Sustainability disclosure – the need for a common language

Imagine opening a manufacturing company’s annual report and finding this statement: “We pollute because it is in our financial interest to do so. For the same reason, we hire lobbyists to ensure that the regulatory constraints on our pollution are minimized. And we skirt the rules that do exist: an occasional fine is a good business investment.”

That’s pretty unlikely to happen. After all, when it comes to PR, honesty is not always the best policy. But, as investor interest in sustainability grows, so do expectations around corporate disclosure. Many companies pollute or discharge carbon into the atmosphere or do things that impact local communities and the environment in a long list of other ways. Investors (and others) have a legitimate interest in the extent to which they do so.

At the Thinking Ahead Institute, we believe that institutional investors need to understand and articulate the impact of their investment decisions on all stakeholders, including wider society and the planet, because their long-term sustainability depends on it.

To understand impact, it helps to have data. But data on sustainability is limited and difficult to make sense of. There’s an incentive to put a positive spin on it: “we actively engage with regulators” sounds so much better than “we hire lobbyists”. Even working out what it is we’d like to know is not straightforward. Increasing the volume of disclosure is relatively easy. But how do we make sure the new data is actually useful?

A thorough analysis of the current state of disclosure (specifically: ESG disclosure) has recently been produced by Nissay Asset Management, in a report commissioned by Japan’s GPIF. This is publicly available both in summarised format and in the full 241-page detailed analysis, and well worth a look for interested readers. I will not restate the contents of these reports here. Rather, I want to highlight one topic it raises: the need for a common language.

The most significant global disclosure initiatives include the International Integrated Reporting Framework (<IR>), the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB).

These initiatives each originated with a different purpose. To some extent, it can be argued that they are complementary. For example, Nissay characterise SASB and GRI as offering normalised information, making comparison across companies easy. <IR>, in contrast, is more tailored, principles-based, with greater emphasis on business models. The principles-based approach allows for deeper understanding at the individual company level, but does not necessarily enable easy comparisons across companies. Hence <IR> is a framework rather than a standard, into which the disclosure items specified by the other initiatives can be incorporated.

At this point in the development of sustainability disclosure, the need for a more common language – standardisation of reporting requirements – is particularly pressing. Disclosure standards allow companies to be confident in what is expected of them and to move away from having to react to a stream of one-off requests from shareholders. SASB’s materiality map, for example, identifies which issues are likely to be financially material to each of 77 separate sectors (data security is probably material for a bank but not for an appliance manufacturer, water management for a chemical manufacturer but not for an asset manager). The standards list specific disclosure items relating to each issue.

Standards also ease the development of analytical tools, which turn data into actionable information. And they raise the bar, making it harder for laggards to duck the issue with empty platitudes and cherry-picked numbers.

It’s quite possible that one day I will find myself arguing that “it’s better to report the right things imprecisely than the wrong things exactly” and that principles are what is needed – but today is not that day. The more companies go beyond the standards and produce meaningful <IR> reports, the better, but the biggest need today is for better baseline reporting from everyone.

Another area of difference between the various initiatives is the breadth of their scope. <IR> and SASB report information that is relevant to a company’s operating performance and financial condition, while GRI extends to consider wider impact, including environmental and social effects. The former approach builds on existing norms, focusing on a single set of users; the latter aims higher. As noted above, TAI believes that understanding wider impact is essential. But targeted initiatives such as <IR> and SASB are necessary extensions of current practice.

The developers of the various standards and frameworks recognise the need to work together. The International Integrated Reporting Council, SASB and GRI participate in a corporate reporting dialogue that also includes CDP, ISO and a list of other bodies. The more successful this dialogue, the easier the transition to better reporting is likely to be for corporations, and the faster progress is likely to be made.

In the longer term, the Nissay report argues that “the possibility of mergers or the weeding out of ESG disclosure frameworks/standards cannot be ruled out.” That may be driven either by markets or regulation.

In summary, investors need to improve their understanding of the wider impact of their decisions so that they can start to manage it better. That means better corporate disclosure is needed, and common standards are a key element of making that happen. Investors are increasingly focused on the sustainability of their portfolios, but all too aware that good intentions do not easily translate into meaningful impact. Disclosure standards can help to close both the saying-doing gap and the doing-impact gap.