January 28, 2022
By Adam Schwarz, Sustainability and ESG Reporting Consultant, The Delphi Group
Value Reporting Foundation (VRF) convened a symposium in December 2021 to discuss the latest trends in sustainability reporting and disclosure practices. The VRF is a global non-profit organization that was formed in June 2021 when the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB) merged.
It’s no wonder that this year’s inaugural VRF Symposium brought together some of the greatest minds in ESG disclosure to converse on the hottest topics in sustainability, including the direction of the newly minted International Sustainability Standards Board (ISSB). Below are the top seven takeaways about the direction of sustainability reporting, best practices for disclosure, and latest trends in ESG.
1. Convergence of Sustainability and Financial Materiality
Many speakers at the symposium contended that sustainability data, historically viewed as non-financial information, is increasingly becoming as significant as material financial information. While securities regulators are beginning to evaluate the financial significance of ESG data, market forces are pushing the convergence of the two at an astonishing rate. Just one example is the Glasgow Financial Alliance for Net Zero (GFANZ) capital allocation commitments, which are intended to accelerate decarbonization of the economy through investment.
Many companies known for their sustainability leadership within their sectors, such as The Co-operators and Capital Power, are acknowledging the importance of ESG data through integrated reporting, merging their sustainability reporting with their annual reporting commitments. Companies can save resources, increase efficiencies, create value, and harmonize disclosure by moving towards integrated reporting. Approximately 2,500 organizations across 70 countries disclosed under the integrated reporting framework, and wide-spread discussion at the VRF symposium indicates that this will become best practice soon.
2. ESG Disclosure is a ‘Must-Have’
Discussions around ESG disclosure are now less focused on the ‘why’ than the ‘how’ to use ESG disclosures most effectively. ESG reporting is no longer ‘nice to have’ for companies of every size, but instead an integral part of corporate strategy development. An August 2021 study by Millani found that 71% of companies listed on the S&P/TSX released a dedicated ESG report. A wide array of key stakeholders now expect companies to have some sort of ESG disclosure, and this is even truer now that banks, investors, and capital have become the main drivers of this impetus. Blackrock’s CEO Larry Fink commented in his 2022 Letter to CEO’s that total sustainable investments have now reached $4 trillion dollars, a ‘tectonic shift in capital [allocation]’. Companies that do not collect and disclose data on their ESG performance are increasing their exposure to risk, missing opportunities for greater value creation, and trailing behind their competitors. As the cost of capital becomes increasingly tied to ESG performance, companies that do not produce complete reports on their sustainability performance will experience increased costs, increased risk, and missed opportunities.
3. ESG Performance Reduces the Cost of Capital
Companies who disclose full ESG information have more access to capital in the form of Sustainability-Linked Financial (SLF) instruments. Commonly issued as loans or bonds, SLF instruments tie sustainability metrics, like those defined by SASB, to the price or coupon rate that these instruments yield. Ratcheting mechanisms create the ability for this price to go up or go down depending on sustainability performance, creating an incentive for companies to decrease these capital costs through complete and transparent ESG disclosure.
Unlike a green bond, which may support a sustainable company or environmental project, SLFs specifically target areas of a company’s sustainability performance that are most material to their business risks, and then offer direct incentives to improve. They also supply credible information that markets can use to offer a more exact valuation of enterprise value. SLF instruments are inadvertently driving increased data collection and disclosure that financial markets are demanding. In June 2021, Bloomberg revealed that 81% of asset managers feel that their firms need greater ESG data disclosure.
4. ESG Data Tells the Real Story
As the number of companies that disclose ESG data increases and the aggregate amount of ESG data grows, the market has seen a vast increase in maturity when it comes to how ESG performance is valued. Companies that do not offer tangible proof of ESG risk mitigation, that is both consistent with reporting frameworks and comparable across sector peers, can be devalued by the market. For example, when the European Commission rolled out its Sustainable Financial Disclosure Regulation (SFDR) — they created a set of rules governing what can be considered ‘sustainable’ in the investment world. Many investment funds were burdened with increased costs and a reallocation of ‘green’ investments as companies lacked the proper data to prove their ESG claims. As time goes on, consistent and complete data disclosure will be essential to assessing ESG performance and respective value as a result of this data.
