In 2015, the Paris Agreement and broader societal changes coming to the fore resulted in a mindset shift among many CFOs and treasurers. Sustainability started to emerge in many of their day-to-day interactions, in questions they were receiving from investors, their relationship banks, their board – and in their own team meetings.
Sustainability has since been rising on the treasurer’s list of priorities, shifting from a ‘nice to have’ to a ‘need to have’, with treasurers understanding that they rather urgently have to upskill their finance teams in this topic. Such upskilling includes establishing processes that help to assess the company’s environmental and social impact, and ultimately help to deliver a corporate narrative with sustainability at its core.
Corporate sustainability reporting has been on the periphery of corporate reporting for over a decade, with many larger companies already reporting on their sustainability practices, such as environmental protection, occupational health and safety, diversity or community giving.
However, what was traditionally considered a voluntary practice is gradually becoming a ‘must have’; in particular, for sustainability issues that are commercially relevant to a firm’s business operations and hence of significant interest to its stakeholders. At the same time, a number of companies want to proactively promote their sustainability credentials to signal their intent to embed sustainability considerations more broadly into all of their activities.
Whether preparing for a sustainability issuance or loan, or aiming for a positioning as a good corporate citizen, companies face a number of reporting challenges and potential pitfalls. So, how to tell the full story? We’ve identified three major areas that need to be addressed:
Whether investors, customers, employees or other stakeholders, a strong ESG proposition delivers proof that a company is doing or developing strategies to do ‘the right, responsible thing’. While many ESG ‘newcomers’ tend to look at leaders in order to learn and copy, they need to be aware that a strong ESG proposition has many facets and will in fact look different for each company.
Therefore, the ESG journey needs to start with a robust internal review of key sustainability issues and their impact on a company’s risk profile and performance. Typical questions would be:
While the list of questions could become very long, companies need to be mindful that the Pareto principle also applies to a sustainability context: 20% of ESG metrics demonstrate 80% of a firm’s footprint and sustainability impact. Therefore, reporting ought to focus on those 20% material sustainability issues.
Once agreed on the key narrative, firms need to be aware that a one-story-fits-all approach won’t do justice to the varied information needs of the diverse pool of stakeholders and not only investors. Therefore, sustainability reporting needs to happen with each stakeholder in mind. To help with this task, corporate sustainability leaders have formed stakeholder panels to continually identify changing information needs and expectations.
During its infant stages, sustainability reporting was often characterised by bold mission statements and a few selected sustainability measures. However, that is quickly changing with calls for access to more reliable and comprehensive data as well as a fuller articulation of a company’s value-creation story.
Investors, rating agencies, regulators (for example, through the EU Taxonomy) and other stakeholders are calling for authentic, measurable and standardised ESG data. Therefore, firms need to re-evaluate what and how they report, and focus on impact and value creation rather than only citing sustainability measures and efforts.
Choosing the right reporting format poses another challenge: the sustainability reporting landscape has been fast evolving with many different standards and frameworks. However, there are efforts under way to help standardisation and simplification. An initiative called The Corporate Reporting Dialogue has been working to respond to market calls for greater coherence, consistency and comparability between financial and corporate sustainability reporting frameworks and standards. Furthermore, two of the most recognised standards, the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB), have announced a strategic collaboration.
Finally, looking at whether and how to combine financial and sustainability data, the direction of travel is clearly moving towards finance teams taking more interest in sustainability reporting, and some firms producing a sustainability supplement as part of the annual report.
Sustainability reporting can often be misaligned with a company’s purpose and priorities. Every company needs to recognise that each sector, geographic footprint and product or service offering may require a different approach and a different narrative with regard to its transformation to a sustainable business. This presents major challenges for global corporations operating in multiple lines of business.
Issuers are recognising that their sustainability disclosures can be pertinent in helping investors, rating agencies and other stakeholders to form a better assessment of how they are embedding sustainability considerations.
A strong sustainability disclosure should evidence that a company fully understands its material issues and actively develops responsible business strategies that are aligned with its corporate purpose and strategy. This needs to encompass a clear articulation of the firm’s broader societal purpose, beyond maximising financial returns for shareholders.
At the same time, companies should be open about dilemmas they face on their sustainability journey and be transparent about, for example, future resource constraints potentially affecting their operations and positive and negative aspects within their value chain in terms of environmental, social and economic impacts. Many companies now address this by publishing clear position statements and reporting extensively on specific sustainability issues, risks and mitigating factors/actions.
Over the past few years we have seen a significant growth in the use of ESG ratings. According to the Global Initiative for Sustainability Ratings (GISR), there are well over 100 organisations that produce sustainability research and ratings on companies.
How do ESG rating agencies differ from credit rating agencies? Generally speaking, ESG rating agencies arrive at the overall rating of a company’s ESG performance by calculating a composite score of individual ESG indicators, ranging from 70 to up to hundreds of different indicators, with each weighting differently. There are many differences in approach, in methodology and in nomenclature between ESG rating agencies, which are crucial to understanding the meaning of each rating and which make ratings difficult to compare.
Contrary to credit ratings, ESG ratings are in most cases unsolicited. ESG rating agencies typically make their evaluations based on publicly available information, such as corporate sustainability reports and information from corporate websites, although a growing number are issuers and rating providers can offer a solicited approach. The difference also lies in the fact that ESG ratings are mostly paid for by the user of the ratings, whereas credit ratings are paid for by the rated entities.
Depending on levels of awareness, company size and the extent of pressure from investors, firms have been allocating differing levels of resources to manage their ESG ratings, with many acknowledging that they need to engage in active dialogue with agencies to understand and ensure ratings are accurate.
As outlined in the context of sustainability reporting, for companies it is important to actively understand and meet the information requirements of the different agencies. We advise on (i) focusing on two or three of the major ESG rating agencies; (ii) identifying material drivers and quick wins; and (iii) engaging proactively with agencies in information provision.
Dr Arthur Krebbers is head of sustainable finance, NatWest Markets, and Varun Sarda is head of ESG Advisory, NatWest
