At Davos 2020, the World Economic Forum’s (WEF’s) International Business Council (IBC), in a largely glowing blaze of publicity, issued a consultation draft proposal outlining a set of common environmental, social and governance (ESG) metrics for inclusion in mainstream company annual reporting.
The need to streamline current frameworks
The WEF’s proposal directly confronts widespread criticisms of the high number of ESG-related reporting frameworks with which companies have had to contend. It calls not just for greater cooperation and alignment among existing ESG reporting frameworks, but also endorses the creation of a generally accepted international standard, consistent with what the WEF refers to as the ‘principles of stakeholder capitalism’. These principles outline that a company is ‘more than an economic unit generating wealth’ and something that ‘fulfils human and societal aspirations as part of the broader social system’. This means performance should be measured not only on delivered returns to shareholders, but also on how it achieves its environmental, social and good governance objectives.
Accountancy Europe, in a similar vein to the IBC, recently issued a consultation report seeking to create a core set of non-financial global metrics and to connect these to financial reporting. The stated aim of this is to coordinate, rationalise and consolidate non-financial reporting initiatives in order to enable stakeholders to understand both financial and non-financial information together for a better insight into company performance and its impact.
Both initiatives reflect an escalating interest among investors and other stakeholder groups in information that helps to evaluate companies’ impacts and dependencies on a range of social and environmental factors, such as climate change and human rights. The accounting profession is increasingly engaging with these areas, with various international accounting bodies and firms now playing a central role in the development of a standardised set of ESG metrics. With Peter Bakker, president and CEO at the World Business Council for Sustainable Development, having once said that accountants can help to “save the world”, such engagement may just seem to be a natural extension of decades of attempts to develop the social significance of international financial reporting and auditing practice standards.
However, this commitment to a common set of ESG metrics is worth a second take on a number of grounds. It is interesting to see the often glowing reports in the financial press, some of which have characterised the large accounting firms as riding in on their sturdy charges to bring order where there is currently chaos. Intriguingly, these are the very same firms at the centre of the widely reported auditing crisis in relation to the external audit of corporate financial statements. Such a contrast should, at least, instil a cautionary tone as to whether what is on offer is a definitive and productive solution for an area as complex and subjective as ESG performance.
An over-reliance on the numbers?
We also need to remember that standardised ESG reporting can easily become a tick box exercise. As Jerry Muller, in his book ‘The Tyranny of Metrics’ stressed, the damaging consequences of over reliance on prescriptive metrics include the promotion of short-termism and the dissuasion of risk-taking and innovation. As this issue picks up pace, we certainly should be asking whether the pursuit of a standardised set of ESG metrics is really a route to socio- and eco-salvation.
What does the proposal outline?
The IBC consultation draft, prepared in collaboration with the Big Four professional services firms, outlines a set of core and expanded metrics. The metrics are organised under four themes – principles of governance, planet, people, and prosperity – all of which are associated with core elements of the UN’s Sustainable Development Goals (SDGs). The draft seeks to ease companies towards using standardised metrics already appearing in reporting frameworks produced by, among others, the Global Reporting Initiative (GRI) and Task Force on Climate-related Financial Disclosures (TCFD). Accountancy Europe calls for global metrics to achieve a ‘base level of transparency and comparability’. This base level of focus seems to lack ambition given that these existing (and now to be consolidated) forms of ESG reporting have evolved over the past 20 years without compelling evidence that they deliver improvements in corporate responsibility.
Hiding behind the numbers
While there is a lengthy history of ESG reporting, issues such as climate change, modern day slavery, inequality and corruption remain core environmental and social concerns that are evidently rising rather than diminishing. So we have to ask if the problem is really one of reporting and the multitude of measurement methods? Or is the problem much deeper, and fundamentally one of action (and inaction) – rather than reporting? The selective nature of many of the IBC’s core metrics stand at some distance from the IBC’s proclaimed recognition of the ‘bold and transformative steps that are needed to shift the world onto a sustainable and resilient path’. Does the fix really lie in a basic set of indicators? If it was this simple, surely it should have been done before? Could it be that the sheer complexity of the problem is a direct cause or driver of the proliferation of metrics?
