Mei Ashelford and Ian Roe explain what UK companies can do to ensure that they provide stakeholders with a compelling picture of value creation.
Sustainability, ESG and broader non-financial reporting are now mainstream components of corporate reporting, but the link to value creation is not always clearly articulated. Information quality often lags behind financial reporting, and differences in metrics and scope make it difficult for investors and other stakeholders to assess and compare how businesses are performing and progressing against their sustainability ambitions and targets. This article looks at what companies can do to improve how they report and provide a more complete, clear and compelling picture of value creation.
From voluntary to mandatory disclosures
To date, the bulk of sustainability and ESG disclosure has been made voluntarily, often in alignment with voluntary frameworks such as those issued by the Global Reporting Initiative (GRI) and Sustainability Accounting Standards Board (SASB). This has served businesses and stakeholders well, providing a broad framework within which businesses can disclose what is most material to them. However, as incidents of green- and social-washing continue to raise concerns, key jurisdictions around the world are seeking greater regulatory oversight.
Largely building from the foundations of these voluntary frameworks, sustainability and ESG reporting regulation is evolving rapidly. The EU’s Corporate Sustainability Reporting Directive (CSRD) came into force at the beginning of the year and the International Sustainability Standards Board (ISSB) has recently published its first two IFRS Sustainability Disclosure Standards. Closer to home, climate-related financial disclosures are now mandatory, not only for all main market-listed companies through the FCA’s Listing Rules but also larger privately-owned businesses through the Companies Act. It is crucial for companies to be robust and cautious in their preparations, ensuring that their reporting practices do not inadvertently harm their reputations and brand value.
A potential game-changer
A possible catalyst for change lies in the FRC’s proposed update to the UK Corporate Governance Code. Due to be finalised by the end of the year, the proposed amendments are intended to implement the government’s ongoing audit and governance reform package, which at first glance may not appear to be directly related to sustainability reporting. However, these changes could influence how companies approach and report on their sustainability ambitions, targets and progress going forward.
If the proposals go through as drafted, the UK regulatory framework would, for the first time, include explicit requirements for:
- the board to describe in the annual report how environmental and social matters are considered in the delivery of its strategy, including its climate ambitions and transition planning;
- the audit committee to monitor the integrity of narrative reporting, including sustainability matters; and
- remuneration outcomes to be clearly aligned to performance, purpose and values, and the successful delivery of the company’s long-term strategy including environmental, social and governance objectives.
This explicit connection between good corporate governance practices and the significance of sustainability-related matters has the potential to be a game-changer, compelling boards to evaluate their integration of environmental and social matters into long-term strategic progress and remuneration outcomes, as well as the integrity of their reporting and communications.
Telling an integrated story in the annual report
When it comes to the annual report, sustainability disclosures should go beyond mere compliance. While there are mandatory elements, they should be interconnected to tell a coherent story about the business, its performance during the year, and its future prospects of creating value. If boards embrace the draft amendments to the Corporate Governance Code in their day-to-day governance and business activities, weaving sustainability information into the annual report will become intuitive and may manifest in the following ways:
- leadership statements giving more emphasis to sustainability matters as they rise up the business agenda;
- setting a broader market context by capturing how wider economic and social trends impact key stakeholders, thus providing the context for the rest of the annual report’s content;
- including sustainability in strategic priorities and metrics, linking them to remuneration outcomes;
- progress against clearly stated sustainability and ESG priorities and targets will be integral to strategic success, resulting in the convergence of sustainability strategies with broader corporate strategies, and the reporting of non-financial and financial metrics together;
- explaining the consideration of environmental and social matters in everyday operations as part of the business model’s evolution; and
- adopting a more integrated approach to governance reporting, reconsidering the traditional separation of strategic and governance reports to present a more integrated, strategic and governance-driven narrative.
Addressing the challenges of a transatlantic investor base
For companies with global investor bases, an additional complication is the increasing politicisation of ESG and sustainability in the US. For many years, most major jurisdictions globally were trending towards more ESG – ie, increasingly broad sets of activity, analysis and disclosure and an increasingly deep integration in mainstream decision-making. However, over the past few years, the US has seen a divergence between the two major political parties. While the Biden administration and many Democrats are supportive of ESG principles, many Republicans actively oppose the movement with at least seven Republican state governments (including Florida, Kansas, Texas and West Virginia) enacting anti-ESG laws in the past two years.
Focusing on value creation and material issues is good practice for all businesses – rather than being an end in itself, ESG is a means to drive sustainable long-term value for stakeholders. Ensuring that connection is clear is especially important for those with a US investor base.
Communicating, rather than simply disclosing
The content in the annual report remains the most trusted source of corporate information. However, in many cases it is presented as a static PDF download on the corporate website. Companies have the opportunity to unlock the value of this content by repurposing narratives, infographics and data to engage with employees, customers, suppliers and partners through various media and channels.
With digital and social media platforms, adopting a campaign mindset that serves the right information to the right audiences at the right time through the appropriate channels not only improves communication strategies but is also a cost-effective way to get more out of the annual report. This approach not only helps create interest but also serves to motivate and connect with stakeholders on a deeper level. By leveraging different media and channels, companies can maximise the reach and impact of their sustainability reporting, fostering stronger connections with their audiences.
Mei Ashelford, Director, Brunswick, and Ian Roe, Partner, Brunswick