How non-financial reports can tell your value creation story

Katrina F. Francisco

Of late, a number of companies in the Philippines have been releasing non-financial reports, either called “Environmental, Social and Governance (ESG) Reports,” or “Integrated Reports,” or “Sustainability Reports.” However, these are not yet mandatory. In fact, it was just recently that the Securities and Exchange Commission (SEC) released Memorandum Circular No. 4, which provides the sustainability reporting guidelines for publicly-listed companies on a “comply or explain” approach for the first three years of implementation, starting with the 2019 reporting period. In the absence of a reporting requirement, a key driver that has influenced companies to disclose non-financial information has been the demand from their investors for such reports.

In the past four years, EY Global has been commissioning the Institutional Investor’s Custom Research Lab to conduct surveys with institutional investors around the world, to assess if non-financial information plays a role in their decision-making. According to the 2018 EY Global Climate Change and Sustainability Services study, “Does your non-financial reporting tell your value creation story?,” ESG information is now considered an essential criterion for investor decision-making. Investors have come to understand the significant link between ESG factors and a company’s performance and long-term value.

A high of 97% among the investors surveyed in 2018 said that they evaluate, whether formally or informally, the non-financial disclosures of target companies. Risks related to governance, supply chain, human rights, and climate change are some of the main ESG factors that they look into. In the previous year’s report, only 78% undertook reviews of non-financial disclosures. The dramatic increase is mainly a result of widely-known scandals related to poor corporate governance, more data showing the impact of climate change on business, and an increasing awareness of the social impact of business.

The quality and relevance of disclosed non-financial data vary considerably by company, industry, and region, with 56% saying that the disclosures are either lacking or not available for any meaningful comparison to take place. Investors now want to see more comparable data at specific points in time, as well as over a period of time, which allows them to evaluate progress within a company and identify the leaders and laggards within an industry. In addition, investors note that there are extensive disclosures relating to governance policies and practices, yet they often overlook discussions on accountability in relation to non-financial information. Investors want to see not just the current practices, but also management effectiveness on these non-financial metrics over a short, medium and long-term basis.

Investors agree that ESG disclosures have improved significantly over the years, especially in the area of governance, which is largely driven by exchange-listing or accounting requirements. Additionally, investors perceived that 82% of the companies they do invest in are actually able to assess materiality of governance factors properly. However, only 64% of the companies they invested in actually assessed social factors properly, and only 11% of these companies properly assessed environmental factors. The surveys indicate positive growth in the area of ESG disclosures, although the numbers also show that the concept of materiality in relation to ESG factors and sustainability still has a long way to go before majority of them comprehend and integrate them into their business practices.

Given that the risk from climate change is one of the main factors investors scrutinize, a majority (around 70%) indicated that they will closely evaluate disclosures relating to the physical risks of climate change in their investment decisions and allocations over the next two years. Without disregarding transition risks, 47% of the investors said that they will also consider these risks of adjusting to new regulations, practices, and processes. Investors are apparently keen on how board members and senior management intend to exercise oversight around these risks, especially if they are material to the business.

Of the survey’s respondents, 59% of investors saw the need for more prescriptive accounting standards for non-financial information. The investors recognize that since they are not experts in every industry, they need to adapt and try to establish the material factors for each industry with focus on those that mitigate risks and create value for business. However, quantifying those risks and translating them into financial terms can be challenging. This is why investors believe it is critical to develop a common standard that has enough flexibility to allow companies to report what is material to them and their respective industries. This way, they will be able to compare, establish benchmarks and spot trends relevant for their decision-making.

Investors are confident that this can be realized when there is greater collaboration among regulators, trade groups, NGOs and even among themselves. The collaborative effort will assist investors in defining what are most substantial to a company’s long-term sustainable growth.

The report recommends four key areas that companies should consider to effectively articulate what investors are looking for.

First, establish a structured materiality analysis process that allows companies to:

* Set strategic objectives and overall corporate strategy;

* Define the issues that will be covered in disclosures and reporting;

* Design Key Performance Indicators (KPIs) to enable measurement of performance; and,

* Align ESG risks with the risks managed and prioritized by business for a more cohesive sustainability risk management.

Second, since the materiality process allows companies to see where the largest impact can be made, appropriate methods to measure and report the social and environmental outcomes should be properly identified.

Third, identify the KPIs that would translate risks and outcomes into financial proxies for investors to assess the risks and long-term value creation process of the companies.

Last, continue to engage with investors and other stakeholders and report more comprehensively on material non-financial information for a better understanding of how they are creating long-term value. With the increasing global focus on environmental issues and corporate social responsibility, and now additional compliance pressure from SEC MC No. 4, Philippine companies with robust ESG reporting policies may find themselves reaping more significant long-term economic, social and reputational benefits.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co.

Katrina F. Francisco is a Senior Director for Climate Change and Sustainability Services (CCaSS) under Assurance (Service Line) at SGV & Co

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