Signal or noise? Four things to know about sustainability metrics
Over the last few years there has been a groundswell of support for “non-traditional” metrics and disclosures on company operations. This trend coincides with a growing public awareness of business’s impact on society and the planet and vice versa - the impact of climate change and societal trends on business. These disclosures can be called sustainability metrics, ESG (environmental, social, and governance) metrics, stakeholder metrics, or non-financial metrics.
Whatever the name, the expectation is that demand for these non-traditional metrics will continue to increase and that companies will increasingly disclose such metrics.
Many companies, investors and organizations are already preparing for this new reality, even amid the current noise of multiple frameworks and standards. However, convergence is happening among these approaches, and the likely path for companies and investors is becoming clear. Four basic questions are core to understanding the disclosure landscape and what it means for companies and investors.
Why are metrics beyond traditional reported financials necessary?
We know there is more to any company than its financials, and investors generally base their decisions not on historical financials but on the expectations of future success. One way to anticipate that success is to see how companies are adapting to changing societal expectations.
Furthermore, investors want to incorporate intangible factors such as reputation, brand, or sustainability profile into their investment decisions. In response, investors and data providers are collecting information from multiple sources beyond the company – including social media – and making their own judgments or providing ESG ratings. Companies often find it challenging to verify the accuracy of such information or incorporate it into their narrative, causing confusion and frustration.
The key distinction is between judgments and data. Investors and ESG raters are paid to make judgments and ESG raters’ judgments will always differ – just as buyers’ and sellers’ judgments differ. Nevertheless, comparable and reliable data, disclosed by the companies themselves, will simplify the situation for everyone involved.
Who are non-traditional disclosures for?
There are two important audiences for these metrics: those who focus on the impact of the climate or society on a company and those who focus on a company's impact on the climate or society.
Investors in public companies are the first audience. Most investing today is driven by models that need quantitative inputs – hard numbers. Ignoring sustainability factors in those models would be imprudent but incorporating them in their current format is challenging. And those metrics are being demanded not just by ESG or sustainability focused investors, but by all investors because they are increasingly material to their decision-making processes. Consistency of non-traditional disclosures would address this challenge.
The second audience is much broader – policymakers, customers, employees, and others who are interested in a company’s environmental footprint or impact on society. These groups care not about shareholder returns but about whether a company is having a material impact on the planet or society as a whole. It is unlikely that investor-focused metrics will encompass the range of issues that these other stakeholders would like to see.
Of course, both private and public companies can have significant impact beyond their walls. In fact, the only difference between public and private companies is their shareholders – not their employees, customers, supply chains, communities, or planet. Using public securities disclosure to address critical societal issues is overly limited and could give private companies a pass, even large ones. Achieving this broader goal would require regulations or disclosures beyond public securities reporting standards.
How will non-traditional disclosures work?
From the investor point of view, the best way to accumulate and distribute non-traditional metrics is the same way financial metrics on publicly traded companies are shared. Financial metrics are governed by standards, often assured by auditors, treated as material information for markets, and distributed in computer-friendly formats that can feed into investment models. Sustainability metrics should follow the same pattern – and therefore be constructed and handled like traditional financial metrics that are comparable across companies.
Who will oversee new disclosures?
Just as accounting standards have evolved over time, non-traditional metrics will require ongoing refinement. An experienced, global standard-setter is best placed to manage this process in a way that generates global certainty, impartiality, and respect. The IFRS Foundation has the opportunity to build on the work of the IIRC, SASB, TCFD, and many others to take on this role.
Having two separate sets of books – one that covers traditional financials and one that covers material non-traditional metrics – is a recipe for failure. That is why there is such an opportunity for the IFRS Foundation to take a leadership role in creating a single integrated approach to disclosure standards for listed companies, and for global securities regulators to support such an effort.
Beyond investor-focused metrics, we recognize that there is demand for a different effort to marshal resources to report on companies’ progress towards meeting the UN Sustainable Development Goals (SDGs), or other issues of importance to a broader range of constituents. For the non-investor focused metrics, perhaps there is a role for the World Economic Forum, UN, or OECD to drive the process.
Wider reporting on corporate sustainability is all but a foregone conclusion – it’s not a matter of if companies will have to report on these issues, but when and how. For regulators and standard-setters, ensuring that companies have clear guidance will build investor confidence in the reported sustainability metrics. And for companies and investors, now is the time to prepare to ensure these metrics provide a clear signal rather than more noise.