach rests on the concept of materiality under the U.S. securities law. The underlying basis of their standards is the reporting of all material information to the reasonable investor, including sustainability information. The goal is to issue standards that, when applied, move many current risk disclosures from boilerplate to specific ESG-related metrics.
The SASB’s guidelines are industry-specific. In the SASB’s standard-setting process, its research team, with help from volunteer working groups, attempts to identify the ESG information that has the most material effects on the reasonable investor’s decision-making on an industry-by-industry and sector-by-sector basis.
For example, the SASB’s standards for the hardware manufacturing industry recommend the quantification and disclosure of the percentage of products, based on revenue, that contain critical, environmentally-sensitive minerals. The measurements may vary by industry, but they can include employee diversity, water usage, and the use of renewable energy.
The SASB has issued final standards for five sectors: healthcare, financial, technology, transportation, communications, and non-renewable resources. The SASB’s schedule indicates completion of standards for all eleven sectors by early 2016.
Prominent constituents from the corporate reporting area are contributing directly to the SASB’s activities. Two former SEC chairs, Mary Schapiro and Elisse Walter, sit on the Board. Most recently, in October 2014, Robert Herz, former FASB Chairman, also joined the Board. In the SASB’s view, investor decision-making today requires consideration of all material information, including sustainability-related metrics.
In addition to the work of the standard setters, some thought leaders on sustainability reporting note the efforts of the world’s securities exchanges. NASDAQ’s OMX Group, among others, is leading an effort among exchanges throughout the world to promote the reporting of materiality-based ESG metrics by listed companies.
In the end, however, the SEC retains the authority to set disclosure regulations in the U.S. Comments by SEC Chairman Mary Jo White and Commissioner Daniel M. Gallagher indicate that the Commission does not view sustainability reporting as a priority.
Despite the lack of regulatory activity in the U.S., sustainability information is becoming an important component of investor decision-making. In order to comply with Europe’s new directive and to compete for capital, companies will continue to issuing more comprehensive and relevant sustainability information. In many cases, these companies will primarily follow the frameworks established by the GRI, IIRC, and SASB.
Accounting & Compliance Alert–Complete Edition (WG&L)
Volume 8, No. 115
© 2014 Thomson Reuters/Tax & Accounting. All Rights Reserved.