Sustainability reporting: What directors need to know and do

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Sarah Barker, Managing Director, Pollination, Simon Learmount, Associate Professor in Corporate Governance, Cambridge Judge Business School

• A step-change in sustainability-related financial disclosure requirements represent the biggest shake-up of financial reporting standards in a generation.
• Benefits of voluntarily adopting sustainability-related disclosures to meet directors’ duties and the information needs of key stakeholders are increasingly recognized by board members.
• Here’s why directors must act now to prepare their company for rising expectations on sustainability and to ensure compliance with their duties on the board.

Authors Sarah Barker and Simon Learmount are Co-Chairs of the World Economic Forum’s Community of Climate Governance Experts.

Sustainability – including, critically, climate change – has rapidly evolved from an ‘environmental, non-financial’ consideration to a set of issues that often present material financial risks and opportunities for business, across real economies and financial systems alike. Sustainability risks are now financial risks and sustainability opportunities are now financial opportunities.

Around the world, regulators and accounting standards setters are responding to calls from investors to provide consistent frameworks for the financial reporting of sustainability-related information, in a way that is decision-useful and comparable between investee companies.

At their core, these new standards require companies to not only consider how sustainability may present financial risks and opportunities, but to ‘connect the dots’ to the financial bottom line.

Whether companies operate in one of the many countries that have committed to implementation of the new International Sustainability Standards Board Standards , in value chains touched by the European Union’s Corporate Sustainability Reporting Directive, or under the proposed United States’ Securities and Exchange Commission’s Climate Disclosure Rule or Californian Senate Bill 261, there is no doubt that we are facing a step change in reporting practices.

Why do all directors need to act on sustainability – and why now?

Many directors still do not perceive sustainability as a material financial risk or opportunity, or have assumed that there will be no obligations to disclose or manage relevant risks until the shifting sands of regulation settle.

However, there are three key reasons why directors should consider the new frameworks as effectively mandatory for all companies:

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1. The speed and scale of regulatory change: The new disclosure requirements demand early preparation. In many jurisdictions, mandatory sustainability-related financial disclosure standards will commence within the next two financial years – often targeting public companies first, closely followed by large private and not-for-profit companies.

Compliance will require significant internal capacity-building and systems change, which in turn take time. The impact of anticipated new regulation may be broader and faster than board members foresee, requiring early dialogue with management about preparation and the benefits of voluntary adoption in advance of mandated regulation to meet market expectations.

2. Director’s duties and liability exposures: Beyond ‘corporate compliance’, the new norms of climate- and sustainability-related financial reporting are directly relevant across directors’ strategy, risk oversight and disclosure functions. To state the obvious, boards are ultimately responsible for all financial disclosures.

Diligent oversight of financial information systems and consideration of whether existing verification processes remain ‘fit for purpose’ to assurance of the additional disclosures, will be required. This includes diligent consideration of the credibility and adequate resourcing of any targets or transition plans disclosed. Given the significant changes required by the new regimes and the highly complex and dynamic nature of the relevant subject matter, it is likely that specific board capacity building will be warranted.

3. Competitiveness and evolving expectations of shareholders, lenders and customers: Beyond strict regulation, key stakeholders – investors, customers, community, employees – are demanding more information about material sustainability and climate-related risks and opportunities.

By taking appropriate action and disclosing how sustainability is embedded in strategy, governance and risk management, companies can attract customers, reduce the cost of capital and increase employee engagement.

Compiling more information on suppliers and customers will assist companies to manage sustainability-related downside risks, identify market opportunities and find ways to preserve and enhance shareholder value. And this will gain momentum as the economy-wide transparency created by the new standards results in more efficient pricing of relevant risks and opportunities.

So where to start on sustainability? Key steps for board members to take now

The magnitude and complexity of the new sustainability-related financial reporting landscape can often be overwhelming for directors. The following questions may help to provide a strong foundation from which to navigate the strategic, risk oversight and disclosure implications. These are:

1. Assess capacity and governance
What capacity building is required for the board and its reports? Do we have the right people advising us? How effective are our prevailing governance structures, processes and accountability/responsibility mechanisms in the evolving context? Is change being adequately resourced? Consider assurance readiness – where do we anticipate data gaps or uncertainty requiring estimation, and how does this impact data completeness, relevance, reliability and verifiability? Do we need to strengthen processes for disclosure assurance including forward-looking statements?

2. Oversight of risk management and controls – consider the implications for disclosure content and underlying information systems

Has management considered the gap between what we already disclose and the additional information required? What additional information do we need to capture under prevailing data and reporting systems? What are the information capture and control gaps, and what uplift, expansion and restructuring of our internal systems and controls is required?

3. Consider the implications for strategy

What additional assessment of sustainability-related risks and opportunities will we need to undertake within our business and across our value chain? What is our threshold for ‘materiality’ – and why? How are our investors and insurers positioning themselves in the evolving context – and what are the implications for our access to finance and insurance, and its cost? What are the consequences for our strategy and business planning – over the short-, medium and long-term? At a higher level, what does the step-change in transparency mean across the economy – and how are we positioned in that context?

The runway to sustainability-related financial disclosures is short. Board members acting in the best interests of the companies they serve need to oversee appropriate preparation and resourcing to meet the new compliance obligations as well as proactively consider the implications for strategy, business planning, financial position and performance.

Is your board prepared for increasing sustainability-related financial disclosures?

Learn more and take action: The World Economic Forum´s Community of Climate Governance Experts is an inter-disciplinary knowledge network dedicated to advance good climate governance at the board level as an enabler for climate action. Read more of their activities here.

The Climate Governance Initiative mobilizes boards of directors around the world to address climate change in their businesses. They do this by developing and supporting local networks that equip their members with the skills and knowledge needed to make climate a boardroom priority, building on the World Economic Forum’s Principles for Effective Climate Governance.

Join your local Chapter of the Climate Governance Initiative. To learn more, visit: Join a Chapter – Climate Governance Initiative.