Accordingly, before committing to metric consolidation and standardisation processes, we should be questioning whether existing metrics (let alone any derived subset of ‘core’ metrics as proposed by the IBC) have enabled companies to demonstrate the contribution they are making towards a more sustainable and socially desirable world. Can stakeholders, more specifically, use such metrics to gain sufficient assurance as to the appropriateness and quality of corporate action in meeting the UN’s SDGs?
Compelling, challenging reporting
While there is an understandable desire to avoid reinventing reporting wheels, the innate focus on simple measurement and the nature of the metrics suggests a lack of ambition. Will they compel businesses to report on impacts and dependencies that might ‘hurt’ corporate profits and encourage them to pursue activities that deliver a greater good for the many (as compared to reporting on the scale of reduction in abusive practices)? For example, the IBC report rather passively “encourages” companies “to disclose positive and negative impacts of their activities and investments where possible”.
The restrictive mind-set of the IBC report is also evident in its suggestion that companies should not be compelled but merely encouraged to report on a list of ‘expanded’ metrics, even when these seem essential to achieving the IBC’s ambitions. For example, if we are to take companies’ efforts seriously surely they should be required to disclose the ‘material stakeholder buy-in’ metric which indicates ‘[t]he percentage of each stakeholder group that is aware of the company’s stated purpose and believe they are authentically realising it’. Moreover, it has to be questioned as to whether injury and absentee rates really provide a comprehensive material view of advancement in human rights and wellbeing. We should not presume that ‘progress’ will automatically follow from a standardised set of metrics; we must continually question if the pursuit of shareholder value creation supported by some additional ‘agreeable’ disclosures is ever going to be socially sufficient?
Is standardisation essential?
The Accountancy Europe paper calls for a conceptual framework for ‘connected reporting’ that embraces and links financial and non-financial reporting. However, the prospects here, in the short to medium term look far from promising when one contrasts the global scientific community’s emphasis on the urgency of action on climate change with the recognition that the field of financial reporting is still not settled on its underlying conceptual framework or indeed its definition of operating profit. The type of debates over the relative prominence of stewardship and fair value objectives that have pervaded the financial reporting conceptual framework project could well pale into insignificance compared to those that could be expected over what conceptual criteria should define appropriate ‘non-financial’ or ESG reporting.
The accounting profession needs to be careful that it is not just advocating for easily auditable metrics. Although Accountancy Europe pioneered developments in sustainability assurance and reporting in the 1990s, there are still very different perspectives on what stakeholder value creation means in practice and some quite vivid tensions between shareholder and stakeholder priorities. There also remains much to scrutinise in terms of the proclamations of investment institutions, banks and companies regarding the importance of stakeholder value creation and the impact that such proclamations have had on day-to-day business practices.
The real risk with the rapid implementation of a single core set of metrics is that it will almost as quickly close down debate; that, once consistent metrics are in place, we will forget about discussing critical (and unresolved) issues. Such a set of metrics will make it easier to produce standard answers but will it stop us from asking the right questions?
Innovative initiatives that assist in tackling issues like climate change, human rights and modern slavery are vital. But innovation requires ambition and action, and standardising ESG indicators runs the risk, metaphorically, of rearranging the deck chairs while the environment burns, the oceans rise and societies implode. Or as Jerry Muller concluded: “Many matters of importance are too subject to judgment and interpretation to be solved by standardised metrics”. Even the audit firms will readily tell you this when a company unexpectedly collapses following the issuing of a clean audit report on its financial statements. Life is a more complicated mix of actions and consequences than a few words of assurance or a few core standardised metrics – and we must not allow the pursuit of comparability to engender a false sense of assurance that we are suitably addressing the most fundamental of business, social and environmental challenges.
Being well informed and acting in a responsible manner is the ultimate standard to pursue but it is not easily or readily standardised. Those advocating a core set of ESG indicators should remember this.