Increased data disclosure has created a greater understanding of ESG metrics, leading markets to recognize when a company is not being honest about their sustainability reporting. This is resulting in a decrease of greenwashing as markets now price this deception into company valuations. In November 2021, the Chartered Financial Analyst (CFA) Institute published its first set of ESG standards to help guide the understanding of this valuation process and to help mitigate greenwashing by harnessing ESG data.
With further interest in ESG disclosure from financial markets comes an increased demand for credible, consistent, and comparable information. As with many elements of financial reporting, auditing and assurance are a near guarantee of accurate reporting and data disclosure. As ESG data is increasingly considered on par with material financial information, investors and markets are looking to see the same level of scrutiny applied across sustainability information as financial information. The scope of assurance practices will need to be increased to satisfy this demand from markets looking to properly price companies’ climate and sustainability risks.
5. Net-Zero Commitments Need Credible Plans
An emerging area of disclosure is net zero. 2021 has seen an exponential rise in entities making net-zero goals. However, these declarations are seldom accompanied by credible plans to achieve them, which gives rise to questions over whether net-zero commitments are fully supported business plans or lofty aspirational statements lacking the financial backing to make them happen. This has sent reverberations through financial markets, which are looking to price these net-zero goals into their valuation models but are left without hard data to perform proper analyses. As expectations shift, companies will need to consider developing and disclosing details on how they will reach their net-zero goals to avoid negative ramifications in the market.
6. Executive Pay-For-Performance Increasingly Tied to ESG
Executive remuneration is increasingly being scrutinized by shareholders, as is the lack of linkage between sustainability performance and executive remuneration. As of 2021, only 58% of FTSE 100 companies have an ESG measure in executive pay. However, companies that make this connection tend to outperform their peers with no executive remuneration tied to ESG performance targets. In Q1 of 2021, The S&P/TSX Commercial Banks Index (whose ranks have 6 out of 9 companies with executive remuneration tied to ESG) rose 15% compared with gains of 8.1% for the broader S&P/TSX Composite Index. Executive remuneration linked to sustainability performance is the hallmark of a mature and accomplished sustainability strategy, one that can affect more meaningful ESG improvements.
7. The New ISSB Will Change the Way ESG is Disclosed
As the discussion around ESG disclosure gains increasing attention from financial markets, a common topic at the VRF symposium was the role that the ISSB will play in harmonizing ESG disclosure. The hope by many is that by combining three of the top ESG frameworks: VRF (which is composed of SASB and IIRC), and the Climate Disclosure Standards Board (CDSB), it will create a common language that the financial world can use to synchronize ESG data. Work at the ISSB has begun as they plan to release their first set of standards on Climate Disclosure by June 2022. ISSB is also working closely with the Task Force on Climate-Related Financial Disclosures (TCFD) as part of the effort, with the hope that the new standard will bring consistency to climate and ESG disclosures under one financial reporting standard that is recognized and accepted across all markets and jurisdictions. This will, in turn, create market efficiencies around valuation. It is likely that many elements of the ISSB framework will look familiar, such as the SASB metrics, but new elements born from accounting standards will help enhance ESG disclosure to the level of financial reporting. For now, many ESG reporting enthusiasts will have to wait patiently for June to roll around. In the meantime, stakeholders of all corners of the business community are invited to take part in the ISSB’s Due Diligence process taking place through Q1 and Q2 of 2022.
Adam Schwarz is a Sustainability and ESG Consultant with The Delphi Group. For more information on how we can help you meet your ESG disclosure and net-zero goals, reach out to Adam directly at aschwarz@delphi.ca.
