The ‘M’ word: No, not materiality


The ‘M’ word: No, not materiality Ethical BoardroomBy Tracey Rembert, Ceres’ Investor Initiative for Sustainable Exchanges



Readers of Ethical Boardroom have seen plenty of references to the growing demand from investors for environmental, social and governance (ESG) information from companies.

While debate has often swirled around ‘stakeholder versus shareholder’ or ‘materiality versus decision-useful’ terminology, few have been brave enough to use the M word – mandatory. But, for good reason, that is clearly where we are headed and 2016 will likely be an interesting if bumpy ride for companies, investors, regulators, stock exchanges and sustainability experts as the dust settles around core questions for such disclosure requirements, namely:

■ How would mandatory ESG information meet the needs of a diverse set of investors?

■ Will 2016 be the year when climate change reporting and the drive to make it mandatory reaches a tipping point?

■ Will efforts to press global stock exchanges to produce ESG guidance and listing rules yield success, especially among the largest exchanges?

■ Will board directors and company executives continue to sit on the sidelines as these issues move forward?

■ If the European Union’s directive on non-financial reporting, going into effect in 2017, lets each country implement it in the way it sees fit, how do we get consistent, comparable reporting from that effort?

Let me start by saying that my non-profit sustainability group Ceres knows well the value of voluntary reporting initiatives. Ceres was formed in the wake of the Exxon Valdez oil spill, with a coalition of investors and environmentalists asking companies to report against a 10-point code of environmental conduct. In the late 1990s, we co-launched the Global Reporting Initiative with the Tellus Institute. During the last 15 years, we have released a number of frameworks for disclosure of climate and water risks – all voluntary exercises by companies. But we have also noticed that as the number of voluntary sustainability reporting frameworks has proliferated, the number of companies reporting on sustainability information seems to have flat-lined overall.

Yet, when regulations or stock exchange listing rules are introduced, the number of corporate reporters climbs dramatically in a relatively quick period of time (as you would expect it to). KMPG found in its Currents of Change 2015 sustainability reporting trends survey that the eight countries with sustainability reporting rates above 90 per cent also had mandatory reporting requirements to get them there. It concluded that it is very unlikely that countries will see rates of reporting that high unless it is mandated by legislation.

Corporate Knights, the Canadian-based sustainability research firm, reached similar conclusions in its 2015 benchmarking report of global stock exchanges, which assessed how the exchanges’ listed companies were reporting on seven ‘first generation’ ESG indicators. It found that every one of the 10 top-ranked exchanges in its report were in countries with mandatory sustainability disclosure policies – either by stock exchange listing rules or government regulation.

We would surely have not gotten to this point – the possibility that there could be widespread mandatory regimes for sustainability disclosure – without three key factors. First is the increasing global demand by investors for inclusion of sustainability data in company reports. There are now nearly 1,500 signatories to the United Nations-supported Principles for Responsible Investment, representing more than $59trillion assets under management. There are also 822 investors, with an impressive $95trillion in assets, advocating for corporate climate reporting on CDP surveys. And this strong investor demand shows no signs of abating.

Second, there has been a relentless increase in environmental and social risks and overall uncertainties facing companies – from escalating climate and severe weather impacts to water risks to food system disruption to human trafficking. The level of shareholder engagement with companies on these issues has skyrocketed – especially by major investors with more than $100billion in assets, through shareholder resolutions, dialogues and joint initiatives.

Third, the very proliferation and success of voluntary initiatives has played a significant role in getting companies to report where they already are on sustainability matters and these frameworks, through their competition with each other, continue to drive continuous improvements in the reporting process that companies benefit from (even as they rightly complain about reporting fatigue).

Investors increasingly using the ‘M’ word

Since 2014, a number of investors have stepped up their calls for mandatory reporting of sustainability information, including BlackRock, Aviva and the New York State Common Retirement Fund, largely because of concerns around a long-time lack of consistent, comparable and high quality information coming from the companies
that they own.

In a column last June, Corporate Knights’ CEO Tony A. A. Heaps summed up the argument this way: “Whether carbon emissions or earnings numbers, timely, comparable and reliable data does not
grow on trees; it is the result of precise regulatory requirements.” He went on to add that voluntary reporting initiatives have served their purpose, but it was now time for regulators to step in and finish the job, especially when it comes to climate risk disclosure.

BlackRock, the world’s largest asset manager, echoes that sentiment. A recent op-ed by its global head of governance and responsible investment, Michelle Edkins, was entitled Exchanges Worldwide Should Require Companies to Report Uniformly on Sustainability. It noted the increasing demand from clients to assess and integrate ESG information into the investment process and the dearth of comparable ESG information in the marketplace to do so. Stock exchanges, by driving consistent listing rules on ESG reporting, might solve that problem, BlackRock concluded.

KPMG’s 2015 survey on sustainability reporting trends is indeed sobering and supports the view that voluntary schemes have their limits. Its survey of major companies found that:

■ Just months ahead of the global climate talks last December in Paris, one in five large companies in high carbon sectors were still not reporting on their carbon emissions

■ There is a great lack of consistency on ESG reporting around the world

■ The quality of sustainability reporting slightly improved in Asia Pacific, but declined elsewhere

■ And the main driver for ESG reporting continues to be legislative

Risk, risk everywhere

So what is the best path to higher rates of reporting? Is it government regulation? Stock exchange rules? Increasing investor demand for more consistent data? It seems it has to be all of the above, working in tandem to drive that needed level of consistency.

Ceres has been a long-time advocate for playing the regulatory card when needed, including its successful push with investors for mandatory climate risk reporting from the US Securities and Exchange Commission (SEC). The SEC issued formal guidance in 2010 on what companies should report.

