The news that the way is paved for the formation of a new International Sustainability Standards Board (ISSB) to develop global high-quality sustainability disclosure standards to meet investors’ information needs was, for many, a high point of COP26.
There was a simultaneous commitment by leading investor-focused sustainability disclosure organisations to consolidate into the new board. The IFRS Foundation will complete the consolidation of the Climate Disclosure Standards Board and the Value Reporting Foundation (which houses the Integrated Reporting Framework and the Sustainability Accounting Standards Board (SASB) Standards) by June 2022.
What the announcement means to companies
This announcement is the culmination of many years’ work by numerous organisations. The work undertaken by SASB is a case in point. “SASB Standards were developed to facilitate communication between companies and investors in a way that would be usable around the globe by multinational corporations or by domestic companies,” says Hales. “They are for the benefit of investors that need information beyond that which is captured in traditional financial statements, but this information is not disconnected from financial statements either.”
He points out that financial statements have been developed using what we think of as generally acceptable accounting principles that are well established and serve a very important purpose – but they were developed in a way that was not intended to go beyond the boundaries of what an existing asset or liability looks like today. “The SASB Standards facilitate a communication between companies and investors about the risks and opportunities that lie just beyond the existing boundaries of an asset and liability, and what a company is doing to manage those risks and to take advantage of the opportunities that are available to create value,” says Hales.
The SASB Standards are primarily intended to meet the information needs of investors when they are making assessments of enterprise value, thinking about capital allocation decisions, thinking about how they might vote when it comes to shareholder proposals, and when exercising their rights as capital providers. “All of this is within the context of information that would affect their assessments of the company's enterprise value,” he adds. “I think that's a growing aspect of the marketplace.”
What does this term “enterprise value” mean?
Hales responds: “It relates to the projections that investors, writ large, think about when valuing a company. Those projections relate to cashflows over a long time-horizon, which match the strategic planning horizon of the company, as well as the investment time horizon.”
And there is a real head of steam building behind sustainability standards. “I’ve been involved in the development of SASB Standards since 2012. I have seen the pace of change shift upwards such that every two or three years there is a very different perspective in the marketplace. Investors have really started to take note. Then companies started to take note in response to the institutional investor community showing clarity around what they were looking for,” he says.
But there has been a lot of confusion in the marketplace too. That is until we started to see that industry-specific disclosures on sustainability issues can be very useful. “We heard from large pension funds and sovereign wealth funds, all around the world, calling for not just increased disclosure, but disclosures in line with TCFD recommendations as well as the SASB Standards, and that that led to a very big uptake,” says Hales.
From their launch at the end of 2018 until now, over 1,400 companies worldwide have incorporated SASB Standards into their reporting – that reflects about 55% of the S&P Global 1200, with about half of those companies located inside the US and the rest of them outside. “We are increasingly seeing small and mid-cap companies use the Standards as well,” he says.
The next step is, essentially, for the IFRS Foundation to take responsibility for the SASB Standards. “There are recommendations that the SASB Standards be incorporated into the ISSB resources and for ISSB to formally recognise the Standards as part of their hierarchy,” says Hales. “Eventually they will be folded into the standards that are designated ISSB Standards through that body’s due process. The important thing to keep in mind right now is that these are recommendations. But this is nevertheless a strong endorsement of SASB Standards.”
What about the public sector? How far should the public sector report on sustainability matters – should it keep pace with the private sector? “I think sustainability issues are universal and should be considered not just by private sector entities, but also by public sector ones. But we do need governments to report on how they are managing the sustainability issues that are relevant to their citizens,” says Hales. “And I can certainly imagine cities doing a good job of attracting capital by reporting in this way. A big part of all of this is infrastructure. It's very important that we consider the huge capital outlays and the long-term planning horizons that relate to infrastructure investment. It all needs to be done in a way that's sustainable and, for that, clear standards will help.”
Hales concedes that there is a challenge for SMEs in reporting on sustainability issues. “The cost of allocating staff to manage the reporting angle of a sustainability issue can be cumbersome for a small entity. But the hope is that will be a more efficient process when there are well developed standards in place,” he says. He expects the market to step in to facilitate reporting by developing solutions like the creation of XBRL taxonomy, and Enterprise Resource Management Systems that assist with the collection of data. “Companies can choose whether or not to manage sustainability data at present, but they can't choose whether or not it is an issue – these types of investment will prove to be worthwhile,” he says.
Retaining high quality assurance
And what is the role of assurance in all this, and are the right skills in place amongst the profession? “I think that as the sustainability reporting space has moved from telling the story of the good things that a company is doing, to speaking more directly to the capital markets around the material issues that are risks or opportunities for a company, it has become increasingly important to speak with confidence around the quality of what it is you're disclosing,” responds Hales. “If you get the numbers wrong, it's not so clear what the risks or consequences of that might be. From a reputational standpoint – if you’re talking to a major institutional investor – it's increasingly important to have high quality disclosure. And that means putting into place good controls, thinking about the assertions you're making, and whether they are in line with a particular framework.”
Although Hales reckons there’s increasing market need for third party assurance, he concedes that it is not clear yet what the market is willing to pay. “But there is a new potential market for assurance services,” he says. “The skills needed are the existing professional practices that are required to do good assurance in general: understanding the role of independence, scoping out of an engagement, thinking about appropriate criteria to be used for benchmarking, and so on.”
And there is a wealth of information located outside corporate reporting upon which investors increasingly rely. “We've seen a huge increase in alternative data—whether it's satellite imagery of who's shopping where, scraping social media, or employee opinions on websites such as Glassdoor. There may be opportunities for companies to take control of some of these issues by engaging with their employees and communicating with them about how they're managing their human capital in a way that is more reliable than these alternative data sources,” he says.
But Hales has never been more optimistic about the prospects of high-quality sustainability disclosure to the capital markets. “I don't think there's a capital market solution to every issue that we face as a society. Governments do need to step in. But I've never been more optimistic about the role that capital markets can play.”
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