Beyond the Bottom Line

It’s a cliché to say that companies are obsessed with the ‘bottom line’, which is a polite way of saying they are entirely driven by maximizing profit. In fact, this has never been true. Even companies that don’t have an explicitly social purpose frequently have a commitment to providing high quality products and services, or solving real problems faced by everyday people.

But how can we be sure how well companies are performing on the issues that we care about as citizens? Most of the legal duties on companies relate to them providing returns to shareholders and reporting their financial situation in an honest way. Part of the impetus to develop sustainable finance arose from investors, regulators and citizens expecting more from companies and demanding to know about how their money is made and spent, rather than just how much of it there is.

To provide information that was reliable and comparable between companies is quite a challenge and was originally called ‘non-financial reporting’ but is more often now called ‘sustainability reporting’. The UK’s business department defines it as follows: ‘Non-financial reporting refers to reporting on any matters relating to activities of a business that are beyond the financial transactions and financial standing of a business.’ While there are accounting standards for financial reporting there are, as yet, no internationally accepted standards for non-financial reporting; the EU is leading the way in seeking to establish these.

The EU launched its Non-Financial Reporting Directive NFRD in 2018, for the first time imposing obligations on large European companies to disclose information on their sustainability risks and impacts. While this was an important first step, the Directive has been criticized for lack of stringency around the quality and relevance of information required. The EU Commission has itself accepted that the way information was reported under the Directive was not easily comparable from company to company, missed out some vital elements, and was not widely trusted as reliable. The EU is now revising this Directive and renaming it as the Corporate Sustainability Reporting Directive.

As somebody who used to work on legislation myself, I tend to focus on that, but the first moves to establish non-financial reporting standards came from the private sector – and in the area of climate. Nick Robins, formerly head of the UNEP work on sustainable finance and a co-founder of Carbon Tracker, identified three types of initiative:

• Disclosure, i.e. the provision of information to investors beginning with carbon disclosure but moving on to disclosure of Environmental, Social, and Governance impacts of the firm’s investments. • Responsibility, beginning with voluntary Principles for Responsible Investment, reporting these as part of annual accounts and using them to influence investment decisions. • Climate Change, including a particular focus on climate-positive investments and lobbying governments and policy-makers to introduce policies to reduce climate risks.

The highest profile initiative in this space is the Taskforce on Climate-related Financial Disclosures. In 2017 it reported that the risks to the value of assets from climate change has been underestimated and that this threatens the stability of financial markets:

The reduction in greenhouse gas emissions implies movement away from fossil fuel energy and related physical assets. This coupled with rapidly declining costs and increased deployment of clean and energy-efficient technologies could have significant, near-term financial implications for organizations dependent on extracting, producing, and using coal, oil, and natural gas.

The report quotes a previous study that estimates this risk as ranging from $4.2 trillion to $43 trillion between 2015 and the end of the century. The 32 members of the Taskforce were drawn from across the world and represent the relevant industry sectors: banks, insurance companies and pensions funds, assets managers, accountants, credit-rating agencies and including non-financial companies.

The role of the Taskforce was to develop consistent standards for financial-market players to use in report climate-related risks. The Taskforce’s recommendations apply to financial-sector organizations, including banks, insurance companies, asset managers, and asset owners. They boil down to three essential points:

• Carbon-related risks should be reported in mainstream financial filings, since they constitute a material risk to company valuation. • They should be reported according to four elements, building outwards: metrics and targets; risk management; strategy; and governance. • Such disclosures should take into account a range of future climate scenarios including a 2° Celsius climate warming or lower scenario.

There are a number of key players in this field.

The Global Reporting Initiative, based in the Netherlands, is an independent organisation launched in 1997 that launched its voluntary reporting standards in 2000. They have been regularly updated since then. They provide a framework for companies to report their impact in terms of climate, environmental and social impacts.

It is the job of accountants to make these reports so you would expect their professional body to take a role. International Financial Reporting Standards (IFRS) is a not-for-profit organization that was established to develop a globally accepted set of accounting standards and is now extending its activity in the area of sustainability. In April 2021 the IFRS made moves towards establishing an International Sustainability Standards Board as a first step to develop accounting standards explicitly relating to sustainability.

With the increased focus on sustainability reporting we are also seeing changes in the voluntary bodies that have developed the idea of non-financial reporting, alongside the mainstream accounting bodies making moves in this direction. The International Integrated Reporting Council (IIRC) and Sustainability Accounting Standards Board (SASB) have merged into the Value Reporting Foundation. They are working with three other organisations that have pioneered ESG reporting — the Carbon Disclosure Project, the Climate Disclosure Standards Board, and the Global Reporting Initiative (GRI), to become the Group of Five. Their intention is to produce a disclosure standard focused specifically on climate risks: this ‘sustainability-related financial disclosure standards would enable disclosure of how sustainability matters create or erode enterprise value’.

Since this section has mostly been about how companies explain the social and environmental impacts of their activities let’s just remind ourselves what this has to do with sustainable finance. You need to know what banks, pension funds and other investors are doing with your money. Reporting is a way of them letting you know this clearly – and in a way that allows you to compare with other companies you might choose to have your money with instead.

And this is just the start. We can imagine a future where, before you buy a winter coat or an electric bike, you can check the ESG label to see how the product scores in terms of the treatment of the people who made it or the amount of energy used or pollution emitted. As you now check your washing machine for an energy-efficiency market you can have access to summarized but reliable ESG data about everything in your life. But this will only work if the information is scientifically measured and honestly reported and that relies political commitment and requires that our politicians resist the lobbying of those who will seek loopholes and opportunities to water down this vital regulation.