We have been leading a coalition of investors advocating for mandatory listing rules from stock exchanges since 2011 and worked with many exchanges to drive cooperation in that community to bring investors greater consistency of rules and guidance. And we work with reporting framework organisations to continue to raise the bar on voluntary reporting guidelines. So, yes, in our experience, all paths are clearly needed to get the reporting job done and all parties need to be sharing insights with each other, which is currently not the case.

But we are in a critical window this year where ESG risks are becoming looming financial concerns and clearly something needs to happen to break open the floodgates of reporting. It is not uncommon now for investors and some central bankers to use the term ‘systemic risk’ when referring to issues like climate change. The World Economic Forum, in its 2016 global risk assessment, noted that the top five risks over the next 10 years were all ESG-related, including:

■ Water crises

■ Failure of climate change mitigation and adaptation

■ Extreme weather events

■ Food crises

■ Social instability

“Debate has often swirled around ‘stakeholder versus shareholder’ or ‘materiality versus decision-useful’ terminology, few have been brave enough to use the M word – mandatory”

It is not simply a matter of whether ESG information coming from companies is useful in understanding risk and opportunity. It is the broader fact that the information investors get is not consistent, varies in quality and is oftentimes sporadic, not verified and not comparable from company to company in the same industry or otherwise. Quite simply, we need regulators and exchanges to solve some of these challenges and create a ‘floor’ for reporting and mandatory disclosure is the tool most likely to accomplish this.

Investors took note of this when the Financial Stability Board unveiled the first phase in its plans for a Task Force on Climate-related Financial Disclosures (TCFD) at the start of April 2016 – developing guidance on voluntary, climate-related financial risk disclosures for companies to provide information to investors, lenders, insurers and other stakeholders.

Disclosures would show how a company is exposed to climate risk, such as from potential physical threats like floods, or liability risks, such as if an asset manager has large holdings in fossil fuel companies that would be hit
by curbs on greenhouse gas emissions.

When the initiative was announced last year, investors were fearful that another voluntary regime, without the backing of securities regulators, governments or stock exchanges, will fall short in bringing us to a tipping point of needed climate disclosure by all companies.

The planned regime will be voluntary, but it is hoped the task force will encourage more companies to improve through a rigorous framework for disclosing risks and opportunities in financial filings.

Is 2016 the year of mandatory climate reporting?

Recent investor and regulatory activity shows that this year could be the one that puts us clearly on the path of mandated climate disclosures.

Shareholder resolutions on climate reporting and strategy are growing bolder, as are company responses to them. The G20 is paying attention. Recent ESG-related listing rules from stock exchanges clearly address climate and emissions reporting. And 6,000 European companies can expect after December to have to report on a slate of environmental impacts, performance indicators and risks, once the directive on Disclosure of Non-Financial and Diversity Information (Directive 2014/95/EU) is rolled out across EU Member States. Investors expect the directive to have significant short-term influence on other companies on these issues.

You also have the World Federation of Exchanges issuing ESG Guidance for its 68 member exchanges last November. That guidance included a half dozen climate-related indicators for companies to report on, including Scope 1 and 2 emissions and 33 indicators in total on environmental and social matters.

A 2016 report by the Climate Disclosure Standards Board (CDSB), done in partnership with the OECD, noted that the recent Paris climate accord (forged by 196 countries), added to escalating climate risks, has led to the increasing introduction of mandatory corporate reporting schemes across the world.

Their findings indicate that, while there is “no universally agreed definition of corporate climate change-related information” and, therefore, a great need for harmonisation of climate reporting, 15 of the G20 countries now have mandatory reporting schemes for climate change disclosures and nine schemes encourage reporting of information other than emissions data, such as risks and strategies. Hopefully, the industry-led FSB Task Force will figure the harmonisation piece out. Stock exchanges and regulators will then be critical to making all of this data comparable and accessible in (mandatory) corporate reports. As CDSB’s founding director Lois Guthrie puts it: “If climate change is a mainstream risk to financial stability, then it should be reported through mainstream filings just like equivalent risks.” Well said.

Companies need to step up and help shape reporting standards

As someone that has assisted investors to engage with stock exchanges for the past five years and with companies for more than a decade, a question I often ask here is, “Where are companies in this debate and what are their views?” Behind the scenes, we hear from large institutional investors that companies would welcome having mandatory reporting regimes, but they don’t want to stick their necks out and ask for it.

This has to change. Many are schooled to oppose all regulations outright. Many are even nervous pushing back on investors, ESG raters and data providers with their own views of what is important to report, or where ESG reporting should be headed. In the absence of corporate leadership, the train has left the station without them. It is critical that regulators and stock exchanges spend more time bringing investors and companies together to solicit their views so that mandatory reporting can work for all of us. Companies can be a mighty source of support to get things done on ESG disclosure when they want to be. But they need to speak up to do so.

In the meantime, the train is heading to Mandatory-ville – with or without certain passengers. No doubt, sustainability disclosure will be a key foundation of the 21st century economy. If green finance, climate solutions and a more stable, sustainable economy are to be achieved, robust, comprehensive, mandatory ESG disclosure will be critical.

About the Author:

Tracey Rembert oversees Ceres’ Investor Initiative for Sustainable Exchanges, where she leads a coalition of investors focused on engagement with stock exchanges to improve ESG reporting across the markets. She also serves as Director of Investor Programs at Ceres, working closely with institutional investors to improve their investment practices on climate and sustainability issues, and to help investors better promote ESG practices at global corporations through shareholder engagement, regulatory advocacy and strategic joint initiatives. She has a 16-year career in corporate governance and responsible investment.