Wider corporate reporting is being promoted as a means to improve corporate governance, as stated by International Accounting Standards Board (IASB) Chairman Hans Hoogervorst in his speech in Tokyo on Aug. 29, 2018. The IASB chair admitted that financial reporting has its limitations and cannot adequately capture certain elements that might be important to stakeholders, such as the intangibles that are vital to the company’s business model and its strategy for long-term value creation. Financial statements are essentially backward-looking reports that contain limited forward-looking information, which means that in their current state, financial statements do not address emerging sustainability issues that might impact a company’s future cash flow.
However, the IASB Chair made it clear that the Board is not equipped to enter the field of sustainability reporting directly. He recognizes in a speech about sustainability reporting in April at Cambridge University that the Board does not have the expertise required to set sustainability reporting standards. Additionally, he notes that there are already several standard setters in this space.
Mr. Hoogervorst also pointed out that regulators and stakeholders should not have exaggerated expectations that sustainability reporting will act as an agent of change and will be effective in forcing companies to “prioritize planet over profit.” That being said, clear public policies can certainly help effect change, and financial incentives are crucial to swaying companies to address material sustainability issues. The rise of sustainability reporting that focuses on stakeholders and provides information about the impact of sustainability issues on the future returns of the company is the most promising development in this space, according to the IASB Chair.
While the IASB will not directly participate in sustainability reporting, it is addressing the limitations of financial reporting through its “Better Communication in Financial Reporting” project. This initiative aims to improve financial communication not by creating new standards, but by providing guidelines on how to better present information that has already been collected. The project contains several strands of work, one of which is revising and updating the Management Commentary (Practice Statement) to include a report on how material sustainability issues may impact the business. The IASB is expected to publish an Exposure Draft of the Practice Statement in the second half of 2020.
On the local front, the Securities and Exchange Commission (SEC) has released a memorandum requiring publicly-listed companies (PLCs) to submit their Sustainability Report together with the 2019 Annual Report (SEC Form 17-A) in 2020. The memorandum issued early this year stated that the guidelines are to be adopted on a “comply or explain” approach for the first three years upon implementation. This means that “companies will be required to attach the template to their Annual Reports but they can provide explanations for items where they still have no available data. However, by 2023, PLCs will need to comply with the Sustainability Reporting Guidelines specified in the memo, or be subjected to the penalty for Incomplete Annual Report (under SEC Memorandum Circular No. 6, Series of 2005).
Like traditional financial reporting, rigorous climate-related financial disclosures do not happen overnight. The path from start to finish can involve twists and turns, as well as the coordination of many moving parts, thereby requiring the collaboration and expertise of a variety of corporate functions to achieve an organization’s ultimate reporting objectives. The following are key action steps companies can take now to prepare themselves for reporting non-financial information.
1. Secure the support of your board of directors and executive leadership team.
2. Integrate climate change into key governance processes, enhancing board-level oversight through audit and risk committees.
3. Bring together sustainability, governance, finance, and compliance colleagues to agree on roles.
4. Look specifically at the financial impacts of climate risk and how it relates to revenues, expenditures, assets, liabilities, and financial capital.
5. Assess your business against at least two scenarios.
6. Adapt existing enterprise-level and other risk management processes to take account of climate risk.
7. Solicit feedback from engaged investors about what information they need to know about climate-related financial risks and opportunities.
8. Look at existing tools you may already use to help you collect and report climate-related financial information.
9. Plan to use the same quality assurance and compliance approaches for climate-related financial information as for finance, management, and governance disclosures.
10. Prepare the information you report as if it were going to be assured, even if you decide not to do so right now.
11. Look at the existing structure of your annual report and think about how you can incorporate the information into your discussion of risks, management’s discussion and analysis (MD&A), and the governance section.
The recent pronouncements of the IASB and SEC on the need for reliable and accurate sustainability reporting underlines the necessity for companies to assess and manage its non-financial performance towards achieving the universal target of improved sustainability. However, for sustainability reporting to be effective and useful, companies should not only view it as an exercise in compliance, but actually a responsibility of every corporate citizen to measure and document their best practices towards achieving the goals of sustainable development to meet the needs of the present without compromising the ability of future generations to meet their own needs.
It would seem then that need for sustainability reporting is here for good. In which case, companies are encouraged not to wait for sustainability reporting standards, or a regulatory requirement, to be mandatory. The time to act for the greater good is now.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.
Benjamin N. Villacorte is a Partner of SGV & Co.