The COVID-19 pandemic has its origins in nature, and through poor biosecurity, it made its way into the human population. Everyone has been impacted to some degree, but how many have considered the pandemic an issue of sustainable development and, perhaps, only the tip of an iceberg?
Sustainability is sometimes seen as a cost, but this is not the case. A report by the Business & Sustainable Development Commission estimates that at least $12 trillion in business opportunities would come with the realisation of the United Nations’ Sustainable Development Goals (UN SDGs) by 2030. So, it is not hard to understand why many companies are setting ambitious strategies and targets to reap the benefits. Examples include PepsiCo pledging net-zero emissions by 2040, Stora Enso issuing a €500 million green bond, and Unilever building its successful strategy around making sustainable living commonplace. Companies are increasingly shifting towards more sustainable strategies and stakeholder capitalism by moving away from short-term shareholder primacy.
Financial and accounting systems influence decision-making, the assessment of corporate performance, and the value attributed to it. Therefore, financial and accounting systems play an important role in helping management and others evaluate a company’s ability to identify and manage ESG risks and create sustainable value over time.
As accountants, we are expert in financial capital, management information, and accounting standards. But I would strongly argue that the stocks and flows, impacts and dependencies of other forms of capital are equally – if not even more – important in the 21st century to understanding value creation.
I argue that we are not accounting for sustainability, value, equity and ultimately, survival. Sure, we might be compliant with the letter of the existing rules as professionals, but we have a duty to act in the public interest, and I feel that today, we are failing in this fundamental duty.
With that in mind, what can we do in our day-to-day lives to fulfil our professional duties?
Keep abreast of the ever-changing landscape
2020 marked the five-year anniversary of the Paris Agreement and UN SDGs and the three-year anniversary of the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). These are fuelling many governments to set out expectations for companies to adopt accounting, financial and reporting approaches designed to support the transition to a more sustainable future. For example, the EU’s non-financial reporting directive (NFRD) update is planned to be adopted by the European Commission in Q1 2021. In a significant move, Canada, New Zealand and the UK are looking to make climate disclosure mandatory for large companies and financial institutions.
Work is also underway to harmonise the so-called non-financial reporting landscape: the big voluntary standard makers announced their intention to work together; the World Economic Forum launched streamlined ESG indicators; and the IFRS Foundation and IOSCO expressed strong interest in taking a role in sustainability. Chartered Accountants must stay ahead of the curve to ensure that compliance does not create a burden, but unlocks insights into the company’s ability to create value for all stakeholders.
Identifying risks, opportunities, and strategies
Companies need to understand and manage ESG-related risks. As well as maximising the potential for $12 trillion in business opportunities, we have seen companies issue profit warnings and file for bankruptcy due to ESG-related events. BASF issued profit warnings due to low water levels in the Rhine river, which affected transportation and production in 2018 impacting Solvay, Shell and many other companies as well. Said to be the first known climate change bankruptcy, PG&E filed for bankruptcy in 2019 following California’s drought and forest fires.
However, 44% of companies show some alignment between what they say is material in their sustainability report and what they disclose in their legal risk filings. In practice, this means relevant risks are not being properly disclosed or considered in strategic decision-making. As trusted advisors, Chartered Accountants must provide decision-useful information for both management and investors to make the right resource and financial allocations.
Focusing on materiality
The misalignment in reporting mentioned above is just one indication of the dilemmas companies and others face in determining which ESG matters represent sufficiently serious impacts and dependencies, and over which timescales, to threaten corporate performance.
The concept of materiality is developing. The EU has introduced its double-materiality that takes account of the significance of ESG issues affecting the company’s development, performance and position (sometimes known as “outside-in” materiality) and the significance of the impact of the company’s activities on the environment and society (sometimes known as “inside-out” materiality). We are in a crucial position to ensure that both types of material information get captured, managed, and demonstrated to our key stakeholders.
Providing robust information
The number of signatories to the UN Principles for Responsible Investment (PRI) grew to over 3,000 globally in 2020. Strengthening the investment case, several studies have shown no negative impact of including ESG considerations in the investment selection criteria. Furthermore, companies are likely to generate better returns when they manage ESG issues well. With these trends, we must ensure that the ESG information produced is of high-level, decision-useful quality for internal and external decision-making and that our companies can profit from a lower cost of capital due to more robust management of risks like ESG.
Accounting for ESG matters is not a rejection of traditional accounting. It builds on concepts such as accounting for externalities, which have been in circulation for a century. Many studies in the public domain criticise accounting (at a corporate and national level) for mismeasurement, using deficient metrics that ignore ecological and social depreciation and amortisation. However, the IASB has made it clear that we have existing tools in our armoury of standards to account for ESG risks.
This is a new chapter for Chartered Accountants. We need to embrace the ESG agenda, skill ourselves sufficiently to be competent and honour our profession’s call to act in the public interest. We can be architects of the future, building on our heritage and developing a new accounting language so that new knowledge will emerge to secure both reward and survival. We should, and we must, enhance and share our unique and important skills to help decision-makers understand and act on this new reality.
Ensuring sustainability information is decision-useful: new guidance coming on assurance
Investors are increasingly looking for third-party assurance of sustainability information. The problem is that, unlike auditing financial statements, the market for sustainability assurance is unregulated and practice is inconsistent – even though standards do exist. To strengthen practice, the International Auditing and Assurance Standards Board (IAASB) is developing guidance to assist practitioners with the critical challenges in assuring sustainability information. A primary focus is on report users’ needs to ensure that they can use the information with confidence. The IAASB expects to issue its final guidance in March after an extensive consultation process. Once launched, the guidance will be promoted through the global network of over 170 professional accounting bodies, which are required through the International Federation of Accountants’ membership criteria to follow international standards.
The World Business Council on Sustainable Development (WBCSD) has been instrumental in driving greater credibility in sustainability through its assurance project. In addition to working with the IAASB, WBCSD has produced the freely available Buyers’ Guide to help companies procuring external assurance, guidance on internal controls over sustainability information, and a study of investors’ needs when reviewing sustainability assurance. These tools aim to help practitioners, companies and investors have greater confidence in sustainability reporting so that the information, regardless of what report it appears in, can be relied upon for decision-making.
This article was originally published by Chartered Accountants Ireland in Accountancy IRELAND magazine Volume 53.