Environmental risks categorized as reputational, operational, or legislative.
The United Nations Environment Programme (UNEP)estimates that human use of environmental goods and services in 2008 caused an estimated $6.6 trillion in environmental costs, equal to 11 percent of the global economy. The largest 3,000 listed companies are responsible for 35 percent of those costs. According to a joint report from the UNEP Finance Initiative and Principles for Responsible Investment, this could increase to $28.5 trillion or 18 percent of global GDP by 2050.
With increased data around the costs of climate change, water usage and other environmental risk factors, the maze of voluntary and mandatory reporting frameworks has become increasingly difficult to navigate. Companies need to understand these frameworks, and the requirement for a coherent and streamlined reporting system.
Even for seasoned business practitioners, the reportable risks posed by environmental impacts may be difficult to understand. Under SEC guidance, material risks that should be disclosed are ‘facts, details and information relevant to a company, operation or security that reasonable investors would want to know and that could influence their decisions related to their investment.’ They are risks that have the potential to affect the price of a stock or investment.
The UNEP Finance Initiative breaks environmental risks into three categories: reputational, operational and legislative and policy. One example of a material environmental risk that touches upon each risk area is from a study conducted by the World Resources Institute (WRI), which assesses the financial implications of the operations of 16 oil and gas companies that own or lease reserves in ecologically important and protected areas.
Restricted access to oil reserves due to global support for conservation and/or local opposition to oil and gas development, the WRI estimates, could lead to negative impacts on the shareholder value of these companies of up to 5 percent.
Similarly, reputational risks could arise if the oil firm in question had a valve explosion that contaminated local waters or failed to respect the rights of indigenous populations. Finally, the country of operation may pass legislation that completely outlaws drilling in ecologically important areas, or may impose a stricter regulatory structure that affects the profitability of the investment.
Voluntary disclosure frameworks
Although SEC regulations (and Environmental Protection Agency disclosure requirements, where applicable) provide guidance on mandatory disclosures, voluntary reporting mechanisms are rapidly becoming best practice. Not only do voluntary reporting guidelines help companies benchmark their individual sustainability performance but, from a policy perspective, greater transparency in sustainability information will also hopefully drive CSR efforts of the future.
Currently, the most prominent reporting framework is the Global Reporting Initiative (GRI). The GRI framework seeks to align company disclosures with investor sustainability criteria by outlining the key building blocks for reporting on environmental, social and governance issues. The guidelines are notable in their comprehensive and structured approach to reporting by offering specific sustainability indicators. The GRI is also placing greater emphasis on human rights reporting, by considering factors such as labor standards, benefit coverage and diversity efforts.
Some companies may be familiar with ISO 26000, a reporting system that aims to standardize CSR by defining seven core subjects of social responsibility and guiding companies to implement socially responsible behavior throughout organizational policies and practices. Unlike the GRI, ISO 26000 does not provide guidance on specific indicators.
Another set of sustainability guidelines, the OECD Guidelines for Multinational Enterprises, constitute a code of conduct representing recommended ‘principles and standards for responsible business conduct consistent with laws.’ Whereas the OECD principles provide general policy guidelines – multinationals should ‘contribute to economic, social and environmental progress with a view to achieving sustainable development’ – the GRI asks for specific information about company policy. For instance, under the GRI framework, companies are directed to provide a formal ‘statement of the organization’s vision and strategy regarding its contribution to sustainable development.’
Finally, the AA1000 series is a set of standards meant to help organizations become more accountable to stakeholders. The standards provide organizations with principles to frame and structure the way in which they understand, govern, administer, implement, evaluate and communicate their accountability. Like the ISO and OECD standards, the AA1000 framework is meant to be compatible with other key standards in this area.
A new reporting paradigm?
While a move toward voluntary sustainability reporting is an important one, critics and industry advocates complain that the separation of financial reporting and sustainability reporting makes it hard for investors to take a holistic view of company performance. The growing number of reporting frameworks also makes it increasingly difficult to compare organizations side by side or to evaluate industry-wide sustainability practices in general.
Some advocates, like Toby Heaps, author of Towards a 21st century balance sheet: the first three steps, are now working on the idea of creating an ‘integrated’ reporting system, one that combines both sustainability and financial reporting. Firms can be scored and ranked against their industry peers across a set of financial and focused sustainability metrics, which will allow for tilted portfolio construction where the most sustainable, high-return companies can attract the most capital.
Many of these advocates also suggest that the sustainability reporting community should undergo what the accounting industry did 30 years ago with the creation of GAAP. One commentator suggests beginning with six universally applicable indicators that would create the most value for investors. Many large companies are already tracking these metrics, but the information is not being made available in convenient formats. The suggested factors are: gigajoules of total energy consumed, cubic meters of water consumed, metric tons of CO2 emitted, metric tons of waste produced, number of injuries and fatalities per 1 million hours worked, and payroll.
Another approach would be to standardize portions of the GRI framework through an international body like the OECD. While mandatory sustainability reporting is an unlikely political outcome, adopting key factors (like the six listed above) that are already used by many investors in evaluating long-term investment viability could provide a solid base for sustainability standardization.
In a June 2010 CEO survey published by the UN Global Compact and Accenture, 93 percent of the 766 CEOs surveyed believe sustainability issues will be critical to the future success of their business, and 96 percent believe sustainability issues should be fully integrated into the strategy and operations of a company. Despite these beliefs, only 48 percent of them say they currently integrate sustainability indicators into discussions with financial analysts. Whether the CEO behavior is tied to uncertainties about the correlation between environmental sustainability and financial performance or a missing integrated framework structure, a better voluntary reporting system has an important role to play.
By streamlining the reporting process and working toward a standardized system, sustainability reporting can move a step closer to occupying a permanent place in major corporate decision making.
