Prior to the global spread of COVID-19, sustainability, climate change and responsibility were at the top of the agenda for executives around the world, as evidenced by this year’s annual meeting of the World Economic Forum (WEF) in Davos, Switzerland (January 2020). During the week-long event these themes dominated much of the agenda and sparked wide-ranging debate.
And it was not just all theory. There was a powerful consensus that the time has come for concerted action. One manifestation of this was the publication of a new set of proposals from the WEF’s International Business Council (IBC) for common metrics and reporting disclosures around environmental, social and governance (ESG) factors.1
A significant number of frameworks and voluntary standards already exist for ESG reporting, even running into the hundreds. But in fact, this is part of the problem. There are so many that for some preparers it can be hard to know which one to follow.
For financial institutions, meanwhile, it is becoming increasingly important to take account of ESG factors when assessing credit and market risk. But this multiplicity means that it can be challenging to take an objective view because the different frameworks are often not directly comparable.
This is why the proposals put forward by the IBC are potentially so significant. Developed in conjunction with the Big Four accounting firms, the proposals aim to create a core set of commonly adopted metrics that will bring consistency, comparability and transparency to reporting of non-financial risks and ESG factors.
The IBC consists of around 120 members, including many of the world’s largest businesses (and a plethora of major financial services organizations). So these are proposals developed by business, for business.
They are also significant because one of their core aims is to bring about the ‘mainstreaming’ of ESG reporting — by bringing key ESG disclosures into annual reports themselves, rather than being confined to separate, standalone reporting documents.
A significant number of frameworks and voluntary standards already exist for ESG reporting even running into the hundreds. But in fact, this is part of the problem.
Another critically important feature about these proposals is that they are absolutely not about ripping out what already exists and starting again. On the contrary, their aim is to build on the good work already in place and bring it all together. As the WEF put it in their announcement during Davos:
“The metrics are drawn, wherever possible, from existing standards and disclosures such as Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), Taskforce on Climate-related Disclosures (TCFD), Climate Disclosure Standards Board (CDSB) and others. Instead of reinventing the wheel by creating a new standard, they aim to amplify and elevate the rigorous work that has already been done by these initiatives, bringing their most material aspects into mainstream reports on a consistent basis.”
So what is actually in the proposals? There are 22 core metrics that are spread across four pillars — Principles of Governance, Planet, People and Prosperity. These are aligned with the United Nations Strategic Development Goals (SDGs) and with the principal ESG domains.
Principles of Governance is the ‘G’ of ESG, covering a company’s commitment to ethics and societal benefit; Planet is the ‘E’, looking at themes of climate sustainability and environmental responsibility; People is the ‘S’, focusing on the roles human and social capital play in business; Prosperity meanwhile brings a financial lens, but one that is concerned with business contributions to equitable, innovative growth — economic prosperity on a wider basis than simply a company’s own profit generation, including community investment and tax.
It goes without saying that, in the wake of COVID-19, these attributes of social responsibility, commitment to communities, and contributions to economic growth, will become more important than ever before. Consequently, consistent and transparent reporting around them will become even more crucial too.
To report against the core metrics should not, in fact, be a challenge for ‘mature’ businesses who have an established ESG reporting program. For example, we ran an analysis for one client of KPMG and found that they already report against 21 of the 22 core metrics.
However, for those businesses that do not report on ESG factors, the nature of the task will be quite different: significant work will be required to gather the necessary information. The proposals are voluntary so no business will be compelled (at this stage at least) to report against them — but if, as expected, they gain traction amongst investors and stakeholders, then pressure will inevitably grow for organizations to adopt them.
The main focus of this pressure will of course be on publicly-listed companies, but at the same time could spread into the private arena. Private businesses need financing and equity as much as public entities — and if financial institutions continue the trend of factoring ESG issues into their lending and investment decisions, then increasing numbers of private companies may adopt the reporting metrics too.
It is also to be hoped that the reporting framework will be adopted not only by businesses (and promoted by regulators) in mature markets in the Americas, Europe and ASPAC, but in many other countries too. There could be a real investability dividend for companies in less developed markets that adopt the metrics, increasing their attractiveness to financers. By taking the lead locally, they could also encourage others to follow suit. Embracing the framework is an opportunity for business communities in less developed jurisdictions to send out a strong message to stakeholders and investors internationally about their commitment to the ESG agenda.
There could be a real investability dividend for companies in less developed markets that adopt the metrics, increasing their attractiveness to financers.
The core metrics are very much positioned as the minimum requirements. In addition, there are a further 30 expanded metrics and disclosures that are more challenging to report against. These, the IBC says, can help companies “progress towards greater depth, breadth and precision of reporting on the factors influencing long-term value”. They provide a “pathway for continuous improvement” that companies can aspire towards.
To take one example that illustrates this, in the People pillar there is a core metric of ‘skills for the future’ in which companies are asked to quantify the average hours of training per person that the organization’s employees have undertaken, together with the average training and development expenditure per employee.
The expanded metric against this asks for information that is much harder to calculate: the monetized impacts of training. That is to say, the estimated future uplift in lifetime earnings as a result of training intervention. This should be calculated using the income-based approach to human capital valuation. Clearly, this is of a different order of difficulty than quantifying how much training has been delivered and how much it cost.
In keeping with the general recognition that the world needs to act fast on climate and other issues, the proposals are set to be introduced on an accelerated timeline — the expectation is that many companies will incorporate reporting against the metrics in their annual reports for financial years ending 31 December 2020 and others will follow. In other words, we should see the first reporting in annual reports early next year.
To achieve this, there will be a consultation period in the next months. The consultation period on the proposals closes this month. And any necessary revisions and updates will then be made to the metrics, before they are ‘stress‑tested’ with a selection of issuers and investors over the summer period. A key consideration, of course, is that investors should find the reporting valuable and informative — so their feedback will be critically important. The hope is to find a format similar to Task Force on Climate-related Financial Disclosures (TFCD) reporting where key summary information can be presented in one table — easy to digest and examine, with more detailed reporting sitting behind it.
For financial services businesses, we hope the proposals will be truly welcome. The new metrics will fill the information gaps that sometimes exist in ESG reporting and provide direct comparability between businesses. This will enable financial organizations to make better-informed lending, investing and underwriting decisions.
At the same time, it will be important that the financial sector leads the way in adoption of the metrics in its own reporting. If financial institutions are to expect clients to report against them, they will need to have their own houses in order too.
At KPMG, we are proud to be involved in the development of this new ‘common language’ for ESG reporting and look forward to advising clients on meeting the requirements.