ESG Focus | Feb 22 2019
International companies are increasingly adopting industry-specific sustainability accounting standards. This will be a bonus for some companies, but a ball-and-chain for others.
-World’s first industry-specific sustainability accounting standards were approved on October 16
-Regulatory requirements and threat of legal action could force listed companies into quick adoption
-Financial regulators internationally are not on board as yet
-Early adopters include GM, Merck, Nike, Kellogg’s, CBRE, and Diageo Groupe
By Sarah Mills
The year 2018 proved a quiet watershed for industries and financial markets. On October 16, the Sustainability Accounting Standards Board (SASB) voted to approve the world’s first industry-specific sustainability accounting standards.
This event hardly sounds earthmoving but the repercussions are already rippling through the world: a quiet de-rating of some industry sectors is under way; surveys show chairmen of top corporations are spending more than half their time determining how to incorporate the SASB standards into their companies’ annual reports; and investment advisers are actively spruiking ESG options for clients’ portfolios.
It has been an extraordinarily ambitious project, led by some of the world’s financial heavyweights, and which involved more than six years of research and consultation with the world’s leaders of business and industry.
Of course, the accountancy initiative has its detractors, and reporting seasons in 2019 will prove the first test of its success.
SASB, The New Accountancy Framework
For the past several years, ESG (environmental, social and governance) investing had been gaining momentum, but apart from exclusionary investing – which usually targeted the sin stocks: alcohol, weapons, pornography, tobacco and gambling – few industries were caught in the net.
The SASB is determined to change that. Guided by the Standards Advisory Group, comprising global industry leaders, the SASB developed sustainability standards for 77 industries – those standards that have financial materiality to the company.
The SASB has published reporting standards for non-renewables, health care, financials, technology and communications, transportation, automobiles, auto parts, car rental and leasing, airlines, air freight and logistics, marine transportation, rail transportation, mining, coal, pharmaceuticals, road transportation, and more.
The SASB framework is divided into five categories, which the SASB refers to as “dimensions”: environment, social capital, human capital, business model and innovation, and leadership and governance.
These dimensions cover issues ranging from health-and-safety, to the industry’s environmental footprint, and bribery and corruption.
For example, the pharmaceuticals industry standards include reporting on: access to medicines; drug safety and side effects; safety of clinical trial participants; affordability and fair pricing; ethical marketing; employee recruitment; development and retention; employee health and safety; counterfeit drugs; energy water and waste efficiency; corruption and bribery; and manufacturing and supply-chain quality management.
The logic behind the approach is that companies in industries share the same materiality issues. The SASB has listed these issues for each industry and identified standard metrics for reporting on each, which, by default, obliges corporations to report on them in the US 10K filing form (the annual report without the bells and whistles), the 10Q form (quarterly report) and the 20K form (for foreign organisations).
SASB: Not Mandated, But Mandatory
The beauty of the SASB industry approach is that once the genie is out of the bag, all corporations in all nations with disclosure laws will to some extent be obliged to report on sustainability standards. That encompasses most of the western world, including Australia.
While not mandated by regulators, the SASB standards have the power to prove just as binding, given they are bound by the same disclosure laws governing US securities.
Rule 405 of the US Securities Act and Sections of the Sarbanes Oxley Act, requires disclosure of any information that could have a material quantitative impact on a company’s bottom line – an increase or decrease of 5% being the rule of thumb.
The company’s board and management must sign certification that the information is accurate and complete and not misleading. Failure to report on the sustainability standards could have serious repercussions.
Not only will investors favour complying corporations; a failure to disclose information that results in a financial loss to shareholders could open the door to investor lawsuits and give enforcers cause to issue sanctions and fines, suspend trading in company stock; and lay criminal charges.
“Could” is the crucial term.
The proof will be in the pudding. Also, it is important to note that under US law, regulatory filings do not require the disclosure of all material information – leaving some discretion and flexibility to companies.
SASB: Regulators Not On Board (Yet)
US companies have, to date, shown resistance to any type of disclosure in ESG regulatory filings. However, it is likely that those backing the SASB, with their substantial financial weight, will be active in prosecuting their agenda and testing their power in the courts.
