Our morphing focus from ESG to sustainability

The Long and Winding Road to Financial Reporting Standards

This is an excellent summary of the history of financial accounting standards, which serves as a reminder that developing and adopting a global set of disclosure standards takes a lot of time and hard work. It is required background information to understand what is happening today in the corporate sustainability reporting landscape. Indeed, the speed and frenzy of mobilization across the globe to increase companies’ sustainability disclosures are overwhelming. It’s also worth having this background information in mind when considering that the overarching objective of regulators and standard setters is to achieve the same level of quantity, comparability, and reliability in sustainability reporting as we have today in financial reporting. This is not easy, and the resulting standards will not be perfect the first time (can anything ever really be?) but both the IFRS Sustainability Disclosure Standards and the European Sustainability Reporting Standards are important, they are an improvement over what we have now, and they are moving quickly in the right direction. By and large, I think we can expect them to be complementary, and I really wonder if they’re as much at odds as outside observers seem to think.

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EY’s report on the emerging sustainability information ecosystem

Many people are putting pen to paper – or fingers to keyboard – to offer their explanation of ‘ESG’ – what it is and isn’t, what it can and can’t do, should we keep it or throw it away, should we focus on the E, the S, or the G, should we add more letters (please, no)… All of which results in more confusion, acrimony, and entrenchment, especially as we near the end of the consultation periods for both the draft IFRS Sustainability Disclosure Standards and the draft European Sustainability Reporting Standards.

I’m not sure if the latest paper from EY on the emerging sustainability information ecosystem does anything to help clarify the confusion. For starters, it identifies two distinct primary user groups which the ecosystem serves, based on whether they are focused on financial materiality – impacts of environmental, social, and governance issues on the company – or impact materiality – impacts of the company on the economy, the environment, and society. I suggest this distinction should lie at the information level, not the user level, because it’s very likely that users of the information will be interested in both. The premise that financial materiality and impact considerations are mutually exclusive is flawed. The fact that generating these impacts may have financial repercussions on the company, or that investors (and other stakeholders) care about the impacts the business generates enough to base their investment decisions on it, makes them financially material. If an issue is relevant, it should be considered.

The question is what the issue relevant to: the wellbeing of the company, or the wellbeing of the environment and society? It’s a matter of perspective and intention. These inform different management initiatives, different performance measures, and different disclosure content. Investors and other stakeholders can care about how a company treats its employees or how many women it employs and how it makes sure to respect human rights throughout its supply chain. They can care whether a company’s assets are in a high-risk zone for climate disasters and if it has a credible emissions reduction plan. They can care whether employees are paid at least living wages and whether investors are paid fair rent on their capital.

Another source of confusion with this paper is that its first recommendation to strengthen decision-usefulness and trust in sustainability information is to increase the transparency… of ESG ratings, which it cleverly rebrands as “composite indicators”. While indeed, there is a lot of work to be done to make private third-party ESG assessments more transparent and to better understand what they are and the role they play in the information ecosystem, they are not, and should not be perceived as, the primary source of corporate ESG data or disclosures for investors. They do not provide performance data, they provide a subjective opinion about a company’s performance on ESG issues based on data that is either provided by the company or other sources.

The paper does very aptly point to the need for more external assurance of sustainability information produced by companies, as well as the need for interoperable taxonomies of what constitutes sustainable economic activities.

Read the EY document

UNRISD Thresholds for Transformation working paper

Speaking of what constitutes sustainable activities, this report published by the United Nations Research Institute for Social Development (UNRISD) and r3.0 summarizes the outcomes of a pilot project testing a set of UNRISD-designed Sustainable Development Performance Indicators (SDPI) that are intended to gauge whether economic entities are on a pathway consistent with the Sustainable Development Goals. The SDPIs assess sustainability performance against normative, context-based thresholds and transformative change potential. The report finds that these indicators are quite implementable by both for-profit and ‘social and solidarity economy’ organizations, and that they can serve as levers of transformation in effecting system-level changes. It’s worth noting that this SDPI framework is not about creating a whole new set of measures, but rather adjusting the economic, environmental, and social corporate performance indicators that we are growing familiar with, to contextualize this performance within macro-level thresholds and more clearly determine whether a company’s actions are sustainable or not. To be clear, this is not the same as quantifying impact, but rather determining the sustainability of actions or activities in the context of social (floor) and environmental (ceiling) boundaries. In this respect, it offers a useful tool for companies to begin to make the connection between their actions and the macro-level economic, environmental, and social ecosystem in which they operate.

Read the report