The growing importance of ESG is compelling many organisations to make radical changes to their strategic choices, how they manage and structure their organisation, and how they report on ESG (environmental, social and governance). Taken together, these changes are creating a true ESG revolution.
A programme for improving non-financial information reporting often forms the starting point of that revolution. But the new insights which then emerge can quickly necessitate new strategic choices and operational changes.
In a three-part series, we discuss the three dimensions of the ESG revolution: a new approach to reporting, strategic reorientations, and large-scale business transformations. In this first part, Viviane Voorwald and Alexander Spek discuss the importance of reporting on non-financial information.
"The point has been reached where it is becoming increasingly clear that organisations need to make fundamental changes around ESG. Cosmetic interventions and slick PR are no longer enough."
The very first ACC Award, co-founded by the chartered accountants united in NIVRA (now NBA), was presented to DSM in 1995 for its environmental report. Meanwhile, most organisations are convinced of the usefulness and necessity of reporting on their sustainability and corporate social responsibility efforts. Ninety percent of the companies in the S&P500 published a sustainability report in 2019, with 29 per cent providing some form of assurance.
Despite that, organisations are under rapidly growing pressure to disclose their environmental performance and risks in a more detailed, comprehensive and consistent manner. Various stakeholders - investors, customers, employees, regulators, politicians, NGOs - are calling for this. The urgency is underlined by the new, stricter European rules on reporting non-financial information coming into force in 2023.
'Companies are aware that they need to take some major steps when it comes to ESG reporting,' says Alexander Spek, responsible for reporting and assurance within PwC's ESG team. ‘At the same time, many companies are still at the start of the long journey involved in organising their data and other processes, systems, and internal organisation in such a way that their ESG information can be audited. The quality and reporting of their non-financial information is currently a long way behind their financial reporting.’
Many organisations that have already embarked on the journey quickly feel the pressure. The point has been reached where it is becoming increasingly clear that they need to make fundamental changes around ESG. Cosmetic interventions and slick PR are no longer enough.
'The question is whether organisations truly believe in their underlying strategy,' says Viviana Voorwald, responsible for ESG services at PwC Netherlands. 'Are you convinced that investing now, in making your business model more sustainable, will pay off in the long term and improve your chances of survival, or are you just doing the bare minimum because you have to?’
Making these choices and their effects transparent - which is what ESG reporting does - plays a crucial role here. Comparable and audited information makes everything concrete. This will show which organisations are actually changing to achieve their goals and which are talking the talk but not walking the walk.
This new transparency has tangible effects. Executive pay will increasingly be linked to achieving non-financial targets. A competitive landscape is emerging: organisations are anxious not to be outdone by their peers, and their efforts are compared to their competitor's. This means ESG information matters more and more.
'And make no mistake: investors see this as added value,' says Alexander Spek. ‘ABP will no longer buy your shares if the ESG risks are too high. Credit rating agencies will lower your ESG rating, which increases your financing costs.'
"This new transparency has tangible effects. Executive pay will increasingly be linked to achieving non-financial targets."
That makes comparable, reliable and verifiable information indispensable for steering the necessary system change in the right direction.
And that in turn makes strong demands on the auditor, especially since there are still no internationally accepted ESG reporting standards. Therefore, much use is still being made of estimates.
Alexander Spek: 'At this stage, the transparent, fair and balanced disclosure of ESG information is an important starting point. It's not just about publishing figures: companies must also explain the methods used to arrive at them as well as the assumptions and choices they have made. Auditors are still facing difficult and unpleasant discussions with their clients. ESG reporting remains very much under development, and there are few hard-and-fast rules as with financial reporting. But it is rapidly growing in importance. The pips are about to squeak.'
However challenging and far-reaching the changes required of organisations, bringing their ESG reporting up to standard is not, according to Alexander Spek, a goal in itself. 'The purpose of reporting non-financial information is not to showcase what you have already done on the ESG front. What it boils down to is meeting the ESG targets you have committed to and showing that you are actually making the necessary changes. ESG reporting makes this possible.'
As better ESG information becomes available, organisations gain fresh insights into their performance and risks in this area. If necessary, they must adjust their goals, make other strategic choices and implement new changes to achieve them. It is precisely because ESG reporting is still under development, that there is constant interaction with strategy and business transformations.
"ESG reporting thus transcends the level of pure reporting and actually becomes part of your strategy: who are we, what do we stand for, and where do we want to go?"
'ESG reporting is not just about how you report, it starts with what you report,' says Viviana Voorwald. ESG covers dozens of topics; organisations cannot possibly report on everything. Therefore, every company will have to identify the themes on which it has its greatest societal impact and define a manageable number of KPIs based on a materiality analysis. This is illustrated by the integrated reporting done by grocery chain Jumbo. ESG reporting thus transcends the level of pure reporting and actually becomes part of your strategy: who are we, what do we stand for, and where do we want to go?
So the ESG revolution may well force organisations to undergo a strategic reorientation, the topicof the next article as part of the three ESG dimensions.
During a recent webcast with Paul Polman, former CEO of Unilever, Viviana Voorwald pointed out that the time has come for 'courageous leadership'. 'Organisations need their leadership to set very ambitious ESG targets to achieve the necessary global systemic change. It’s time for action now. Organisations will initially have to contribute more than they receive, and that’s still very rare in today's leadership culture.'