Martin Baxter


Non-Financial Reporting Regulations Pave Way for More Focused Corporate Governance Approach to Sustainability - Posted 2014-04-06

Martin Baxter, Executive Director – Policy, Institute of Environmental Management and Assessment (IEMA).  IEMA incorporates the Global Association of Corporate Sustainability Officers (GACSO)
Chair – EIGA Sustainability Advisory Policy Committee

Regulatory changes to corporate reporting rules, both in the UK and Europe, are placing greater emphasis on corporate disclosure on sustainability.  Coupled with more direct reporting requirements on conflict minerals, sustainability is fast becoming a core issue for corporate governance.

The United Nations Rio+20 Earth Summit on sustainable development in 2012 set a useful backdrop to the issue of corporate sustainability reporting.  Particularly important is the debate over what is meant by ‘responsible capitalism’, as it forces consideration of “how”, rather than simply “how much”, value is created in companies.  As a driver of increased expectations on transparency and accountability (and therefore corporate governance) it’s powerful.

Demands for a stronger focus on sustainability reporting in the run-up to the summit came from business groups, with the World Business Council for Sustainable Development (WBCSD) calling for the inclusion of “the explicit requirement for companies to adopt standardised, rules-based sustainability reporting”.  The UN Secretary General’s High Level Panel on Global Sustainability was more robust – with its recommendation that “business groups should work with governments and international agencies to develop a framework for sustainable development reporting, and should consider mandatory reporting by corporations with market capitalizations larger than $100 million”.

In setting out the UK Government’s aims for Rio+20 on 9th February 2012, Caroline Spelman (Secretary of State at the time) said in a speech that “We want action to ensure that businesses and governments factor sustainability into every decision they make – and for this to be transparent.  So we will join the call for Rio to drive uptake of sustainable business practices – in particular transparent and coherent sustainability reporting.”

As seems to be the nature of negotiating international agreements, forward looking ambition often gets cast aside as compromise catalyses a race to the bottom.  The watered-down words in the final agreement “We encourage industry, interested governments and relevant stakeholders……as appropriate, to develop models for best practice and facilitate action for the integration of sustainability reporting, taking into account experiences from already existing frameworks…..” meant that national bottom-up approaches will be required to stimulate widespread participation beyond leading blue- chips’ voluntary activity.

Over the last couple of years, two issues in the UK have come together in the 2013 changes to the Companies Act (2006) to place increased regulatory requirements on sustainability reporting.

The first stems from the Coalition Agreement of May 2010 which gave a commitment for Government to “reinstate an Operating and Financial Review to ensure that directors’ social and environmental duties have to be covered in company reporting, and investigate further ways of improving corporate accountability and transparency.”

The second was enactment of corporate greenhouse gas emissions reporting in the Climate Change Act (2008), with the UK being the first country to introduce mandatory GHG reporting regulations.

The new GHG reporting requirements are important, but they will offer only an historical perspective of a company’s performance – i.e. the previous year’s GHG emissions and previous years for comparison where available, and they only deal with a single issue.  So in itself, GHG emissions reporting won’t cover the strategic issues about how companies are responding to the broader issue of climate change – including future carbon liabilities and the impact of climate risks – or of other environmental constraints such as resource availability – all of which might have significant impact on the organisation’s ability to create long-term value.  Neither does it deal with social or human rights issues.

This has been addressed by the new corporate reporting framework which requires a Directors Strategic Report. The strategic report provides shareholders with a concise description of the company’s strategy, risks and business model.  It also integrates wider matters of significance to the company, including key environmental and social information with key financial information and a forward-looking analysis by the directors of the challenges and opportunities they face.  It demonstrates how the board integrates long-term issues and risks – including those relating to environmental, social and human rights issues – into the company’s strategy and business model.  Its value is already being seen – the recent Strategic Report by Shell identified risks associated with future climate change regulation and the carbon intensity of its activities, increasing costs and potentially delaying projects.

While the framework for environment and sustainability reporting in the UK is clearly taking shape, changes are also being made at the European level.  The European Commission’s proposal for a directive enhancing the transparency of certain large companies on social and environmental matters is working its way through the legislative process, with the European Parliament’s Legal Affairs Committee voting unanimously to implement the requirements for all European publicly listed companies employing over 500 people – estimated at over 8000 companies.  Companies will need to disclose information on policies, risks and results as regards environmental matters, social and employee-related aspects, respect for human rights, anti-corruption and bribery issues, and diversity on the boards of directors.

Transparency and disclosure are also being regulated for certain supply chain activities.  In 2012, the US Securities and Exchange Commission adopted a rule mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, requiring companies to publicly disclose their use of conflict minerals that originated in the Democratic Republic of the Congo (DRC) or an adjoining country.  Companies such as Intel and Apple are taking action to address this through their policies and practice.  The European Union is also developing a regulation to establish a scheme to deal with conflict materials although taking a different approach to that in the US.

Of course, regulation isn’t the only driver of corporate sustainability reporting – shareholders and investors also recognise that importance of sustainability and links to long-term business success.  Research by Ernst and Young in 2013 shows that environment and social issues formed the largest category of all shareholder proposals filed in 2013.  The Carbon Disclosure Project analysis for institutional investors of critical issues facing metals and mining companies highlighted that water poses a significant constraint to growth and threatens the future value of companies in the sector.  Not surprising then that the world’s largest investors are calling for global stock exchanges to develop a uniform sustainability reporting standard for companies.

Given increasing attention from regulators and investors, the challenge for Boards is to develop the controls and processes needed to improve and account for sustainability performance.

Martin Baxter

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