Connecting the dots of financial value creation

Is your business ESG assurance-ready?

KPMG has created an ESG Assurance Maturity Index to assist companies in understanding what they need to do to be ready for the external assurance of their ESG and sustainability data and reporting. In the process, they assessed 750 companies for ESG assurance preparedness, finding that while most companies already do produce sustainability reporting, only about one-quarter of them have “robust policies and procedures to support the development of their ESG disclosures” and “feel they have the ESG policies, skills, and systems in place to be ready for ESG assurance”. This is a must-read document for anyone interested in the topic of external assurance of ESG data and disclosures. To be clear, external assurance is required to improve the reliability of sustainability disclosures – much like financial disclosures – so it’s not just about reporting, and not just any data, but about reporting quality information that is decision-useful because it is reliable. This is why external assurance is becoming mandatory in many jurisdictions, including the European Union (under the CSRD) and the US. The report identifies five key steps companies should take to be ready for the external assurance of their sustainability disclosures:

1. Determine applicable ESG reporting standards
2. Build robust ESG governance and develop right skills
3. Identify the applicable ESG disclosures and data requirements across functions
4. Digitize ESG data processes and ensure high quality data
5. Work with the value chain to collect ESG information

Sounds simple enough. But the devil will be in the details. Each of these steps takes commitment, resources, and time. And where it’s being mandated, there is pushback. Because it will be hard. In fact, in a recent webinar about the International Auditing and Assurance Standards Board (IAASB) draft International Standard on Sustainability Assurance 5000 (the final version of which is due to be released in 2024), the IAASB Chair suggested we collectively get comfortable with companies receiving qualified opinions on their sustainability disclosures, because it will take time for them to implement the processes and mechanisms to ascertain the quality of their ESG data and reporting. Good to know.

The Good Lobby Tracker Report??

The Good Lobby is an organization that seeks to enhance the advocacy capacity of civil society organisations and make corporate lobbying more accountable. One of its projects, the Good Lobby Tracker, has assessed the assessment criteria of virtually all major ratings providers, reporting standards and frameworks, and corporate political responsibility initiatives against a set of thirty best practices and expectations for a company’s political activities – its “political footprint”; a footprint that includes all corporate political activities, from corporate lobbying and political spending to other forms of corporate influence aimed at shaping public opinion and public policies in a way that advances a company’s interests. Their report finds that while major frameworks and initiatives encourage disclosure of information beyond legally mandated disclosures, they all fail to capture the full scope of corporate political activities. Interestingly, the UN PRI’s Investor Expectations on Corporate Climate Lobbying ranked highest. The authors attribute the low scores to narrow definitions of corporate political activities, poor recognition of those activities, a lack of focus on third-party associations and involvement, and a lack of recognition of positive lobbying. In other words, all existing frameworks do a poor job of covering all aspects of corporate political activities, so it’s best not to rely only what they prescribe. The authors recommend companies use the Tracker assessment categories and linked questionnaire to:

• inform the adoption of a best practice approach to reporting on all aspects of their political activities as an integrated part of corporate reporting, including assurance and verification;
• conduct an internal governance review of their political activities, to ensure alignment with stakeholder expectations, their strategy, and stated corporate purpose;
• de-risk their trade and industry association membership and re-assess support for third-party influencers by monitoring and addressing any misalignments;
• expand their positive impact on corporate political activities in their industry, by joining collective action initiatives and engaging with policymakers.

The eight corporate political activity assessment categories are shown below.

?Multi-stakeholder perspectives on connectivity - summary report

The European Financial Reporting Advisory Group (EFRAG) has released the summary of a recent symposium on the Connectivity between financial reporting and sustainability reporting information, held during the European Accounting Association’s annual congress. This is more of a meeting transcript, which makes it a little difficult to read (like mining for nuggets of insights). However, the fact that the topic is raised is itself of great interest, as the convergence and interconnection between financial and sustainability reporting continues to amplify. The paper identifies four categories of connectivity techniques consistent with the principles of connected information in the ESRS and IFRS S1 standards:

• reconciliations between information in the financial statements and sustainability disclosure;
• when direct reconciliation is not possible, descriptions of relationships between different pieces of information included in the financial statements and the sustainability disclosures (particularly when a direct reconciliation is not possible);
• cross-references between the financial report and the sustainability report or incorporation by reference of information included in the financial statements in the sustainability disclosures;
• consistency (or lack of) of the underpinning assumptions and scenarios applied in financial reporting and sustainability reporting and disclosures to illustrate such consistency.

To these we could also add the need for consistency between a company’s different reports, i.e., the same information from one report to another and from one year to the next, as well as having the same reporting boundaries, time horizons, and reporting periods for both sets of information.

When speaking about the connectivity of financial and sustainability reporting, one inevitably drifts into the topic of integrated reporting. The paper does propose a really good way to consider the distinction, where ‘connectivity’ does not touch the conceptual borders of financial and sustainability reporting and is more of a communication principle, and where ‘integration in reporting’ is about bringing financial and sustainability reporting together [as one narrative], connecting to the different capitals and defining the value for the shareholders and other stakeholders, therefore modifying the conceptual borders. The paper further notes that the focus of the IFRS Foundation is on general purpose financial reports, which include financial statements, sustainability-related financial disclosures, management commentary, and integrated reporting, and that the goal is to “bring these parts together so connected reporting would be achieved, but connected reporting does not mean that all the components of connected reporting would be in the same document.” In other words, connected reporting is when financial information and sustainability information are combined and cross- referenced but distinct, and can but does not have to be in one document, whereas integrated reporting is one document with one narrative seamlessly blending financial and sustainability information to the point where you might not be able to distinguish them. As we often hear, integrated reporting requires integrated thinking, and many companies are not there, yet.

Guiding the integration of sustainability in valuation: A framework for integration, research examples and reflections

Speaking of the interconnection between financials and sustainability, the World Business Council for Sustainable Development (WBCSD) has published a very interesting primer called Guiding the integration of sustainability in valuation: A framework for integration, research examples and reflections. This is essentially and layperson’s guide to fundamental analysis that explains where sustainability considerations can be integrated in the six steps of the valuation methodology represented in what it calls the Sustainability in Intrinsic Valuation (SiiV) framework (see image below). It complements WBCSD’s earlier financial factsheets for sustainability professionals. Both documents are excellent tools for corporate sustainability practitioners to understand how to speak to the financial value creation potential of proper sustainability initiatives, because this is quite literally the methodology for calculating a company’s market value.