Environmental, social and governance (ESG) reporting is a long-term undertaking that brings significant benefits to companies. Dr Glenn Frommer and Theodora Thunder, Principals, The Sustainability Partnership, outline the groundwork necessary to put in place an efficient and effective ESG reporting process.
Those of us who prepare ESG, sustainability, corporate social responsibility (CSR) and, increasingly, annual financial reports recognise the substantial role material non-financial (social and environmental) issues now play. We use significant resources in preparation and large areas of real estate in our reports to adapt our text to the standards and guidelines of reporting authorities and to channel the ESG corporate message in regards to these issues. However, rarely does the management discussion analysis (MDA) section disclose the guiding role and influence exercised by senior management in framing the materiality and the linking of social and environmental risks’ influence on strategy, policy and performance.
The role of the board and senior management
The Hong Kong Exchanges and Clearing Ltd (the Exchange) recently completed a review of listed issuers’ compliance with its Environmental, Social and Governance Reporting Guide, which forms Appendix 27 of the listing rules. The resulting report, Analysis of Environment, Social and Governance Practice Disclosure in 2016/2017 (Analysis Report), emphasises the importance of board and senior management commitment to ESG. Reports should disclose the approach to ESG issues of the board and management, and should explain how these ESG issues relate to the business. The Analysis Report states that disclosure should include ‘the board’s evaluation and determination of ESG risks and how it ensures that appropriate and effective ESG risk management and internal control systems are in place’. From a governance perspective, this solicits disclosure of board-level directives on strategy, policy and systems in relation to the company’s approach and management of non-financial material risks.
Working backwards from these disclosures, when structuring a report, the lines of responsibility start with the board and top leadership who allocate resources to the reporting tasks and, by approving the final document, are held both publicly and internally accountable for the content. The board and senior management are thus the final arbiters of what is material to the organisation in terms of ESG issues. Their decisions and directives provide the framework and agenda for issue management reporting and public disclosure. It is therefore, fundamental to use senior management’s strategy ‘playbook’ as the starting point of the reporting process.
Provide a strategic view of ESG
While the ‘playbook’ is not always in full harmony with the principles, standards and guidelines used to report, it is the responsibility of the reporting committee to align and ensure that disclosure is in compliance with relevant laws and regulations. In addition, disclosure must be substantive in terms of articulating the drivers (strategy, policy) and actions (governance systems programmes, metrics) that address the material issues that affect corporate viability.
Analysts, for example, expect discussions of current and future plans in regards to the positioning of the company and its products or services to maintain market competitiveness. This necessarily flags the internal understanding of material risks and opportunities and how they are being addressed with some degree of confidence and justification for the plans being implemented. Examples would be the diversification of suppliers due to geopolitical factors, or raw materials availability due to climate change impacts on the supply chain. Such decisions often take multiple years to show results for risk mitigation and would need a clear rationale behind them.
Considering that reporting influences reader perceptions, the elements of corporate trust and reputation are at stake with disclosures. Crafting a series of quality disclosures that inspire trust and confidence is challenging but achievable with some basic reporting cycle preparation guidelines.
Reporting cycle preparation guidelines
Establish data collection, monitoring and feedback systems
First and foremost, reporting is a team effort that requires input from across the organisation and business functions. A reporting committee that has the competencies and, ideally, the experience to work with ESG issues is a prerequisite. Members are responsible for the collection, monitoring and feedback of various systems, programmes and data that are reported on. This is where the clear understanding of the reporting principles of consistency, materiality, balance and quantitative measurements enters and guides the committee’s work.
Identify the message
At the early stages of the cycle, seek direction from the CEO and the head(s) of corporate communications/investor relations as to the messages they want readers to take from the report. Review with them the previous year(s)’ report(s) and feedback for continuity and material issues. This process should identify the ‘no-go’ areas, as well as current performance progress, and extract a suitable ESG message from these dialogues.
Keep in mind that a two- to three-year rolling programme is most likely for messaging on strategy/policy development and the performance metrics, especially for environmental and social issues that are often measured for their impact over the medium to long term. An ongoing dialogue is therefore needed to ensure that departments consistently act on the messaging and metrics beyond just the current reporting cycle. This also makes for a more organised reporting process in future.
Determine the report structure
Structure a story that is concise, on message and linked. Report readers tend to read the chairman/CEO statements and the performance metrics first, followed by the MDA. Combined, these sections are essentially the report. Their interlinking reflects governance at work, that is:
- how the chairman and CEO set out the board’s plans to achieve the corporate goals (strategy)
- how these plans are put into action (policies, material issues, risk and reputation management discussed in the MDA)
- what worked or didn’t work (performance metrics), and
- what material actions are on the books to realign the strategy trajectory (targets).
The material actions should also be included in the CEO’s statement for their strategic rationale and in the MDA for details on the strategy fit.
Consider your audience
Be aware that ESG reporting serves more than just shareholders, regulators and the board. It informs internal management on the thinking, direction and progress of ESG risk management to guide their own departmental alignment and planning. It provides a critical benchmark positioning for industry peers and, importantly, it is a communication tool that enhances corporate reputation both within and outside the organisation. The choice of writing style (non-legal) and the storytelling should enhance the board’s message rather than confuse or distract the reader. Competency in applying the principles of consistency, materiality, balance and quantitative measurements plays a significant role in building and presenting the ESG story.
Groundwork pays off
Mastering the ability to logically link the drivers and actions to reflect the business’s progress gives reporters the ability to parse the committee’s gathered information and metrics for reporting against most of the standards or guidelines the company elects to use, including the Exchange’s Environmental, Social and Governance Reporting Guide.
It may take some time and effort to develop the skills and competencies to plan and execute reporting in this vein. However, the result will be informative, strategically valuable and, above all, influential.
Dr Glenn Frommer and Theodora Thunder, Principals
The Sustainability Partnership
The report ‘Analysis of Environment, Social and Governance Practice Disclosure in 2016/2017’, is available on the Hong Kong Exchanges and Clearing Ltd website: www.hkex.com.hk.
For further information contact: Thunder@streeter.com.hk.