The establishment of the Sustainability Standards Board (SSB), which will have consistency in environmental, social and governance (ESG) reporting in 144 jurisdictions, will be the beginning of a comprehensive corporate reporting system. Corporate reporting can only be well functioning if it is comprehensive. The more comprehensive, the better the quality of comparability, the more informed the information for users, and the more transparent the accountability, writes Mervyn King.
Throughout the 20th century, the primacy of the shareholder and financial reporting were the cornerstones of corporate reporting. By the end of the 20th century, dramatic indicators were showing that the former was not the correct model and the latter was not sufficient for directors of limited liability companies to discharge their duty of accountability.
This was so because by the end of the 20th century it was empirically established that natural assets were being used by companies faster than nature was regenerating them and in the make-up of companies listed on the great stock exchanges of the world, such as the S&P 500 in the United States, only about 20% of the market cap was reflected as additives in a balance sheet of these companies, according to US GAAP.
By 1997 Ocean Tomo, the financial analytics company, showed that 80% of the market cap of iconic companies were not shown as additives in a balance sheet whether the International Financial Reporting Standards (IFRS) or Financial Accounting Standards Board (FASB) standards were applicable. To enable the boards of companies to report on this 80% not reflected in balance sheets, the Global Reporting Initiative (GRI) was founded to guide governing bodies to report on what became known as non-financial assets. Later they were called sustainability issues and today ESG issues.
At a meeting at the United Nations headquarters in Geneva in the first decade of the 21st century with the International Federation of Accountants (IFAC), it was concluded that reports consisting of annual financial statements and some management commentary were not sufficient for directors to discharge their duty of accountability to the company and through the company to all its stakeholders.
Companies were starting to report in two silos, namely financial and so-called non-financial matters, according to the GRI sustainability guidelines. This reporting, however, was contrary to that which was happening operationally, because financial resources have never been separated from natural, intellectual, social, human and manufactured resources. Operationally these resources were not dealt with in silos but were integrated 24/7.
This led to many discussions between the GRI and Accounting for Sustainability (A4S) and these discussions, in turn, led to the establishment of the International Integrated Reporting Council (IIRC). The IIRC in its framework issued in December 2013 contended that companies were involved in a value-creation process consisting of inputs of the six resources mentioned above, its activities, its relationships with its stakeholders, its outputs and outcomes. The activities inside the company resulted in the output of its product or the rendering of its service. These in turn had an impact on the three critical dimensions for sustainable development, as enunciated by Brundtland in 1987, namely the economy, society, and the environment.
The GRI guidelines became standards and the GRI looked at sustainability issues through a civil society lens, namely the impacts which a company’s activities and its product have on the economy, the environment and society.
In the second decade of the 20th century, thought leaders started asking the question whether the economy, the environment and society have an impact on the limited liability companies around the world. For example, the collapse of Lehman Brothers had a huge economic impact on companies. The pandemic of 2020 has had a huge social impact on companies dealing with health and safety issues. Climate change is having and will have a huge impact on companies around the world from an environmental point of view. In other words, thought leaders were starting to look at sustainability issues that were impacting companies.
The Sustainability Accounting Standards Board (SASB) was formed nine years ago and started designing standards for specific industries looking at it through an enterprise value lens, namely the impacts of the three dimensions on companies.
It will be seen that GRI and SASB were fulfilling different purposes for different audiences. GRI was looking at the impact on the world by a company’s activities and its product or service, while SASB was looking at the world’s impact on a company.
Meanwhile in the first decade of the 21st century, because of the growing importance of ESG issues, many framework providers leapt into that space. This resulted in clutter and confusion for preparers and users alike.
At the IIRC, in an endeavour to have some harmonisation and improve comparability, the Corporate Reporting Dialogue was established to encourage these framework providers to meet to see if standards could be harmonised. In March 2019 I said, in London, to the executives of what became known as the Alphabet Soup of framework providers in the ESG space, that it was a social outrage that they were dealing with these public interest issues as if they were competitors when they should be corroborating under SDG 17, because they were doing it in order to achieve the same outcome, namely to make reporting more informed. Reporting is the lifeblood of accountability and the more informed it is, the more transparent is the accountability.
