Why is environmental, social and corporate governance (ESG) reporting important?

As corporate sustainability, social and climate change efforts are fast transitioning from voluntary to mandatory, Jamie Pitcairn, Ricardo's Technical Director for Sustainability explores the benefits that come with robust reporting.

As we move closer to COP26 in Glasgow in November, much of the focus is on the contributions countries can make to reduce global greenhouse gas emissions. Businesses play an intrinsic role in helping the countries in which they operate to achieve these ambitious targets and tackle climate change, but they can only do so with sustainable and socially responsible practices. They have a duty of care for the planet and its people, and they are accountable for their actions. All stakeholders, from their customers to investors, employees and the public, have eyes on the environmental impact. The move towards sustainability includes transparent disclosures with financial implications for companies failing to report.

As a result, corporate sustainability and climate change efforts are fast transitioning from voluntary to mandatory. There is a clear driver for companies to develop robust sustainability and ESG strategies with transparent reporting.

ESG reporting refers to the disclosure of data covering a company’s operations in three areas: environmental, social and corporate governance. It provides a snapshot of the business’s impact in these three areas for investors, customers and wider stakeholders. The value of ESG reporting is that it ensures organisations consider their impacts on sustainability issues and enables them to be transparent about the risks and opportunities they face.

Materiality

Put simply, materiality is a process of understanding what is important to your organisation. It is deemed important if it has a material impact on the financial performance of your organisation. When considering the issues that are ‘material’ and core to the organisation ask yourself:

• What will impact our organisation in terms of growth, cost and risk?

• What is important to our investors, customers, supply chain and other stakeholders?

Over the past decade we have seen a significant growth in organisations reporting on their sustainability materiality processes. Ricardo research has found that 81% of the FTSE 100 & 250 organisations included sustainability materiality processes based on a stakeholder perspective in their disclosure.

Materiality is continuously evolving and with increasing recognition of the financial links between ESG strategies and company performance, there has also been a growth in focus on sustainability issues that are material for enterprise value creation and the adoption of new business models. A good example is the growth in circular economy business models.

In today’s world it is not good enough to simply make claims about your level of sustainability. Now, organisations need to provide tangible, credible demonstrations of their sustainability impacts, by following proper guidelines for sustainability reporting.

Disclosure and reporting are an essential step in communicating your environmental action and financial performance. There is also an emerging consensus on including non-financial metrics in mainstream reports, such as an annual financial report, with the same discipline and rigour as financial reporting and this is where I introduce the concept of double materiality.

What is double materiality?

Double materiality, first introduced by the EU Commission as part of the Non-Binding Guidelines on Non-Financial Reporting Update (NRFD), introduces the concept that risks and opportunities can be significant from a financial and non-financial perspective. In other words, issues or information that are pertinent to environmental and social objectives can have financial consequences over time.
 
The new Corporate Sustainability Reporting Directive (CSRD), adopted by the EU Commission in April 2021, will mandate more than 50,000 companies to conduct a double materiality assessment.

The area of non-financial impact is immensely complex, consisting of many interconnected issues and numerous outcomes. For example, in the ICSU report (A Guide to SDG Interactions: from Science to Implementation) they consider Sustainable Development Goals (SDGs) and their interconnectedness with other SDGs. They found that SDG 14 has 97 relevant systemic interactions with other SDGs.

Sustainability professionals have wrestled with the complexity for decades. The challenge is finding a way to rationalise this without oversimplification so one negative impact is replaced by another. Identifying the right impacts for your organisation to focus on, and more importantly how to prioritise these issues, is an area that is often overlooked.

The good news is that efforts have been made over the past few years to evolve and standardise issue identification and disclosures.

Unified approach by standards setters

Most standards setters and reporting frameworks outline processes for issue identification and prioritisation. However, differing approaches have caused confusion in the market. The good news is there has been a unanimous call from sustainability practitioners, investors and even the standards setters themselves for a unified approach.

In 2019, many of the largest standards setters and reporting frameworks (GRI, SASB, CDSB, IIRC and CDP) came together, facilitated by the Impact Management Project - which provides a forum for building global consensus on how to measure, manage and report impacts – to achieve a harmonised and complete approach to reporting impact. This has helped to mature the area and ensure greater transparency, accountability and efficiency.

Creating consensus on methods at the global level, and ensuring all those who are required to report are following set processes and guidance, will ensure a speedier adoption of best practice within organisations. It will allow those who are not required to report to strengthen their business case for following set procedures for the implementation of sustainability internally. Also, the greater alignment will make reviewing and scoring organisations easier for investors enabling them to identify those organisations creating the most environmental, social and economic value.

Futures thinking

To progress, organisations must start implementing forward-looking, proactive approaches to materiality. In the “Statement of Intent to Work Together Towards Comprehensive Corporate Reporting”, the five standards setters outline the concept of dynamic materiality. This highlights that materiality is not a static process. Issues once considered relevant only to society can rapidly become financially material. Traditionally companies have focused on issues that have been, or are currently, material. Identifying potential issues coming down the line is crucial and we are supporting our clients to do this using methodologies like futures thinking and scenario assessment.

Financial impacts of climate risk

By including ESG issues that are relevant from a financial materiality perspective (double materiality), organisations can really strengthen issue identification and prioritisation for different stakeholders. As an example, and thanks to the work by the Taskforce on Climate-related Financial Disclosures (TCFD), it is now widely accepted within financial markets that climate-related impacts on a company can be material and therefore require disclosure. Climate risk is a relatively new but rapidly growing area and one that investors are increasingly looking at to understand the future performance of an organisation. Climate risk is a good example of where futures thinking is important. Indeed, the TCFD disclosure requires at least two climate scenarios to be used to identify risks and opportunities.

However, in my experience very few organisations are currently undertaking double materiality processes. There is a clear opportunity to move forwards in this area in the future. Strengthening sustainability strategy and disclosure is important for ensuring resilience in the future.

Report well

Public reporting done well is key to showing stakeholders that you are transparent and accountable. Demonstrating that your strategy accepts the challenges of your industry, while understanding the context of global issues, helps to build confidence that your organisation is serious about managing environmental and social impacts.

The key is working out what is important, what is material and to make progress by keeping goals simple and achievable.

A critical friend is always helpful when creating or reassessing a strategy or a process. In response to growing demand we have developed a sustainability strategy ‘health check’. We use this to look across your strategy and operations to identify any gaps and determine areas where you could direct your focus, such as reporting and disclosure. The health check is a free 1:1 surgery with one of our experts for up to an hour. Use the form on this page to request your health check or to contact us for more information.