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In the latest installment of the Salzburg Questions for Corporate Governance, David Simmonds and Michael Ling discuss how directors can ensure an organization can meet rising expectations regarding ESG reporting
This article is part of the Salzburg Questions for Corporate Governance series by the Salzburg Global Corporate Governance Forum
The ESG reporting landscape has become increasingly complex over recent years. Investors are stepping up their demands for organizations to report on a wide-ranging set of ESG issues, from climate change to human rights-related matters.
This article is not intended to examine the different ESG reporting requirements but will discuss how directors can ensure an organization can meet rising expectations regarding ESG reporting while ensuring substance rather than “spin.”
Turning first to the legal requirements, although technical legal tests will differ between jurisdictions, a common requirement is that disclosures should be “true, accurate and not misleading.” This is a fundamental requirement that directors should keep squarely in mind in reviewing an organization’s ESG reporting, just as for financial reporting.
ESG related claims against organizations are becoming more common, largely driven by investors’ increasing reliance on ESG disclosures. This has been a significant shift from the earlier days where ESG disclosures were once made for engagement purposes. With this important change, organizations must apply a higher degree of care, diligence, and supervision in the ESG disclosures preparation.
One of the key challenges with ESG reporting is the plethora of reporting standards and the suite of ESG reporting data demanded by different stakeholders. However, ultimately, an organization should focus its reporting on those ESG issues material to the organization.
A structured materiality assessment exercise to ascertain what is most important to the organization’s stakeholders is a sensible starting point in this regard. This exercise must have senior management ownership and involvement, and directors should satisfy themselves that a robust process has been followed with the right questions answered.
Looking at the nature of the ESG information, there are two broad sets, one regarding “historical” data or backward-looking data, and needless to say, these would need to be true, accurate, and complete. The other set relates to the “forward-looking” information, such as targets, scenario analyses, and forecasts of the associated business impacts.
In terms of the underlying accuracy and verification of the ESG information and statements, directors should look to management to demonstrate they have undertaken a robust process in compiling these. Where appropriate, a third-party assurance process will also be undertaken regarding the ESG data and information. However, it is the forward-looking information the board should pay particular attention to, ensuring there is substance rather than “spin” and a reasonable basis for the targets set and the statements made.
Directors, particularly independent directors, are well placed to scrutinize these ESG forward-looking statements to ensure these are presented with substance in a well-considered and balanced manner. Whilst the targets, objectives, and aspirational positions are obvious headline messages, the ESG risks and uncertainties and the impact of any external factors are equally important.
Management may be motivated to report on the former as that is perceived as “good news;” however, organizations should be vigilant that the latter (which in certain circumstances may not be viewed as “positive messages”) needs to be appropriately managed and disclosed. Accordingly, directors should ask how the organization identifies the principal ESG risks and uncertainties, what they are, the level of risk or opportunity, and how these are being managed in today’s fast-changing environment.
With the increasing focus on ESG issues and the significance of these issues to the long term success of a business, it is more important than ever that ESG reporting is an accurate reflection of the corporate strategy and a meaningful description of the company’s plans, progress, achievements and shortcomings in this area.
The area where directors can add the most value and influence to support this objective is to ensure the material ESG issues are integrated into corporate strategy development and appropriately addressed as part of strategy implementation.
Whilst reporting is often prepared and submitted for the directors’ review and consideration as part of the year-end process (and targets often set and reviewed even less frequently), by integrating ESG into strategy, the foundation is laid for appropriate management focus and more regular and substantive review of these issues right throughout the year. This is the most effective way to ensure the company’s ESG reporting and target setting is consistent and coherent with the corporate strategy and that substance trumps “spin.”