Disclosing sustainability-related information, or: bad reputation!

As we addressed here, the International Sustainability Standards Board has issued its first two exposure drafts, General Sustainability-related Disclosures and Climate-related Disclosures, both open for comment until July 29, 2022.

Here are some extracts:

  • Sustainability-related financial information is broader than information reported in the financial statements and could include information about… the entity’s reputation, performance and prospects as a consequence of the actions it has undertaken, such as its relationships with people, the planet and the economy, and its impacts and dependencies on them.
  • An entity’s sustainability-related risks and opportunities arise from its dependencies on resources and its impacts on resources, and from the relationships it maintains that may be positively or negatively affected by those impacts and dependencies. When an entity’s business model depends, for example, on a natural resource—like water—it is likely to be affected by changes in the quality, availability and pricing of that resource. When an entity’s activities result in adverse, external impacts—on, for example, local communities—it could be subjected to stricter government regulation and consequences of reputational effects—for example, negative effects on the entity’s brand and higher recruitment costs. Furthermore, when an entity’s business partners face significant sustainability-related risks and opportunities, the entity could be exposed to related consequences of its own. When such impacts, dependencies and relationships create risks or opportunities for an entity, they can affect the entity’s performance or prospects, create or erode the value of the enterprise and the financial returns to providers of financial capital, and the assessment of enterprise value by the primary user.

Clearly, this is indeed broader than existing financial reporting, no part of which for example specifically addresses an entity’s reputation. The basis for conclusions provides an example of what this might cover:

  • a beverage company might need to disclose the risk of water use, especially in areas identified to be of high water stress. It might describe how its use of water affects the supply available to meet its operational needs. It might also discuss the effects on communities close to the company’s operations, which could lead to risks of reputational damage and loss of customers, or the imposition of taxes or limits on the use of the resource. It could also describe how these risks have been assessed throughout the supply chain.

Of course, this all comes back to the core reliance on the enterprise value concept that we discussed here. Global Risk Institute in Financial Services opined that the disclosure objective is “not clear enough,” and went on:

  • Enterprise value includes in its calculation the market capitalization of a company but also short-term and long-term debt as well as any cash on the company’s balance sheet. However, non-financial performance/achievement, such as change in strategy taking sustainability risks into account, enhanced governance, and others will also add future value to the firm. Climate-related information that has not been captured in the financial result could be disclosed through a forward-looking perspective so it is assessable by report users, and thus should be considered as a part of the definition of sustainability-related financial information

The following points were made by IEK Consulting:

  • Materiality is assessed regarding impact on enterprise value. This implies that if the users (or the majority of users) lack willingness to address a sustainability issue, it shouldn’t be disclosed as the financial impact on enterprise value is small. We recommend to assess the materiality based on the impact of the externalities rather than impact on enterprise value. We believe this is important as part of the users might base their investment decision on a combination of risk/return/impact rather than traditional risk/return parity. This is particularly true for investors with a combined social and financial return expectation (i.e. social return with adequate or sub-market financial return).
  • For example: Should a Tobacco company disclose the amount of healthcare expenses and human capital losses caused by its cigarettes consumption even if clients would continue to consume cigarettes ? Basically, this information has no direct impact on enterprise value (EV) as its revenue streams are not impacted, but has a negative effect on the entity’s brand, which may indirectly impact EV if disclosed. While the case is obvious in this example, other situations may be more complicated to assess.

Indeed, it’s not entirely clear whether the references to reputation should often trigger some specific disclosure that wouldn’t otherwise be provided, or whether they’re just used in a general way, to encourage preparers to think broadly about the impact on enterprise value.  Some respondents, such as the Japanese Institute of Certified Public Accountants, think it’s a step too far:

  • information about the entity’s “reputation” is stated as a piece of information that should be included in sustainability-related financial information…but it does not sound right to us. “Performance” and “prospects” stated in this item are included in the core content of the Draft S1, but we consider that “reputation” should not be included in this item given that reputation is not designated as a piece of information to be disclosed.

Unless you read the references to “reputation” as really being a kind of existentially-charged shorthand for, well, an entity’s entire capacity to endure…

The opinions expressed are solely those of the author

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