Practical perspectives on reporting #23: New Year, new news – what the new sustainability standards could mean for financial reporting
By Tamara O’Brien, TMIL’s roving reporter
Happy New Year! It’s true that the news lately is mostly discouraging, but I have a new approach to assimilating it. I’m taking a leaf out of the investors’ book and taking a wider view: looking at how things might pan out in the medium and long term, as well as the here and now. Because as events insist on proving, significant change can happen over aeons – or in the twinkling of an eye.
It’s certainly a lesson I took from the public reaction, here in the UK, to the brilliantly dramatized true story of the Post Office scandal. The first episode of Mr Bates vs The Post Office was broadcast on New Year’s Day, and the drama unfolded over the next three nights. Its impact has been seismic.
What’s fascinating from a communications point of view is that information about this terrible tale of corporate wrongdoing and miscarriage of justice has always been there. For over 20 years, involving governments of all political stripes, the story has been investigated, inquired into and reported on. And yet blameless postmasters continued to be prosecuted, and have their lives, livelihoods and families wrecked.
It took a creative dramatisation to break through our collective apathy, crack open our hearts and fully comprehend the truth. Before 1 January, relatively few people knew or cared about the scandal. After 4 January, a whole nation was enraged and galvanised. As a result, a former CEO lost her CBE. And the glacially-paced juggernaut that is the British legal system was suddenly found capable of performing pirouettes: all the falsely-accused postmasters were exonerated at a stroke.
So what did we learn?
Time, justice, change, systems, all the big things – they’re not immoveable constants. They can be stretched or compressed according to human will.
While information matters, how it’s communicated may matter even more. Just as justice can stifled by bureaucracy and inertia, so truth in reporting can be stifled by evasion, waffle and obfuscation.
Both ideas informed today’s discussion on the new sustainability reporting standards coming our way. Claire made the communication point in her introduction. As corporate reporters, she said, we can only communicate well if we understand why we've been asked to meet particular requirements – especially such complex ones – so that we respond to the regulation in its intended spirit, rather than in a tick-box manner that gives little away. She invited the panel to give their take on the ‘devilishly difficult’ task of explaining the impact of sustainability issues on business performance, which requires an understanding of the relationship between sustainability and financial materiality. This is exactly what the new reporting standards are designed to do, quoth Claire: to which all I can add is, then they’re not coming a moment too soon. Also: sooner the finance team than me.
ISSB standards: a clear picture
In the great tradition of educators, sustainability finance ‘trainer’ (and AICPA & CIMA’s Global Head of Sustainability) Jeremy Osborn came armed with a presentation. He ducked Claire’s long-standing injunction against ‘boring slides’ in her webinars, because his were of the succinct and helpful kind, explaining things in pics and diagrams that even I could follow. He set the scene by outlining the ISSB’s first two global standards, which came into effect on 1 January:
S1, General Requirements for Disclosure of Sustainability-related Financial Information. This is the main standard, to which reporters must defer in the absence of a more ‘topical’ standard… the first of which is…
S2, Climate-related Disclosures.
This trickle will become a flood in the months and years ahead, as standards covering topics like biodiversity, human capital and connected reporting will be released. He explained that if you already report against TCFD, the structure of the ISSB standards will be familiar. What’s different is that they require accountants and finance teams to consider financial performance in new ways:
To look forward as well as back; and think about the impact of sustainability issues on value creation in the short, medium and long term
To consider their impacts on customers and suppliers, not just on their own business
To make connections between how the company manages its material sustainability issues and its financial performance (the tricky bit!)
To speak the language of ‘multi-capitalism’ that’s integral to ISSB’s definition of sustainability – ie not just financial but human capital, natural capital, social capital…
Jeremy spoke further about new standards in Europe, which sounded rather complicated, and the US, which sounded rather laggardly – but did benefit from a lovely slide of the State Seal of California. It was included because California has two interesting laws (SB253 and SB261) that will require any large business operating there to report their climate-related financial risks, governance, Scope 1, 2 and 3 greenhouse gas emissions etc – and they go further than America’s federal body, the SEC, in that these laws apply to privately-owned as well as public companies. Which might just change the reporting baseline for the SEC and in other US states. You heard it here first!
Making your business investable
Claire’s question to equity analyst Jeremy Stuber was, what do investors want? And here’s a man who speaks my language, because his immediate answer was ‘A bargain!’. We’re not talking knock-down cashmere though. For him, it means spotting a share that’s undervalued, either because the market doesn’t appreciate its potential, or has exaggerated the risk associated with it.
Investors want information that’ll give them the most complete picture of a company’s performance, position and prospects, and sustainability information is clearly part of that. And yes, investors do check whether the narrative in the front half of the annual report aligns with the numbers in the back half. If both tell a consistent story, the company gets a higher valuation. If the links aren’t clear, there’s a ‘perception of elevated risk’ and ultimately a lower valuation.
