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The Ingredients for Good Non-Financial Reporting

Robert Herz | December 22, 2014

 

I assumed the role of chairman of the Financial Accounting Standards Board in 2002 at a moment in history when U.S. financial reporting was in the spotlight and being criticized. In responding to these challenges, I knew we needed to continue to enhance the standards development process, including expanding outreach activities to stakeholders.

Thus, it’s no surprise that I believe the same need for extensive stakeholder engagement exists in the realm of sustainability reporting—perhaps even more so, as it’s a relatively new field. That's one of the reasons I am joining the board of the Sustainability Accounting Standards Board, a non-profit working with companies, investors, and other stakeholders to develop a comprehensive set of industry-specific standards for reporting material sustainability information to the capital markets.

Information in financial statements has long been important to investor decision making. In today’s world, however, management of risks and opportunities not reflected in financial statements is also critical to corporate success and to the investment process. Beyond financial data, investors are now interested in issues such as how a company is prepared for challenges to its operations from resource constraints, the potential effects of climate change, and increasing demand resulting from population growth and emerging markets.

As investors increasingly recognize the financial effect of sustainability factors, their demand for this information is growing. A recent survey of institutional investors by EY, “Tomorrow’s investment rules: Global survey of institutional investors on non-financial performance,” found that during the prior 12 months, assessment of performance on environmental, social, and governance issues “had played a pivotal role in their investment decision-making process” for 90 percent of the responding investors.

The quality and accessibility of information that’s available can, however, be improved. Investors are engaging in unproductive and costly means to get the information they need: 89 percent of global institutional investors responding to another recent survey by PwC, “Sustainability goes mainstream: Insights into investor views,” say they will request sustainability information directly from the company, and 50 percent report they are “very likely” to sponsor or co-sponsor a shareholder proposal related to sustainability issues. Significantly, two-thirds of these investors say that they would be more likely to consider this type of information when making investment decisions if common standards were used.

The Sustainability Accounting Standards Board arose to fill the market need for standardized sustainability information. SASB standards are designed for the disclosure of sustainability information in the MD&A section of the Form 10-K. The standards help companies disclose material non-financial information in a cost effective, decision-useful way. Companies can voluntarily use SASB standards to help them comply with Regulation S-K’s requirement to provide management’s view on known trends and uncertainties that are reasonably likely to have a material effect on the financial condition or operating performance of the company.

What’s in It for Companies?

Using SASB standards to disclose material sustainability information in Securities and Exchange Commission filings offers various benefits to companies. First, doing so allows companies to provide the information investors are increasingly requesting. Because SASB standards are intended for use in SEC filings, they allow investors to access and assess sustainability fundamentals and financial fundamentals side-by-side. Furthermore, by standardizing sustainability disclosures, SASB standards can help reduce excessive or boilerplate disclosures and enable apples-to-apples comparisons among firms within an industry—the No. 1 need cited by institutional investors in another recent EY survey on Tomorrow’s Investment Rules.

Standards cannot be set in a vacuum. Companies that have a say in the standards development process will benefit when the provisional standards are issued and available for use.

Second, SASB standards are intended to be cost-effective for companies. SASB standards identify the minimum set of sustainability factors likely to be material for companies in an industry and provide a model for reporting on those factors in a decision-useful way for investors. SASB saves companies time and costs by: (a) performing evidence-based research and industry vetting to identify the likely material issues; and (b) identifying metrics that companies can use to disclose performance on these issues. SASB standards average five topics and 14 metrics (79 percent quantitative) per industry.

It’s important to note that companies are already disclosing material sustainability information. SASB research shows that 70 percent of SASB disclosure topics are already being addressed in companies’ 10-K filings—but of those disclosures, 37 percent are boilerplate information. The quality of disclosure can be improved; it’s not about more sustainability disclosure, it’s about more useful sustainability disclosure for investors.

Stakeholder Participation

Since its official launch two years ago, SASB has implemented a standard-setting process that welcomes and integrates input from corporate professionals, investors, and intermediaries such as accountants and lawyers. This includes balanced industry working groups, public comment on draft standards, and public comment on provisional standards issued by SASB.

Several factors are critical to the success of SASB’s industry working groups. First, providing research to the working groups is a starting point for the evaluation of issues, disclosure topics, and metrics, which helps achieve consensus on the issues likely to constitute material information for companies in an industry. Second, collecting feedback from industry group participants via online surveys reduces the likelihood of groupthink and allows SASB to host large working groups. Nevertheless, I believe SASB should consider further enhancements to the industry working group process, including, for example, holding in-person meetings to discuss key issues.

The groups consist of one-third corporate professionals, one-third investors, and one-third other stakeholders. SASB has completed working groups for eight sectors: healthcare, financials, technology & communication, non-renewable resources, transportation, services, resource transformation, and consumption. To date, more than 2,100 experts representing $9.8 trillion of market capital and $21.7 trillion in assets under management have participated in SASB’s working groups.

Two sectors remain open to working group participants: renewable resources & alternative energy, which will convene in February; and infrastructure, convening next May. Involvement includes committing four hours over a one-month period to read a background brief and complete a self-paced online survey. Participation is free of charge, is open to all with at least five years of experience in their designated industry, and does not imply endorsement of SASB by an employer.

In both financial accounting and non-financial reporting, creating robust standards necessitates proactive and extensive stakeholder engagement. Standards cannot be set in a vacuum. Companies that have a say in the standards development process will benefit when the provisional standards are issued and available for use.

To participate in SASB’s standards development process, join an industry working group and provide feedback on draft and provisional standards via SASB’s public comment portal. It provides companies with a real opportunity to participate in the evolution of corporate reporting.