by Diana Rose A. Sadili-Chu, Director in SGV Climate Change and Sustainability Services (CCaSS)

The sustainability and long-term value disconnect

Sustainability is now top of mind for many leaders because of evolving consumer trends, government regulations and the increasing commitments of companies worldwide to combat the impacts of climate change. Companies worldwide continue to invest more time, resources and leadership effort into sustainability, which should be prioritized to protect and better yet, create value now more than ever.

Leading companies embrace sustainability and environmental, social and governance (ESG) as an approach in financial and business decisions. This approach is vital to enable better and more informed decisions by investors, consumers, and the companies’ employees. However, despite both companies’ and investors’ sustainability considerations during decision-making, there is still a disconnect between the expectations and goals of companies and their investors when it comes to corporate and sustainability reporting, specifically ESG disclosures.

EY’s 2022 Climate Change and Sustainability Services (CCaSS) Sixth Global Institutional Investor Survey explored the future of corporate reporting. The survey solicited opinions from 1,040 senior finance leaders from companies issuing corporate reports, and 320 senior investors as users of disclosures. Based on the results, 80% of investors claim that companies often fail to articulate their rationale for long-term investments in sustainability, which makes these investments difficult for investors to evaluate.

According to the EY survey, 99% of surveyed investors use company ESG disclosures as part of their investment decision-making, as these disclosures provide them insights on how sustainability issues affect a company’s financial performance, risks, and long-term growth prospects. However, 73% of them also believe that companies fail to present a more comprehensive report that encompasses both financial and ESG disclosures. These challenges may potentially contribute to a trust deficit among investors, but there are ways to address this and close the stakeholder disconnect.

Meanwhile, ESG information is now becoming more consistent and harmonized as a result of consolidation and heightened regulatory reporting requirements. Globally accepted sustainability reporting standards are being applied to data collection and common measurement tools are being defined.

Bridging the gap

Effective corporate reporting is essential to fostering the alignment and understanding of sustainability expectations of long-term investors, and this includes strengthening the involvement of “F” financials in ESG disclosures: “FESG”. The concept of FESG recognizes the importance of connecting financial and non-financial information to shape strategy and allow interested parties to assess sustainability in terms of both financial performance and financial consequence. A data-driven and transparent sustainability report makes a company’s intentions clear, helping it earn the trust of its investors.

In response to the demand of organizations and investors to connect FESG, the International Financial Reporting Standards (IFRS) Foundation, through its International Sustainability Standards Board (ISSB), defined a global baseline of sustainability-related disclosure in its exposure drafts on sustainability standards published in March 2022. The ISSB also unanimously confirms Scope 3 GHG emissions disclosure requirements with strong application support, among key decisions, and the use of climate-related scenario analysis. The ISSB plans to issue the final Standards as early as possible in 2023.

In the Philippines, the Professional Regulatory Board of Accountancy issued Resolution No. 44, Series of 2022 on September 16, 2022 to adopt the IFRS Sustainability Disclosure Standards in the preparation of the general-purpose financial statements; and to rename the Financial Reporting Standards Council (FRSC) to Financial and Sustainability Reporting Standards Council (FSRSC). Under the FSRSC, the Philippine Sustainability Reporting Committee (or PSRC) was also established to issue implementation guidance on Philippine sustainability disclosure standards adopted by the FSRSC from sustainability disclosure pronouncements issued by the ISSB.

Memorandum Circular No. 11 series of 2022 issued by the Securities and Exchange Commission (SEC) on January 3, 2023 also aims to provide guidance for investment companies in making better-informed, sustainable and responsible investment decisions.

Moving forward

Corporate reporting within the ESG movement is at a critical moment. To realize the potential of ESG, companies need to prioritize the alignment of their ESG disclosures with investors and other stakeholders. As companies and investors gradually move forward in disclosing their ESG insights, it is also essential that the relevant opportunities and risks are discussed.

For greater accountability and moving beyond ESG pledges and into actions and results, there is a need to prioritize continuous engagement between investors and company leaders on sustainability progress and goals.

To satisfy the rising demand for global reporting standards of stakeholders and to ensure scrutiny of sustainability disclosures, there should be an advancement in emerging global reporting standards and improvement in the quality of ESG data by having the right data experts equipped to handle current and emerging reporting requirements.

The EY research also suggests that companies should build a better understanding of the sustainability expectations of long-term investors and earn their trust by defining the involvement of the finance function in ESG disclosures. Companies must rethink the involvement of finance leaders, as finance leaders’ demonstrating visible leadership on sustainability and ESG reporting are vital in building confidence in sustainability.

Lastly, it is critical for organizations to recognize and adhere to the risk management concept known as the “three lines of defense,” which are significant for organizations aiming to build

trust and maintain a rigorous reporting system. Thus, it is necessary for organizations to have corporate governance, including a strong system of internal controls with roles for management, board, audit committee and internal audit and accountability for stakeholders to have organizational oversight. In addition, stakeholders and consumers will demand more robust, independent external assurance over sustainability information in the coming years.

Realizing the full potential of ESG reporting has substantial opportunities and rewards, as well as potential benefits for all stakeholders. However, implementing these changes will take time while the external landscape will continue to evolve. Businesses, investors and leaders should act now to build the necessary expertise across their organization.

References:

How can corporate reporting bridge the ESG trust gap? EY Sustainability - value proposition and narrative
How to realize the full potential of ESG-plus | EY - Global Five priorities to build trust in ESG | EY - Global