Of course, nothing’s ever quite that straightforward, and Jeremy identified key differences between sustainability information and financial information as far as investors are concerned…
Reporting boundaries: There’s a lot of inconsistency in sustainability reporting. A company might report emissions in its consolidated businesses one year, and the next year include emissions in joint ventures too. So investors aren’t always sure they’re comparing like with like.
Timescales: climate-related targets and ambitions are often decades into the future, but very few line items on the balance sheet actually reflect this timescale. And a philosophical question: when a risk is far into the future, it’s deemed a sustainability risk. When it’s closer in time, it becomes a financial risk. At what point does this crossover happen?
Reporting units: sustainability targets are typically expressed in non-financial units – tonnes of carbon emitted per year, number of hours worked etc. And (that tricky bit again!) it’s really challenging to understand this in relation to financial information, which of course is expressed in currency units.
Level of assurance: investors know that sustainability reports have a ‘limited’ or ‘reasonable’ level of assurance, compared to financial reports. They contain more estimates, there’s missing data, and data from outside the organisation. So there isn’t quite the same level of trust in the numbers.
But Jeremy was in no doubt of the crucial importance of such disclosure to investors, and left us with a neat analogy: if financial information is like an x-ray of a company, then sustainability information is like an MRI scan. Considered together they provide a fuller picture.
A journey, not a destination
What does this all mean for the people who have to put sustainability reporting standards into practice? Matt Cox, Group Controller of Rio Tinto, gave us the view from the ground. And Rio happens to be grounded in bringing materials critical to a low-carbon economy – such as copper, lithium and high quality iron ore – to market.
Matt established that this isn’t Rio’s first time at the rodeo. As a resources business, he said, we know the importance of good sustainability information. It’s used internally in Rio’s investment decisions, planning and risk management, and shared externally via their Sustainability Fact Book. Moreover, sustainability considerations already underpin information in their financial statements. They need the full data picture to make complex, long-term judgements and estimates about asset impairment and closure dates.
But even they are feeling a tectonic shift in expectations. NGOs, investors and stakeholder groups want more and better-quality disclosure of climate risks, and what that means to the business financially. Rio’s own climate disclosures within the financial statements have expanded from a few paragraphs to a densely packed, three-page section.
Matt gave a fascinating glimpse into the problems they face. A key challenge is balancing the appetite for sustainability information with the fundamental requirement to give a true and fair view of the business. With climate change, for example, the expectation may be that they’ll align with Net Zero 2050 and this is Rio’s own stated ambition. But, will we see the pace of decarbonisation across the global economy and development of government policies to support this and what does this mean for commodity markets? The company wants to give useful information, but they’re dealing with highly uncertain sets of variables. How do they provide useful insights about that kind of issue, without making an already long and complex report totally indigestible?
He made another interesting point about the tendency for financial reporting to focus on the downside risks to the business of climate change, such as the aforementioned asset impairment and closures. Yet Matt sees opportunity for some of the commodities they produce, like copper, which are key to a low-carbon future. The prospects for these commodities could be very positive as demand increases. How the company describes the potentially positive upsides of these traditionally downside risks is a sensitive challenge, but it’s been helpful because it’s made them think hard about how they present their financial statements – which are of course subject to audit, and must be consistent with other statements in their reporting.
Matt had more to say, on the consistency of sustainability terminology, the importance of good data and controls around data gathering, that the new standards should help with; though he’s ‘under no illusions about the effort required to implement them’. A final observation was that it’s easier to teach a financial control person about sustainability, than to imbue a sustainability SME with a control mindset. Probably a conclusion every finance team has to work out for themselves!
Q&A and a new buzzword
And so to questions from the audience, which is where our guest panellists can loosen up and enjoy a bit of back-and-forth. From the bluntly basic (‘How confident are you that the standards will actually help companies create long-term value and more sustainable business models?’) to the literarily allusive (‘We seem to be Alice in Wonderland territory, where the word “material” can mean whatever people want it to mean!’), our audience held nothing back.
Another questioner raised the rather poetic-sounding issue of ‘greenhushing’. It’s a new one on me, but it’s when companies simply don’t report on their sustainability goals so as to avoid the risk of litigation. Big in the US apparently. And I think it says something for our own reporting environment that our panel responded with a kind of collective shrug. Will more insistence on assurance lead to less being reported? Maybe, but not because of fear of litigation – more, one suspects, from sheer exhaustion.
The panel left us with a final few words of advice on how companies can ensure they achieve both the letter and spirit of the new standards:
JO: It’s essential to start with a robust materiality process to see which of the standards are relevant to your business model. You may subsequently have a bit more leeway in the metrics you report against. The regulators understand that no-one will produce perfect information from the start… though they will get stricter over time!
MC: Start with a materiality assessment, understand the risks to the organisation and how that flows through the operating model, and then report from that. The key thing is, it’s going to require a different mindset.
JS: Make the links between the two types of information, sustainability and finance, as clear as possible.
So maybe a theme for 2024 is ‘reframing our thinking’. About what to report, how… and grasping that nettle of how to put a value on what sustainability means to your business. Because if not now, when?