2020 was the year of change, not only with the pandemic but in an atmosphere of collaboration under SDG 17 to find a vaccine for the virus, and these framework providers also started collaborating. The first was the World Economic Forum (WEF) working with the Big 4 accounting firms issuing metrics for sustainability reporting. Then there was the statement of intent of collaboration between the IIRC, SASB, CDP, CDSB (Climate Disclosure Standards Board) and GRI.
The IFRS has announced an intent to expand their mandate to include sustainability as well as financial issues and to establish a sustainability standards board by November 2021 in Glasgow.
At the same time, the European Commission (EC) is continuing with its non-financial reporting directives. It would be an irony of ironies now that the framework providers are collaborating that the international institutions do not collaborate on harmonising these standards. It is gratifying to know that the EC Task Force and the collaborators are talking about the alignment of the EC financial directives and the standards in the proposed SSB.
The indication from the IFRS, The International Organisation of Securities Commissions (IOSCO) and the ESG framework collaborators is that the SSB standards will be looked at through an enterprise value lens, in other words enterprise value creation, preservation and erosion. As set out above, the three critical dimensions of the economy, the environment and society have impacts on companies. They impact on a company’s financial condition (its balance sheet), its operating performance (income statement and cash flow) and its risk profile (the cost of capital and its market capitalisation).
If a company wants to report on a sustainability issue which is not yet material from an enterprise value perspective, it would be perfectly entitled to use, for example, a GRI standard, and report on that to satisfy the needs of a particular stakeholder.
The IASB financial standards are applicable in 144 jurisdictions and they have consistency and rigour. The concept is to have the same consistency and rigour in the ESG standards of the proposed SSB.
It is an exciting time for the accountancy profession because, as I wrote in 2016, the CFO has become a misnomer and he or she should rather be called a chief value officer. The reason is that the accountant with his or her public interest training, organisational ability and a steward of business information understands the value creation proposition. It has resulted in a rebirth of the accountancy profession.
In 2018, Linda de Beer (chair of the Public Interest Oversight Board) and I asked the question, ‘The auditor – quo vadis?’ Well, the task teams working on the proposed sustainability standards board are doing so in cooperation with the IAASB in an endeavour to ensure that the language of these standards are assurance friendly. At present there is some limited assurance on parts of sustainability and integrated reports. The aim of the SSB, working together with the IAASB, is to arrive at a situation that one can have a reasonable assurance of a sustainability and an integrated report.
The drive of the international bodies mentioned in this article is to have a holistic, comprehensive corporate reporting system and to build adoption globally of integrated thinking and reporting. The IFRS Foundation’s statement that it is expanding its mandate to establish a sustainability standards board, alongside the IASB and the work of the European Financial Reporting Advisory Group on Non-financial Reporting Directives, are clear indicators of the urgent demand for convergence, harmonisation and consistency in reporting. Both these bodies have identified the important role integrated reporting has to play to connect the financial with the so-called non-financial aspects.
The IIRC and the SASB have announced their merger under title of the Value Reporting Foundation. When the provisions of these two framework providers are used together for reporting it provides a more complete picture of long-term enterprise value creation while meeting the needs of the providers of financial capital for comparability, consistency and the reliability of information.
IOSCO has recently said that there is ‘an urgent need to improve the consistency, comparability and reliability of sustainability reporting, with an initial focus on climate change, related risks and opportunities, which would subsequently be broadened to other sustainability issues’.
The chairman of the Bank of America and of the International Business Council as well as the chairman of the World Economic Forum have said that the world needs a global standard for sustainability reporting. In order to achieve this, they recommend that, first, an independent global standard-setting body should develop ESG standards that can be adopted worldwide; second, for the standards to be enforced in the individual capital markets, regulatory authorities must endorse their use; and third, for the IFRS standard-setting process to best succeed, it should build on the main reporting initiatives already in use.
Mervyn King’s article first appeared in Accountancy SA, SAICA’s member magazine. Please note that these are opinions of the author and not necessarily SAICA’s views. SAICA will, therefore, not be held liable for the views and opinions expressed by the author.
Mervyn King is a Senior Counsel and former Judge of the Supreme Court of South Africa. He is Professor Extraordinaire at the University of South Africa on Corporate Citizenship, Honorary Professor at the Universities of Pretoria and Cape Town and a Visiting Professor at Rhodes University.