The SASB is not a governmental body. It is a philanthropic organisation led by international heavyweights and, while its standards have no legal mandate, its industry credentials and ingenious plan have helped it gain strong momentum over the past six years.
Even if its standards do not become “legal” requirements, widespread voluntary acceptance or use within the marketplace could render the SASB standards as functionally obligatory for many companies.
However, regulators have equally proven resistant to the SASB and other non-regulatory bodies that appear to be stepping on their turf.
The US Securities Exchange Commissioner has distanced itself from the SASB standards, saying: “the Commission does not and should not delegate to outside, non-governmental bodies the responsibility for setting disclosure requirements” and that “groups like SASB have no role in the establishment of mandated disclosure requirements.”
Just prior to the SASB announcement, ASIC in Australia released a report on climate risk disclosure, recommending that corporations report on risks, but has managed to avoid any mention of SASB in its reports.
For now though, it’s a softly, softly approach, based on the premises of co-operation and opportunity. For example, there is a growing international consensus that coal and single-use plastics are public enemies No 1 and 2, and the standards provide a means of grappling with the problem.
Also, the SASB has done much of the thinking around sustainability reporting, saving corporations and industries, which have already made some clumsy and widely differing attempts, the effort. It provides both consistency and global relevance. So for many corporations and investors, it is a gift; for others, it is a ball and chain.
SASB: Early Adoption Is Spreading
At its launch, the SASB said the publication of the standards ushered in a new era for global capital markets in which businesses can better identify and communicate significant opportunities for sustaining long-term value creation.
National Australia Bank, for example, found that 80% of one Chinese company’s facilities were located in areas of high water stress and scarcity, and after incorporating it into its valuation model, discounted the share price target by 20%.
Indeed, the standards were well aired and many major corporations have been using the development process to gain a competitive advantage. As far back as 2013, a KPMG survey of the largest companies in 41 countries found that 71% reported on areas of corporate responsibility but reporting varied widely in content, format and detail.
Europe issued a directive in 2014 that corporations with more than 400 employees must also report on non-financial disclosure for sustainability in their reports. In 2017, more than 7,000 European companies reported on environmental, social and employee-related, human rights, anti-corruption and bribery matters.
Closer to home in Australia, the Australian Council of Superannuation Investors and the Financial Services Council have jointly published an ESG Reporting Guide for Australian Companies for several years.
All eyes will be peeled to estimate the degree of changes in annual reports for the FY19 reporting season.
The degree of adoption of SASB metrics by the end of the year will be a gauge of its success. Companies such as GM, Merck, Nike, Kellogg’s, JetBlue, CBRE, Diageo Groupe PSA, Schneider Electric, Host Hotels and NRG Energy have already started using the SASB standards.
But they will be the exception rather than the rule. There is not much point reporting on ESG standards if a company has no way of measuring them internally, and it would take at least a year for many corporations to adapt.
Internationally, a keen eye will be peeled to reports from industries with high greenhouse gas emissions and plastics producers, given coal and single-use plastics have weak ESG profiles.
However, all industries have an exposure to emissions emitters and plastics; so all will have to make adjustments through their supply chains. These changes will take many companies years to implement.
Resource-intensive industries such as materials are highly exposed; and industries such as energy and beverages face risks driven by changes in the availability of resources.
Companies in industries that rely on complex global supply chains such as IT manufacturing, auto manufacturing and pharmaceuticals can be affected by extreme weather events anywhere along their supply chain as well as their facilities location. They will also feel the brunt of social investing based on working conditions in their supply chains.
Financiers will need to be more careful about which projects they finance; construction companies will face rising costs; and miners will have to demonstrate state-of-the art water, energy and labour management.
And let’s not mention the sextet of sin: tobacco, alcohol, weapons, gambling, pornography and nuclear energy. Not only will these sectors suffer from exclusion investing but equally from tighter regulations and taxes.
On the flipside, industries and companies that support a circular economy (recycling) will be favoured, and great opportunity exists for innovation that supports a circular economy.
SASB: In Focus
Over the next six months, FNArena will be examining the likely impact of SASB industry reporting standards on Australian companies. Key industries for the Australian economy will include coal, mining, transport and financial services but all industries are likely to feel the impact of the standards at some stage.
For more details, it is possible to download any of the 77 industry-specific standards from the SASB website.
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