Investors who care about ESG want to know what’s up with companies apart from their financials. They want to know the non-financial factors influencing any business activity and what companies are doing to mitigate possible exposure to climate change and social risks.
Here are some statistics from a recent survey by EY:
- 98% of investors evaluate companies’ non-financial information, either formally or informally
- 67% of investors make significant use of ESG disclosures shaped by the TCFD framework
- 83% of investors consider formal frameworks to be necessary to assess the long-term value of a business
- 75% of investors surveyed would find value in the assurance of the robustness of an organization’s planning for climate risk
(ESG stands for Environmental, Social, and Governance. TCFD stands for Task Force on Climate-Related Financial Disclosures)
EY also found that 74% of institutional investors are more likely to divest due to ESG performance than before the COVID-19 pandemic. These numbers indicate a shift in how investors now perceive a business entity – not just as a financial unit but one influenced by the environment and society in which it operates. In this article, we attempt to address what investors are looking for in terms of ESG disclosures.
Integration between Financial and Non-financial Reporting
Investors have long relied on companies’ financial reports to understand their capability to create value. The time has now come for financial reports to evolve. Value cannot derive purely from financial factors without regard for the non-financial factors that influence business decisions. The need of the hour is an integrated reporting approach.
Efforts are being made to create a sustainability standard that is accepted as the de facto standard worldwide. The International Sustainability Standards Board (ISSB) was set up expressly for that purpose. The ISSB’s integration with the Value Reporting Foundation (VRF) – which in turn is a merger of the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) – is indicative of an integrated approach to sustainability standard-setting.
It is, however, up to companies to choose an approach to communicate value factoring in both financial and non-financial factors.
Internal Control & External Assurance on Non-financial Information
ESG as a concept has fallen on hard times of late. After a spurt of enthusiasm in the wake of the Covid pandemic, the concept is now being characterized in some quarters as ‘little more than a glorified marketing exercise’.
That is not to say that there are no takers for ESG. More than 90% of S&P 500 companies have started publishing ESG reports, according to McKinsey & Co. estimate. Bloomberg Intelligence reports that ESG assets will exceed $40 trillion in 2022.
What does this indicate? ESG information needs to earn the trust of investors and other market participants. And what can earn trust better than strong internal controls over ESG information and external assurance? The US and Europe are already moving towards the assurance of sustainability disclosures.
In the US, the Securities and Exchange Commission has proposed sustainability disclosures in the footnotes to financial statements. Those disclosures will be audited along with the financial statements. Scope 1 and Scope 2 greenhouse gas emission disclosures would need a limited assurance during phase-in and, thereafter, a reasonable assurance.
In the EU, sustainability disclosures under the Corporate Sustainability Reporting Directive (CSRD) will need to be certified by an accredited independent auditor.
Use of ESG Reporting Frameworks for more Rigorous Reporting
As we have mentioned above, 67% of investors who participated in the EY Global Institutional Investor Survey said they make significant use of ESG disclosures shaped by the Task Force on Climate-Related Financial Disclosures (TCFD) framework. Investors seek rigorous ESG reporting in accordance with ESG frameworks. In keeping with this demand, regulators in various countries have proposed or mandated sustainability reporting using frameworks. The US SEC has proposed using the TCFD framework. Canadian companies might have to use the TCFD framework for ESG disclosures from 2024. Large UK companies have been using the TCFD framework since April 2022. In the EU, the European Financial Reporting Advisory Group (EFRAG) is in the process of building sustainability reporting standards for being used under the Corporate Sustainability Reporting Directive (CSRD).
Digital ESG Reporting for greater Transparency & Comparability
Digital ESG reporting helps companies present their disclosures in a machine-readable format which facilitates accessibility, analysis, and comparability. Static formats such as paper-based reports or PDFs lock away material information. Any interaction with information in static formats would require manual processes. However, if the information is available in a machine-readable format, it becomes easier to transmit reports across computer terminals. Information in such a format can be pulled into a spreadsheet at a click, making its analysis and comparison easier.
XBRL or eXtensible Business Reporting Language is a machine-readable language that companies in jurisdictions such as the US, EU, UK, South Africa, and others use for financial reporting. To get started with XBRL reporting, companies must study a collection of XBRL codes, which is known as the taxonomy. Regulatory authorities that mandate XBRL reporting make taxonomies available for companies.
XBRL is soon set to be used for non-financial or ESG reporting. Several ESG reporting standards such as TCFD and SASB have their digital versions or taxonomies. Gap Inc., America’s largest specialty apparel company, recently used the SASB XBRL Taxonomy to prepare its 2021 sustainability report in a machine-readable format.
Think there are no takers for ESG information in a machine-readable format? Here’s what Gap Inc.’s Director of ESG Reporting & Disclosure, Marvin Smith, had to say: “Having that machine-readable (XBRL) element is another way to ensure our disclosures are accessible to key stakeholders who are processing and evaluating our ESG performance. We believe it’s important to make information available in a useful, comparable, reliable, and importantly, accessible manner and in a format where investors and stakeholders increasingly process information – in the digital format.”
